How Markets Work - Frank Schneemann CH-4.pdfECON_07NA_se_CH04_S1 8/3/05 10:18 AM Page 80. demand...

How Markets WorkHow Markets Work

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Brainstorm a list of goods that have either alimited supply or are in great demand. Whatgeneralizations can you make about theprices of these items? Compare your list withthose of your classmates.

Focus ActivityFocus Activity

YYour favorite team is playing, the stadiumis right across town, and you really want

to go!

■ How many other people are trying to gettickets?

■ How many tickets are available?

■ What determines the price of the tickets?

■ From whom are you going to buy yourticket? Is there more than one ticketoutlet?

Answers to all of these questions are based onthe laws of supply and demand—two of themost important tools of economic analysis. Inthis unit you will study supply and demand tosee how the prices of goods and services areaffected by all sorts of changes in the economy,including higher incomes, technological innova-tion, and changes in consumer preferences.

Today is the Super Bowl . . .Today is the Super Bowl . . .

Chapters in This Unit4. Demand5. Supply6. Prices7. Market Structures

4. Demand5. Supply6. Prices 7. Market Structures

Chapters in This Unit

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AAndrea couldn’t wait to get the new CD onthe shelves of the music store she managed.

She sold more than 50 copies at $18.99 each onthe first day. Six months later, Andrea moved theCDs to shelves in the middle of the store and cutthe price to $14.99. Three years later, a newmanager moved the four remaining CDs to thebargain bin. Customers could take one home foronly $5.99.

Each of Andrea’s decisions was shaped by theneeds and wishes of her customers. Economistsuse the term demand to describe the ability anddesire of consumers to buy a good. Paired withsupply, demand forms one of the building blocksof the marketplace.

Demand

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Quickly list the last five goods orservices you purchased and howmuch you spent on each. What ledyou to buy each one?

Economics JournalEconomics Journal

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II n Chapter 2, you read about economicsystems, which are different ways of

answering the three economic questions ofwhat to produce, how much to produce,and who gets what. In the United States,most goods are allocated through a marketsystem. In a market system, the interactionof buyers and sellers determines the pricesof most goods as well as what quantity of agood will be produced. Buyers demandgoods, sellers supply those goods, and theinteractions between the two groups leadto an agreement on the price and thequantity traded.

Demand is the desire to own somethingand the ability to pay for it. We will look atthe demand side of markets in this chapter.In the next chapter we will look at theactions of sellers, which economists call thesupply side. In Chapter 6, we will look atsupply and demand together and studyhow they interact to establish the pricesthat we pay for most goods.

The Law of DemandAnyone who has ever spent money willeasily understand the law of demand. Thelaw of demand says that when a good’sprice is lower, consumers will buy more ofit. When the price is higher, consumers willbuy less of it. All of us act out this law of

demand in our everyday purchasing deci-sions. Whether your income is $10 or $10million, the price of a good will stronglyinfluence your decision to buy.

Ask yourself this question: Would youbuy a slice of pizza for lunch if it cost $1?Many of us would, and some of us might

Understanding Demand

ObjectivesAfter studying this section you will be able to:1. Explain the law of demand. 2. Understand how the substitution effect and

the income effect influence decisions.3. Create a demand schedule for an individual

and a market.4. Interpret a demand graph using demand

schedules.

PreviewSection FocusAccording to the law of demand,people buy less of a good when itsprice rises. Demand schedules anddemand curves illustrate how peopleand markets react to different prices.

Key Termsdemandlaw of demandsubstitution effectincome effectdemand schedulemarket demand

scheduledemand curve

If the price of pizza rises, people will buyfewer slices.Incentives What does the law of demandsay about lower prices?

Figure 4.1 Law of DemandFigure 4.1 Law of Demand

DEMANDPRICE

As pricesgo down . . .

As pricesgo up . . .

goes up.

goes down.

DEMANDPRICE

quantitydemanded

quantitydemanded

Chapter 4 ■ Section 1 79

demand the desire toown something and theability to pay for it

law of demandconsumers buy more ofa good when its pricedecreases and lesswhen its price increases

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80 Demand

even buy more than one slice.But would you buy the sameslice of pizza if it cost $2?Fewer of us would buy it atthat price. Even real pizzalovers might reduce theirconsumption from 3 or 4 slicesto just 1 or 2. How many of uswould buy a slice for $10?Probably very few. As the priceof pizza gets higher and higher,fewer of us are willing to buyit. That is the law of demand

in action.The law of demand is the result of not

one pattern of behavior, but of twoseparate patterns that overlap. These twobehavior patterns are the substitution effectand the income effect. The substitutioneffect and income effect describe twodifferent ways that a consumer can changehis or her spending patterns. Together, theyexplain why an increase in price decreasesthe quantity purchased. Figure 4.2describes how the substitution effect andthe income effect can change a consumer’sbuying habits.

The Substitution Effect When the price of pizza rises, pizzabecomes more expensive compared toother foods, such as tacos and salads. So, asthe price of a slice of pizza rises, consumershave an incentive to buy one of those alter-natives as a substitute for pizza. This causesa drop in the amount of pizza demanded.For example, instead of eating pizza forlunch on Mondays and Fridays, a studentcould eat pizza on Mondays and a bagel onFridays. This change in spending is knownas the substitution effect. The substitutioneffect takes place when a consumer reactsto a rise in the price of one good byconsuming less of that good and more of asubstitute good.

The substitution effect can also apply toa drop in prices. If the price of pizza drops,pizza becomes cheaper compared to otheralternatives. Consumers will now substi-tute pizza for tacos, salads, and other lunchchoices, causing the quantity of pizzademanded to rise.

The Income Effect Rising prices have another effect that wehave all felt. They make us feel poorer. Whenthe price of movie tickets, shoes, or pizzaincreases, your limited budget just won’t buyas much as it used to. It feels as if you haveless money. You can no longer afford to buythe same combination of goods, and youmust cut back your purchases of somegoods. If you buy fewer slices of pizzawithout increasing your purchases of otherfoods, that is the income effect.

One important fact to remember is thateconomists measure consumption in theamount of a good that is bought, not theamount of money spent to buy it. Althoughyou are spending more on pizza, you areconsuming fewer slices, so your consump-tion has gone down. If the price rises from$1 a slice to $2 a slice, you may decide topay extra and order your usual lunch, butyou certainly would not choose to buymore slices than before. Although peoplespend more of their money on pizza, when

substitution effectwhen consumers reactto an increase in agood’s price byconsuming less of thatgood and more of othergoods

income effect thechange in consumptionresulting from a changein real income

Price of A decreases Price of A increases

Consumptionof A

Consumptionof other goods

Consumptionof A

Consumptionof other goods

Incomeeffect

Substitutioneffect

Combinedeffect

Figure 4.2 Building the Law of DemandFigure 4.2 Building the Law of Demand

Do you know your rights as an online shopper? The Federal Trade Commission (FTC) requires firms that sell products online to (1) ship the merchandise within 30 days of receiving your order, (2) notify you if the shipment cannot be made on time, and (3) cancel your order and return your payment unless you agree to a delay.

FAST FACT

Both the substitution effect and theincome effect lead consumers to buyless of good A when it becomes moreexpensive. However, the income effectleads consumers to spend less on other

goods so they can afford good A, while the substitutioneffect encourages consumers to replace expensive goodA with other, less expensive substitutes. Incentives Explain in your own words how an increase inthe price of A affects consumption of other goods.


demand schedule atable that lists thequantity of a good aperson will buy at eachdifferent price

the price goes up, the quantity demandedgoes down. In this sense, the income effectleads to the law of demand.

Remember, too, that the income effectalso operates when the price is lowered. Ifthe price of pizza falls, all of a sudden youfeel wealthier. If as a result you buy morepizza, that’s the income effect.

A Demand ScheduleThe law of demand explains how the priceof any item affects the quantity demandedof that item. Before we look at the rela-tionship between price and quantitydemanded for a specific good, we need tolook more closely at how economists usethe word demand.

Understanding DemandTo have demand for a good, you must bewilling and able to buy it at the specifiedprice. This means that you want the good,

and you can afford to buy it. You maydesperately want a new car, a laptopcomputer, or a trip to Alaska, but if youcan’t truly afford any of these goods, thenyou do not demand them. You mightdemand compact discs, though, if at thecurrent price you have enough money andwant to buy some.

A demand schedule is a table that liststhe quantity of a good that a person willpurchase at each price in a market. Forexample, the table on the left in Figure 4.3illustrates individual “demand for pizza.”The schedule shows specific quantities thata student named Ashley is willing and ableto purchase at specific prices. For example,at a price of $2.00, Ashley’s “quantitydemanded” of pizza is two slices per day.

Market Demand Schedules If you owned a store, knowing the demandschedule of one customer might not be veryhelpful. You would want to know how

Quantitydemanded per day

Price of aslice of pizza

Individual Demand Schedule Market Demand Schedule

30025020015010050

$.50$1.00$1.50$2.00$2.50$3.00

$.50$1.00$1.50$2.00$2.50$3.00

543210

Figure 4.3 Demand SchedulesFigure 4.3 Demand Schedules

Price of aslice of pizza

Quantitydemanded per day


� Photographers at a schoolnewspaper might buy a newcamera every two years. If theprice of a camera has fallen by$100 since the last purchase,students could spend thesavings on other goods to makethe newspaper better. This is theincome effect in action.

Demand schedules showthat demand for a good fallsas the price rises.Supply and Demand Howdoes the market demand forpizza change when theprice falls from $2.50 to$1.00 a slice? Be specific.


82 Demand

market demandschedule a table thatlists the quantity of agood all consumers in amarket will buy at eachdifferent price

demand curvea graphicrepresentation of ademand schedule

customers as a whole would react to pricechanges. When you add up the demandschedules of every buyer in the market, youcan create a market demand schedule. Amarket demand schedule shows the quantitiesdemanded at each price by all consumersin the market. A market demand schedulefor pizza would allow a restaurant ownerto predict the total sales of pizza at severaldifferent prices.

The owner of a pizzeria could create amarket demand schedule for pizza slices bysurveying his or her customers and thenadding up the quantities demanded by allindividual consumers at each price. The

resulting market demand schedule will looklike Ashley’s demand schedule, but the quan-tities will be larger, as shown in Figure 4.3.

Note that the market demand scheduleon the right in Figure 4.3 contains the sameprices as Ashley’s individual demandschedule, since those are the possible pricesthat may be charged by the pizzeria. Theschedule also exhibits the law of demand.At higher prices the quantity demanded islower. The only difference between the twodemand schedules is that the marketschedule lists larger quantities demanded.This is the case, since now we are talkingabout the purchase decisions of all poten-tial consumers in the market.

The Demand Graph What if you took the numbers in Ashley’sdemand schedule in Figure 4.3 and plottedthem on a graph? The result would be ademand curve. A demand curve is a graphicrepresentation of a demand schedule.

How do economists create a demandcurve? When they transfer numbers from ademand schedule to a graph, they alwayslabel the vertical axis with the lowestpossible prices at the bottom and thehighest at the top. Likewise, they alwayslabel the quantities demanded on the hori-zontal axis with the lowest possiblequantity at the left and the highest possiblequantity at the right. As Figure 4.4 shows,each pair of price and quantity-demandednumbers on the schedule is plotted as apoint on the graph. Connecting the pointscreates a demand curve.

Reading a Demand CurveNote two facts about the graph shown inFigure 4.4. First, the graph shows only therelationship between the price of this goodand the quantity that Ashley will purchase.It assumes that all other factors that wouldaffect Ashley’s demand for pizza—like theprice of other goods, her income, and thequality of the pizza—are held constant.

Second, the demand curve on the graphslopes downward to the right. If you followthe curve with your finger from the top left

0 1 2 3 4 5

3.00

2.50

2.00

1.50

1.00

.50

0

Figure 4.4 Ashley‘s Demand CurveFigure 4.4 Ashley‘s Demand Curve

Demand

Slices of pizza per day

Pri

ce p

er s

lice

(in

doll

ars)

� A sale canencourageconsumers to buymore.

Ashley’s demandcurve shows thenumber of slices ofpizza she is willingand able to buy ateach price.Supply and DemandHow many slices ofpizza does shedemand when theprice is $1.50?


Section 1 Assessment

Key Terms and Main Ideas1. Define and give an example of the income effect.2. What are three characteristics of a demand curve?

Applying Economic Concepts3. Critical Thinking Explain why the law of demand can

apply only in a free market economy. 4. Try This Create an individual demand schedule like the

one in Figure 4.3 for your demand for CDs. Fill in sixdifferent prices for CDs. Assume that you have a part-time job that pays $80 a week. How many CDs would youbuy at each of the six different prices? Compare yourdemand schedule to those of your classmates.

5. Critical Thinking Some economists believe that thereare goods that do not obey the law of demand, becausethe demand for them would actually drop if their pricefell. One example is a top-of-the-line luxury car. Why do

you think prospective buyers might feel differently aboutthese goods?

6. Math Practice Use the market demand schedule belowto draw a demand curve for miniature golf.


to the bottom right, you will notice that asprice decreases, the quantity demandedincreases. This is just another way ofstating the law of demand, which statesthat higher prices will always lead to lowerquantities demanded. All demand sched-ules and curves reflect the law of demand.

The demand curve in Figure 4.4 showsAshley’s demand for slices of pizza. Amarket demand curve shows the quantitiesdemanded by all consumers at the sameprices. Thus, in Figure 4.5, the prices listedon the vertical axis are identical to those inAshley’s demand curve. The quantitieslisted on the horizontal axis are muchlarger, corresponding to those in themarket demand schedule in Figure 4.3.

Limits of a Demand CurveThe market demand curve can be used topredict how people will change theirbuying habits when the price of a goodrises or falls. For example, if the price ofpizza is $1.50 a slice, the pizzeria will sell200 slices a day.

This market demand curve is onlyaccurate for one very specific set of market

conditions. If a nearby factory were toclose, so that fewer people were in the areaat lunchtime, the pizzeria would sell lesspizza even if the price stayed the same. Inthe next section, you will read about howdemand curves can shift because of changesin factors other than price.

Cost to Play a Game

$1.50

$2.00

$3.00

$4.00

Games Played per Month

350

250

140

80

0 50 100 150 200 250 300 350

3.00

2.50

2.00

1.50

1.00

.50

0

Figure 4.5 Market Demand CurveFigure 4.5 Market Demand Curve

Slices of pizza per day

Pri

ce p

er s

lice

(in

doll

ars)

Demand

The market demandcurve illustratesdemand for pizza inan entire market. Supply and DemandHow is the marketdemand curvesimilar to Ashley’sdemand curve?

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LIFESkills for

1. Determine the kinds of informationshown in the table. The title of thetable and the labels for each verticalcolumn and horizontal row tell youexactly what information is presented.(a) What is the title of the table? (b) What does the first column of dataspecifically describe?

2. Read the information in the table. Notethat each dollar value has two sets ofdata, one for students, and the otherfor parents. Answer the followingquestions. (a) How many studentswere willing to pay $30 for the meal?(b) How many parents? (c) Whichitem were nearly all members of bothgroups unwilling to buy for $30?

3. Study the table to find relationshipsamong the data and draw conclusions.You can use the data in this table tocompare the demand for different

goods at one price level, or to see howdemand for one good changes as theprice increases or decreases. (a) Whichgood saw the sharpest drop in demandwhen its price rose from $5 to $30? (b) Which good saw little change indemand when its price rose? Why mightthis be? (c) How did demand change forstudents when the price of a meal wentup? (d) Name two conclusions you candraw about the differences between thepatterns of demand of the students andtheir parents.

Analyzing Tables

E conomists use tables as a way to organize data and illustrate trends.The table below presents the results of a hypothetical survey of 100

high school seniors from across the country and 100 of their parents. Bothgroups were asked if they would be willing to pay $5 for a ticket to a movieon opening night, for a meal at a fine restaurant, or for an asthma inhaler(assuming they suffered from asthma). Next, they were asked if they wouldpay $10 for each of these goods, and next, if they would pay $30. The tablebelow lists the number in each group that answered “yes” at each price.

Draw a new chart reflecting thedata that you might expect to gatherif you repeated this survey with dif-ferent goods, such as a weekly buspass, a concert ticket, and a best-selling novel.

Additional Practice

Movie ticket

Asthmamedicine

Restaurantmeal

70

91

94

11

86

62

1

79

13

0

85

37

35

88

80

67

94

96

Goods

Demand for Selected GoodsDemand for Selected Goods

$5

Students Parents Students Parents Students Parents

$30$10

84

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TT he market demand schedule for pizza inFigure 4.3 would appear to give the

pizzeria owner all the information sheneeds to set the prices for her menu. All shehas to do is look at the list, pick the priceand quantity combination that will earnher the highest profit, and start baking.

Other factors, however, might have aneffect. What would happen if the day aftershe printed a menu, the governmentannounced that tomato sauce had a naturalchemical that strengthened the immunesystem? Demand for pizza at all priceswould climb.

When we counted the number of pizzaslices that would sell as the price went upor down, we assumed thatnothing besides the price of pizzawould change. Economists referto this assumption as ceterisparibus, the Latin phrase for “allother things held constant.” Thedemand schedule took onlychanges in price into account. Itdid not take the news reports intoaccount, or any one of thousandsof other factors that change fromday to day. In this section, you willlearn how economists consider theimpact of these other changes onthe demand for goods like pizza.

Changes in Demand A demand curve is accurate only as long asthere are no changes other than price thatcould affect the consumer’s decision. Inother words, a demand curve is accurateonly as long as the ceteris paribus assump-tion is true. When the price changes, wemove along the curve to a differentquantity demanded. For example, in thegraph of Ashley’s demand for slices ofpizza, an increase in the price from $1.00per slice to $1.50 will make Ashley’squantity demanded fall from four slices tothree slices per day. This movement alongthe demand curve is referred to as a

ceteris paribus a Latinphrase that means “allother things heldconstant”

Shifts of the Demand Curve

ObjectivesAfter studying this section you will be able to:1. Understand the difference between a

change in quantity demanded and a shift inthe demand curve.

2. Identify the determinants that createchanges in demand and that can cause ashift in the demand curve.

3. Explain how the change in the price of onegood can affect demand for a related good.

Preview

� A sudden winterstorm can increasethe demand for snowshovels.


Section FocusSeveral factors can change thedemand for a good at any price. Achange in demand causes the entiredemand curve to shift to the left orright.

Key Termsceteris paribusnormal goodinferior goodcomplementssubstitutes


86 Demand

decrease in the quantity demanded. By thesame reasoning, a decrease in the price ofpizza would lead to an increase in thequantity demanded.

When we drop the ceteris paribus ruleand allow other factors to change, we nolonger move along the demand curve.Instead, the entire demand curve shifts. Ashift in the demand curve means that at

every price, consumers buy a differentquantity than before. This shift of theentire curve is what economists refer to as achange in demand.

Suppose, for example, that Ashley’stown is hit by a heat wave, and Ashley nolonger feels as hungry for pizza. She willdemand fewer slices at every price. Themiddle graph in Figure 4.6 shows heroriginal demand curve and her newdemand curve, adjusted for hot weather.

What Causes a Shift?As you have read, a change in the price of agood does not cause the demand curve toshift. The effects of changes in price arealready built into the demand curve.However, several other factors can causedemand for a good to change. Thesechanges can lead to a change in demandrather than simply a change in the quantitydemanded.

IncomeA consumer’s income affects his or herdemand for most goods. Most items that wepurchase are normal goods, goods thatconsumers demand more of when theirincomes increase. In other words, an increase

normal good a goodthat consumersdemand more of whentheir incomes increase

3 4

Pric

e $1.50

$1.00 Pric

e

Figure 4.6 Graphing Changes in DemandFigure 4.6 Graphing Changes in Demand

Pric

e

Demand

OriginalDemand

OriginalDemand

NewDemand

NewDemand

QuantityQuantity

Quantity

Change along a curve Left shift of a curve Right shift of a curve

� Used paperbackbooks are ofteninferior goods. When consumerscan afford new,clean books, theywill buy fewer oldpaperbacks.

A change in quantity demanded caused by a change in price is shown as a movementalong a demand curve. The curve does not shift. When factors other than price causedemand to fall, the demand curve shifts to the left. An increase in demand appears as ashift to the right. Supply and Demand If the price of a book rose by $1.00, how wouldyou represent the change on one of these graphs?


in Ashley’s income from $50 per week to$75 per week will cause her to buy more of anormal good at every price level. If we wereto draw a new demand schedule for Ashley,it would show a greater demand for slices ofpizza at every price. Plotting the newschedule on a graph would produce a curveto the right of Ashley’s original curve. Foreach of the prices on the vertical axis, thequantity demanded would be greater. Thisshift to the right of the curve is called anincrease in demand. A fall in income wouldcause the demand curve to shift left. Thisshift is called a decrease in demand.

There are also other goods called inferiorgoods. They are called inferior goodsbecause an increase in income causesdemand for these goods to fall. Inferiorgoods are goods that you would buy insmaller quantities, or not at all, if yourincome were to rise and you could affordsomething better. Possible examples ofinferior goods include macaroni andcheese, generic cereals, and used cars.

Consumer ExpectationsOur expectations about the future canaffect our demand for certain goods today.Suppose that you have had your eye on anew bicycle for several months. One dayyou walk in the store to look at the bike,and the salesperson mentions that the storewill be raising the price in one week. Nowthat you expect a higher price in the nearfuture, you are more likely to buy the biketoday. In other words, the expectation of ahigher price in the future has caused yourimmediate demand to increase.

If, on the other hand, the salespersonwere to tell you that the bike will be on salenext week, your immediate demand for thebicycle would fall to zero. You wouldrather wait until next week to buy the bikeat a lower price.

The current demand for a good is posi-tively related to its expected future price. Ifyou expect the price to rise, your currentdemand will rise, which means you willbuy the good sooner. If you expect theprice to drop, your current demand willfall and you will wait for the lower price.

PopulationChanges in the size of thepopulation will also affect thedemand for most products.For example, a growingpopulation needs to behoused and fed. Therefore,a rise in population willincrease demand for houses,food, and many other goodsand services.

Population trends can havea particularly strong effect oncertain goods. For example,when American soldiersreturned from World War IIin the mid- to late 1940s,record numbers of them married andstarted families. This trend led to the “babyboom,” a jump in the birthrate from themid-1940s through 1964. Initially, thebaby boom led to higher demand forbaby clothes, baby food, and bookson baby care. In the 1950s and1960s, towns had to build thou-sands of new schools. Later,universities opened new class-rooms, dormitories, and evenwhole new campuses to make roomfor the flood of new students. The babyboomers have now begun to retire. Overthe next few decades the market will facerising demand for the goods and servicesthat are desired by senior citizens, includingmedical care, recreational vehicles, andhomes in the Sunbelt.

Consumer Tastes and AdvertisingWho can explain why bell-bottom bluejeans were everywhere one year and rarelyseen the next? Is it the result of cleveradvertising campaigns, social trends, theinfluence of television shows, or somecombination of these factors? Althougheconomists cannot always isolate thereasons why some fads begin, advertisingand publicity often play an important role.

Changes in tastes and preferences cannotbe explained by changes in income orpopulation or worries about future priceincreases. Advertising is considered a factor


�When New York Cityannounced that theprice of a subway tokenwould rise 25 cents,commuters rushed tobuy tokens at the oldprice. To prevent this,the city introduced anew token (bottom) toreplace the older tokencommuters had bought.Expectations of higherprices had affecteddemand.

In the News Read more about changesin demand in “The Surging HispanicEconomy,” an article in The Wall Street Journal Classroom Edition.

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inferior good a goodthat consumersdemand less of whentheir incomes increase


88 Demand

complements twogoods that are boughtand used together

substitutes goods usedin place of one another

that shifts demand curves becauseit plays an important role in manytrends. Companies spend moneyon advertising because they hopethat it will increase the demandfor the goods they sell.Considering the growing sums ofmoney spent on advertising in theUnited States each year, compa-nies must feel that this investmentis paying off.

Prices of Related GoodsThe demand curve for one good can beaffected by a change in the demand foranother good. There are two types ofrelated goods that interact this way:complements and substitutes.

• Complements are two goods that arebought and used together.

• Substitutes are goods used in place of oneanother.

When we consider the demand for skis,ski boots are considered a complement. Anincrease in the price of ski boots will causepeople to buy fewer boots. Because skis areuseless without boots, the demand for skiswill fall at all prices—after all, why buynew skis if you can’t afford the ski bootsyou need to ski safely?

Now consider the effect on the demandfor skis when the price of snowboards rises.Snowboards are a substitute for skis,because consumers will often buy one orthe other, but not both. A rise in the priceof snowboards will cause people to buyfewer snowboards, and therefore peoplewill buy more pairs of new skis at everyprice. Likewise, a fall in the price of snow-boards will lead consumers to buy fewerskis at all price levels.


Key Terms and Main Ideas1. What is an example of something you consider an

inferior good?2. What is one good that can be considered a complement

for another?3. What are two goods that can be considered substitutes?4. How does the ceteris paribus assumption affect a

demand curve?

Applying Economic Concepts5. Using the Databank According to the law of demand

and the chart of median house prices on page 540, howdo you think demand for houses changed between 1998and 2004? Explain.

6. Critical Thinking What is the difference between a shiftalong a demand curve and a shift of a demand curve?

7. Decision Making Decide whether each of these eventswould cause a change in demand or only a change inthe quantity demanded of the good in parentheses, andexplain why. (a) A computer manufacturer lowers itsprices. (computers) (b) A volleyball maker convinces

high schools to fund varsity volleyball teams. (volleyballs) (c) A freeze ruins the orange crop, and orange juiceprices rise. (apple juice)

8. Math Practice Use the following demand schedule todraw a demand curve. Then find and label a combinationof output and price that could result from: (a) an increasein the quantity demanded, (b) an increase in demand, and(c) a decrease in demand.

Price Quantity Demanded$1.00 250$2.00 200$3.00 150$4.00 100$5.00 50

� Ski boots and skisare two goods thatare complements.

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Christy HaubeggerChristy Haubegger (b. 1968)(b. 1968)

It took a tragedy to awaken the nation to the economic power ofHispanic Americans. In March 1995, the Tejano singer Selena wasmurdered. The outpouring of grief in the Latino community wastremendous. American businesses took notice. If Latinos were buy-ing millions of records by a Latina singer, entrepreneur ChristyHaubegger reasoned that there were other products, such as maga-

zines, that could be marketed specifically to their community.

1. Source Reading Explain why thedeath of Selena led to a growth in thenumber of consumer products targetedspecifically at the Latino community.

2. Critical Thinking How is thegrowth rate of the Hispanic Americanpopulation likely to affect the wayproducts are marketed in the future?

3. Decision Making If you were goingto create a publication to sell to a seg-ment of the population in your commu-nity, what factors would you considerin deciding which group to target?

CHECK FOR UNDERSTANDING

The Birth of an EntrepreneurAt the time of Selena’s death, ChristyHaubegger, a recent Stanford UniversityLaw School graduate, was already planningthe nation’s first magazine for HispanicAmerican women. The adopted MexicanAmerican daughter of Anglo parents,Christy grew up in a Houston, Texas,neighborhood with few Hispanic residents.“Other Hispanic kids were frustrated bythe lack of popular images in the media,”she recalls, “but at least when they wenthome they found people who looked likethey did.”

As Haubegger went on to college andlaw school, she and her Latina classmatescontinued to have trouble finding rolemodels. None of the women’s magazinesthat they read reflected their cultural,professional, or beauty concerns. “I felt [a Hispanic publication] was the onewomen’s magazine that I’d want to read,”Haubegger says. “I kept thinking‘Somebody should do it,’ and finally Irealized that that somebody was going tohave to be me.”

Haubegger approached Edward Lewis,founder in the 1970s of Essence Magazine,the first magazine for African Americanwomen. Impressed by her ideas, Lewisinvested several million dollars. In 1996,the first issue of Latina hit the newsstands.

Hispanic Women and DemandLatina is marketed to Hispanic Americanwomen between the ages of 18 and 45. Thearticles, which are in English with Spanishsummaries, focus on people and topics ofspecific interest to Latinas. “It’s 100 percentLatina, cover to cover,” Haubegger saysproudly of her magazine.

Although many of the ads are inSpanish, Haubegger has had little troubleconvincing mainstream companies likeRevlon, Honda, and The Gap to advertisein her magazine. With the HispanicAmerican population growing at four timesthe national average, companies have takennotice. “I show them the numbers that saywe buy 15 percent of the country musicand 10 percent of the lipstick,” Haubeggersays, “and suddenly they’re interested.”

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ECONOMICEconomist

Entrepreneur

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AA re there some goods that you wouldalways find money to buy, even if the

price were to rise drastically? Are thereother goods that you would cut back on, oreven stop buying altogether, if the pricewere to rise just slightly?

Economists describe the way thatconsumers respond to price changes aselasticity of demand. Elasticity of demanddictates how drastically buyers will cutback or increase their demand for a good

when the price rises or falls, respectively.Your demand for a good that you will keepbuying despite a price increase is inelastic,or relatively unresponsive to price changes.In the second example, in which you buymuch less of a good after a small priceincrease, your demand is elastic. Aconsumer with highly elastic demand for agood is very responsive to price changes.

Calculating ElasticityTo compute elasticity of demand, take thepercentage change in the demand of a good,and divide this number by the percentagechange in the price of the good. You canfind the equation for elasticity in Figure 4.7on page 92. The law of demand implies that the result will always be negative. This is because an increase in the price of agood will always decrease the quantitydemanded, and a decrease in the price of agood will always increase the quantitydemanded. For the sake of simplicity, econ-omists drop the negative sign.

Price RangeThe elasticity of demand for a good variesat every price level. Demand for a good canbe highly elastic at one price and inelasticat a different price. For example, demand

elasticity of demanda measure of howconsumers react to achange in price

inelastic describesdemand that is not verysensitive to a change inprice

elastic describesdemand that is verysensitive to a change inprice

Elasticity of Demand

Section FocusElasticity of demand describes howconsumers will react to a change inthe price of a good. Their reactiondepends on the original price of thegood and the way that good is usedby consumers.

ObjectivesAfter studying this section you will be able to:1. Explain how to calculate elasticity of

demand.2. Identify factors that affect elasticity.3. Explain how firms use elasticity and

revenue to make decisions.

Key Termselasticity of demandinelasticelasticunitary elastictotal revenue

Preview

90 Demand

“After taxes, operating expenses andprofits to stockholders, I’m lucky if Isee a nickel of it!”

� Misspelling “lemonade” might not be thisentrepreneur’s only mistake. How many people willbuy lemonade if the price rises to $25.00 a glass?



for a glossy magazine will be inelastic whenthe price rises 50 percent from 20 cents to30 cents. The price is still very low, andpeople will buy almost as many copies asthey did before. However, when the priceincreases 50 percent from $4.00 to $6.00,demand will be much more elastic. Manyreaders will refuse to pay $2.00 more forthe magazine. Yet in percentage terms, thechange in the magazine’s price is exactlythe same as when the price rose from 20cents to 30 cents.

Values of ElasticityWe have been using the terms inelastic andelastic to describe consumers’ responses toprice changes. These terms have precisemathematical definitions. If the elasticity ofdemand for a good at a certain price is lessthan 1, we describe demand as inelastic. Ifthe elasticity is greater than one, demand iselastic. If elasticity is exactly equal to 1, wedescribe demand as unitary elastic.

When elasticity of demand is unitary, thepercentage change in quantity demanded isexactly equal to the percentage change inthe price. Suppose the elasticity of demandfor a magazine at $2 is unitary. When theprice of the magazine rises by 50 percent to$3, the newsstand will sell exactly half asmany copies as before.

Think back to Ashley’s demand schedulefor pizza in Section 1. Ashley’s demandschedule shows that if the price per slicewere to rise from $1.00 to $1.50, herquantity demanded would fall from 4 slicesto 3 slices per day. The change in pricefrom $1.00 to $1.50 is a 50 percentincrease. The change in quantity demandedfrom 4 to 3 slices is a 25 percent decrease.Dividing the 25 percent decrease inquantity demanded by the 50 percentincrease in price gives us an elasticity ofdemand of 0.5.

Since Ashley’s elasticity of demand atprices of $1.00 to $1.50 is less than 1, wesay that Ashley’s demand for pizza isinelastic. In other words, a price increasehas a relatively small effect on the numberof slices of pizza she buys.

Suppose that we survey anothercustomer and find that, when the price ofpizza rises by 40 percent, this person’squantity demanded falls by 60 percent.The change in the quantity demanded of60 percent is divided by the change inprice of 40 percent, equaling an elasticityof demand of 1.5 (60 percent/40 percent =1.5). Since this result is greater than 1, thiscustomer’s demand is elastic. In otherwords, this customer is very sensitive tochanges in the price of pizza.

Factors Affecting Elasticity Why is the demand for some goods so muchless elastic than for other goods? Rephrasethe question and ask yourself, “What isessential to me? What goods must I have,even if the price rises greatly?” The goodsyou list might have some traits that set themapart from other goods and make yourdemand for those goods less elastic. Severaldifferent factors can affect a person’s elas-ticity of demand for a specific good.

Availability of Substitutes If there are few substitutes for a good, theneven when its price rises greatly, you mightstill buy it. You feel you have no good alter-natives. For example, if your favoritemusical group plans to give a concert, andyou want to attend, there really is nosubstitute for a ticket. You could go to aconcert to hear some other band, but thatwould not be as good. You’ve got to have

unitary elasticdescribes demandwhose elasticity isexactly equal to 1

Elasticity in the Kitchen Cooking varies from country tocountry, and so does elasticity of demand for certain foods. If the price of agallon of milk or a pound of ground beef doubled in the United States,consumers might demand intervention by the government. Do you think thiswould happen if the price rise affected onions and potatoes? These twovegetables are essential to Indian cooking, and when floods ruined crops inIndia, their prices more than doubled. In November 1998, angry citizens votedthe ruling party out of office in several states in part because of the high priceof onions.

Global Connections


92 Demand

Figure 4.7 Elasticity of DemandFigure 4.7 Elasticity of Demand

Quantity

Pri

ce

$7

$6

$5

$4

$3

$2

$1

5 10 15 20 25 30

Example 1: Elastic Demand

O

Quantity

Pri

ce

$7

$6

$5

$4

$3

$2

$1

Demand

5 10 15 20 25 30

Example 2: Inelastic Demand

O

Demand

Unitary elastic demand is a special case. When demand is unitary elastic, an increase (or decrease) in price will be met by an equal percentage decrease (or increase) in quantity demanded. Elasticity of demand is exactly 1.

To find the percentage change in quantity demanded or price, use the following formula: Subtract the new number from the original number, and divide the result by the original number. Ignore any negative signs, and multiply by 100 to convert this number to a percentage:

Percentage change in quantity demandedElasticity =

Elasticity is determined using the following formula:

Original number – New number Original number

x 100Percentage change =

If demand is elastic, a small change in price leads to a relatively large change in the quantity demanded. Follow this demand curve from left to right.

The price decreases from $4 to $3, a decrease of 25 percent.

The quantity demanded increases from 10 to 20. This is an increase of 100 percent.

Elasticity of demand is equal to 4.0. Elasticity is greater than 1, so demand is elastic. In this example, a small decrease in price caused a large increase in the quantity demanded.

If demand is inelastic, consumers are not very responsive to changes in price. A decrease in price will lead to only a small change in quantity demanded, or perhaps no change at all. Follow this demand curve from left to right as the price decreases sharply from $6 to $2.

The price decreases from $6 to $2, a decrease of about 67 percent.

The quantity demanded increases from 10 to 15, an increase of 50 percent.

Elasticity of demand is about 0.75. The elasticity is less than 1, so demand for this good is inelastic. The increase in quantity demanded is small compared to the decrease in price.

$4 – $3 $4

10 – 20 10

100% 25%

10 – 15 10

x 100 = 50

50% 67%

≈ 0.75

Percentage change in price

$6 – $2 $6

x 100 ≈ 67

x 100 = 25

x 100 = 100

= 4.0

Elasticity of demand describes how strongly consumerswill react to a change in price. Supply and Demand If a good’s elasticity of demand is0.2, how will consumers react to an increase in price?


tickets for this concert, and nothing elsewill do. Under these circumstances, amoderate change in price is not going tochange your mind. Your demand isinelastic.

Similarly, demand for life-savingmedicine is usually inelastic. For manyprescription drugs, the only possible substi-tute is to try an unproven treatment. Forthis reason, people with an illness willcontinue to buy as much needed medicineas they can afford, even when the pricegoes up.

If the lack of substitutes can makedemand inelastic, a wide choice of substi-tute goods can make demand elastic. Thedemand for a particular brand of applejuice is probably elastic because people canchoose from dozens of good substitutes ifthe price of their preferred brand rises.

Relative Importance A second factor in determining a good’selasticity of demand is how much of yourbudget you spend on the good. If youalready spend a large share of your incomeon a good, a price increase will force you tomake some tough choices. Unless you wantto cut back drastically on the other goodsin your budget, you must reduce consump-tion of that good by a significant amount tokeep your budget under control. The

higher the jump in price, the more you willhave to adjust your purchases.

If you currently spend half of yourbudget on clothes, then even a modestincrease in the cost of clothing willprobably cause a large reduction in thequantity you purchase. In other words,your demand will be elastic.

However, if the price of shoelacesdoubled, would you cut back on yourshoelace purchases? Probably not. Youmay not even notice the difference. Even ifyou spend twice as much on shoelaces, theywill still account for only a tiny part ofyour overall budget. Your demand forshoelaces is inelastic.

Necessities Versus LuxuriesThe third factor in determining a good’selasticity varies a great deal from person toperson, but it is nonetheless important.Whether a person considers a good to be anecessity or a luxury has a great impact onthe good’s elasticity of demand for thatperson. A necessity is a good people willalways buy, even when the price increases.Parents often regard milk as a necessity.They will buy it at any reasonable price. Ifthe price of a gallon of milk rises from$2.49 to $4.49, they will still buy as muchmilk as their children need to stay healthy.Their demand for milk is inelastic.


� Demand for some prescription drugs is relatively inelasticbecause the patient has few alternatives. Demand for anyone of these drinks would be much more elastic because aconsumer can easily find a less expensive choice.


94 Demand

The same parents may regard steak as aluxury. When the price of steak increasesby a little bit, say 20 percent, parents maycut their monthly purchases of steak bymore than 20 percent, or skip steak alto-gether. Steak is a luxury, and consumerscan easily reduce the quantity theyconsume. Because it is easy to reduce thequantity of luxuries demanded, demand iselastic.

Change over TimeWhen a price changes, consumers oftenneed time to change their shopping habits.Consumers do not always react quickly toa price increase because it takes time to findsubstitutes. Because they cannot respondquickly to price changes, their demand isinelastic in the short term. Demand some-times becomes more elastic over time,however, because people can eventuallyfind substitutes that allow large adjust-ments to what they buy.

Consider the example of gasoline. Whena person purchases a vehicle, he or shemight choose a large vehicle that requires agreater volume of gasoline per mile to run.This same person might work at a jobmany miles away from home and shop at a

supermarket that is far from both workand home. These factors determine howmuch gasoline this person demands, andnone can be changed easily.

In the early 1970s, several oil-rich coun-tries cut their oil exports to the UnitedStates, and gasoline prices rose quickly. Inthe short run, there was very little thatpeople could do to reduce their consump-tion of gasoline. They still needed to driveto school and work. At first, drivers weremore likely to pay more for the sameamount of gasoline than they were to buyfuel-efficient cars or move closer to theirschools and workplaces.

However, because gas prices stayed highfor a considerable period of time, somepeople eventually switched to more fuel-efficient cars. Others formed car pools,walked or rode bicycles, and used publictransportation. In the long run, peoplereduced their consumption of gasoline byfinding substitutes. Demand for gasoline,inelastic in the short term, is more elastic inthe long term.

As another example, consider whathappened to gasoline prices from the early1980s through the early 2000s. Adjustingfor inflation, the price of a gallon of gas fell

� When gas prices rose in the 1970s, auto manufacturers advertised how little fuel their cars used. In recent years when gas prices were low, new advertisingemphasized strength and size, even though those cars used more gasoline.

� Many peopleconsider lobster aluxury and caneasily cut it out oftheir budget.


considerably from its highs in the 1970s. Inaddition, gasoline prices remained low formany years. At first, people continued toseek out fuel-efficient cars. Over time,however, many Americans switched backto larger vehicles that get fewer miles to thegallon. Because the price of gas remainedlow, people gradually adjusted their habitsto use more and more gasoline. Just asdemand for gasoline responded slowly toan increase in price, it also respondedslowly to a decrease in price.

Elasticity and Revenue Elasticity is important to the study ofeconomics because elasticity helps usmeasure how consumers respond to pricechanges for different products. Elasticity isalso an important tool for businessplanners like the pizzeria owner describedin Sections 1 and 2. The elasticity ofdemand determines how a change in priceswill affect a firm’s total revenue or income.

Computing a Firm’s Total Revenue A company’s total revenue is defined as theamount of money the company receives byselling its goods. This is determined by twofactors: the price of the goods and thequantity sold. If a pizzeria sells 125 slices ofpizza per day at $2.00 per slice, totalrevenue would be $250 per day.

Total Revenue and Elastic Demand The law of demand tells us that an increasein price will decrease the quantitydemanded. When a good has an elasticdemand, raising the price of each unit soldby 20 percent will decrease the quantitysold by a larger percentage, say 50 percent.The quantity sold will drop enough toactually reduce the firm’s total revenue.Figure 4.8, drawn from the demand curvefor the pizzeria, shows how this canhappen. An increase in price from $2.50 to$3.00, or 20 percent, decreases thequantity sold from 100 to 50, or 50percent. As a result, total revenue dropsfrom $250 to $150.

The same process can also work inreverse. If the firm were to reduce the priceby a certain percentage, the quantitydemanded could rise by an even greaterpercentage. In this case, total revenuescould rise.

It may surprise you that a firm couldlose revenue by raising the price of itsgoods. But if the pizzeria started sellingpizza at $10 a slice, it would not stay inbusiness very long. Remember that elasticdemand comes from one or more of thesefactors:

1. availability of substitute goods 2. a limited budget that does not allow

price changes3. the perception of the good as a

luxury item

If these conditions are present, then thedemand for the good is elastic, and a firmmay find that a price increase reduces itstotal revenue.

Total Revenue and Inelastic Demand Remember that if demand is inelastic,consumers’ demand is not very responsiveto price changes. Thus, if the firm raises itsprice by 25 percent, the quantity demandedwill fall, but by less than 25 percent. Thefirm will have greater total revenues. Inother words, the higher price makes up forthe firm’s lower sales, and the firm brings inmore money.

total revenue the totalamount of money a firmreceives by sellinggoods or services


Price of a sliceof pizza

Quantity demandedper day

30025020015010050

Total revenue

$150$250$300$300$250$150

$ .50$1.00$1.50$2.00$2.50$3.00

Figure 4.8 Revenue TableFigure 4.8 Revenue Table

Setting prices too high or too low can hurt revenue.Markets and Prices When the price doubles from$.50 to $1.00, is demand elastic, unitary elastic, orinelastic?


96 Demand

On the other hand, a decrease in pricewill lead to an increase in the quantitydemanded if demand is inelastic. However,demand will not rise as much, in percentageterms, as the price fell, and the firm’s totalrevenue will decrease.

Elasticity and Pricing PoliciesBecause of these relationships, a firm needsto know whether the demand for itsproduct is elastic or inelastic at a givenprice. This knowledge helps the firm make

pricing decisions that lead to the greatestrevenue. If a firm knows that the demandfor its product is elastic at the currentprice, it knows that an increase in pricewould reduce total revenues. On the otherhand, if a firm knows that the demand forits product is inelastic at its current price, itknows that an increase in price willincrease total revenue. In the next chapter,you will read more about the choicesproducers make to reach an ideal level ofrevenue.


Key Terms and Main Ideas1. Explain elasticity of demand in your own words.2. Name a good with elastic demand at its current price. 3. Why is demand for home heating fuel inelastic in cold

weather?4. How do we calculate total revenue?

Applying Economic Concepts5. Math Practice Use the formula in Figure 4.7 to calculate

the exact elasticity of demand in the following examples.Then tell if, in each case, demand is elastic, inelastic, orunitary elastic. (a) When the price of a deluxe car washrises from $10.00 to $11.00, the number of dailycustomers falls from 60 to 48. (b) A dentist with 80patients cuts his fee for a cleaning from $60.00 to $54.00and attracts two new patients.

6. Try This Interview a manager at a local restaurant orstore. Ask if he or she has changed the price of any goodor service in the past year, and if so, how sales wereaffected. Is demand for each of these goods or serviceselastic or inelastic? What factors might explain youranswer?

7. Critical Thinking Think of a good, like gasoline, forwhich demand can become more elastic over time.What changes can take place in the long term to affectdemand?

Figure 4.9 Elasticity and RevenueFigure 4.9 Elasticity and Revenue

As the price is

lowered . . .

Totalrevenue

rises

Totalrevenue

falls

As the price is

lowered . . .

Totalrevenue

falls

As the price is

raised . . .

Totalrevenue

rises

Elastic Demand Inelastic Demand

As the price is

raised . . .

Elasticity of demand determines the effect of a price change on total revenues. Markets and Prices Why will revenue fall if a firm raises the price of a goodwhose demand is elastic?

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For: Math ActivityVisit: PHSchool.comWeb Code: mnd-2043



What Makes a Person an Entrepreneur?

Entrepreneurs come in all shapes and sizes. Some have become very wealthyand well known, such as Andrew Carnegie who built a successful steel com-

pany in the 1800s, and Mary Kay Ash who founded Mary Kay Cosmetics. Mostentrepreneurs, however, are involved inmuch smaller ventures, but all entrepre-neurs have many things in common.

Traits Entrepreneurs have the ability to seea business opportunity where others do not.In other words, they recognize an existingor potential demand for which there is nosupply. Most of all, entrepreneurs possess awillingness to take risks and an ability tolearn from the mistakes that they make.

Vision A classic story of entrepreneurial success is that of Charles Darrow. In 1933,Darrow found himself out of work. To support his family, he took whatever oddjobs he could find, but he had a brilliantbusiness idea. He wanted to create a com-pelling board game in which people couldlive the fantasy of acquiring land, houses,and hotels which they could rent or sell tofellow players. Recalling a vacation he hadonce taken in Atlantic City, New Jersey, Darrow named the real estate featuredin his game after places in that city. He called the game Monopoly®.

Perseverance Although many people told him he was wasting his time, Darrowspent months developing Monopoly. He then took his game to Parker Brothers,a leading board game company, which rejected the game because it found 52flaws in it. Undaunted, Darrow corrected every one of the flaws. Then, withhelp from a friend who was a printer, he produced several Monopoly sets, whichhe tried to sell to local stores.

Finally, after weeks of pounding the pavement, a Philadelphia departmentstore agreed to buy 5,000 of the Monopoly sets. The store sold all of the gamesso quickly that Parker Brothers reconsidered and agreed to produce the game.Within a year, more than 800,000 sets were sold, and soon Charles Darrowbecame a millionaire. Since that time, some 100 million sets of Monopoly havebeen sold worldwide.

Applying Economic Ideas

1. What entrepreneurial traits did Darrow use to make Monopoly a success?

2. For Darrow, what were the benefits and drawbacks of being an entrepreneur?

� A vacation spent strolling the Boardwalk in AtlanticCity gave Charles Darrow the idea for a game.

97

Entrepreneurs

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98

Chapter SummaryChapter Summary

AA summary of major ideas in Chapter 4 appearsbelow. See also the Guide to the Essentials

of Economics, which provides additional review andtest practice of key concepts in Chapter 4.

Section 1 Understanding Demand (pp. 79–83)Demand describes the ability and desire to buy agood or service. The law of demand says that thequantity demanded of a good will fall as the good’sprice increases. Two possible responses to a changein price, the substitution effect and the income effect,work together to create the law of demand. You canlist demand for a good at all possible prices in ademand schedule and chart these points on a demandcurve. Every individual has a demand schedule for agood, and you can find the demand schedule for theentire market by adding up all individual demand.

Section 2 Shifts of the Demand Curve (pp. 85–88) A demand curve shows demand when price varies,but all other factors stay the same. When other fac-tors change, the demand curve shifts to the left or tothe right. When a rise in income leads a consumerto increase consumption of a good, that good is anormal good. If a higher income leads to lower con-sumption of a good, it is called an inferior good.Other factors that can affect demand are changes inpopulation, tastes, and the prices of other goods.

Section 3 Elasticity of Demand (pp. 90–96) Elasticity of demand describes how strongly buyerswill react to a change in a good’s price. Whendemand is elastic, buyers will make relatively bigchanges to their consumption of a good when itsprice rises or falls. When demand is inelastic, con-sumers will only change their consumption slightlyrelative to the change in price. Demand will be moreelastic if the good has many substitutes, is consid-ered a luxury, or accounts for a large share of thebuyer’s income. Entrepreneurs can estimate the elas-ticity of demand for some goods and use this num-ber to make pricing decisions.

Key TKey TermsermsComplete each sentence by choosing the cor-rect answer from the list of terms below. Youwill not use all of the terms.

1. You would refer to a(n) to find thequantity that a person would purchase ateach price that could be offered in a market.

2. For a(n) , a consumer’s demand willincrease as his or her income increases.

3. The occurs when an increase in pricedecreases a consumer’s real income.

4. Demand for goods that are necessities isusually .

5. If the elasticity of demand of a good isequal to 1, it is described as .

6. According to the , when pricesincrease, demand will decrease.

7. Two goods that are bought and usedtogether are .

Using Graphic OrganizersUsing Graphic Organizers8. On a separate sheet of paper, copy the multi-

flow map below. Organize information onshifts in the demand curve for cars by com-pleting the multiflow map with possiblecauses and effects for shifts in the demandcurve.

normal goodcomplementsincome effectdemand curveinelastic

inferior goodlaw of demandunitary elasticelasticelasticity of demand

Causes this type of shift in

the demand curve

Shift tothe right

No change in demand

An increase incar prices

ECON_07NA_se_CH04_CA 8/3/05 10:49 AM Page 98

99

Reviewing Main IdeasReviewing Main Ideas9. Describe the substitution effect in your own

words, and give one example. 10. List and describe three causes for shifts in the

demand curve.11. Why do economists use percentage change to

calculate elasticity of demand?12. What are four factors that affect elasticity?

Critical ThinkingCritical Thinking13. Predicting Consequences Will there always be a

demand for inferior goods? How could demandfor an inferior good decrease?

14. Drawing Conclusions Do you agree or disagreewith the following statement? An increase inincome will shift the demand curve for a normalgood to the left. Explain your answer.

15. Testing Conclusions Choose three goods. Thenpredict whether they have elastic or inelasticdemand at their current price. Next, determinetheir elasticity by creating a demand scheduleand curve for each one. Gather information forthe demand schedules from your classmates.

Problem-Solving ActivityProblem-Solving Activity16. As a business owner, you are always concerned

about how much of your good or service isdemanded. If there is an increase in your pro-duction costs, what options do you have to keepyour product in demand?

Skills for LifeSkills for LifeAnalyzing Tables Review the steps shown on page84; then answer the following questions using thetable below.17. How many urban residents would take a taxi

ride that costs $20?18. List two outside factors that may be used to help

interpret this table.19. Which service has equally low demand in both

regions at $30?20. Compare lawn mowing and taxi rides. What

reason could there be for such different demandsin different areas?

21. Which service has inelastic demand in bothurban and suburban areas?

Essay Writing Return to the list of five goodsyou recently bought. For each item, explainwhether you consider your demand for that goodto be relatively elastic or inelastic, and why. Listtwo factors for each item that could change yourdemand for that item.

Economics Journal

� 100 people in an urban area and 100 people in a suburbanor rural area were asked if they were willing to pay $10, $20,or $30 for several services. The number willing to pay eachprice is listed below.

Lawn mowing

Taxi ride

Haircut

15

84

92

Service

Demand Schedule for Selected ServicesDemand Schedule for Selected Services

Urban Suburban and Rural

$10

8

78

61

$20

2

37

18

$30

82

10

88

$10

71

8

57

$20

42

1

19

$30

Progress Monitoring Online

As a final review, take the Economics Chapter 4 Self-Testand receive immediate feedback on your answers. Thetest consists of 20 multiple-choice questions designed totest your understanding of the chapter content.

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