Demand TheoryDemand Theory

September 25, 2006September 25, 2006

Short QuizShort Quiz

QuestionsQuestions What is Economics? Why study economics? (10pts)What is Economics? Why study economics? (10pts)

Enumerate at least 3 Basic Economic Questions? (10pts)Enumerate at least 3 Basic Economic Questions? (10pts)

What is Opportunity Cost? Give an example using a PPF What is Opportunity Cost? Give an example using a PPF curve. Describe what happens if the technology/resource curve. Describe what happens if the technology/resource increases for (a) 1 good and (b)both goods. (20pts)increases for (a) 1 good and (b)both goods. (20pts)

Enumerate and give 1 example to the 4 Economic systems? Enumerate and give 1 example to the 4 Economic systems? Explain the example. (20pts)Explain the example. (20pts)

Give 1 economic function of the Government and give an Give 1 economic function of the Government and give an example. (20Pts)example. (20Pts)

Bonus: Draw the circular flow (20PTs)Bonus: Draw the circular flow (20PTs)

OutlineOutlineBasics of Demand TheoryBasics of Demand Theory

Demand definedDemand definedDemand Schedule and Demand CurveDemand Schedule and Demand CurveIndividual Demand and Market DemandIndividual Demand and Market DemandLaw of DemandLaw of DemandChange in quantity demanded vs. change in Change in quantity demanded vs. change in demand-demand-Non-Price determinants of DemandNon-Price determinants of Demand

What is Demand?What is Demand?

It is the plan, or relationship, expressing It is the plan, or relationship, expressing different amounts of a product buyers are different amounts of a product buyers are willing and able to buy at possible prices, willing and able to buy at possible prices, assuming all other non-price factors assuming all other non-price factors remain the same. remain the same.

Also known as Quantity DemandedAlso known as Quantity Demanded

Demand ScheduleDemand Schedule

Shows the quantities of a product that a Shows the quantities of a product that a household would be willing to buy at household would be willing to buy at different pricesdifferent prices

Example of Raw DataExample of Raw Data

Maximum pricewilling to pay

Mary 1 4Bob 1 1Jane 1 5Ed 1 3

Alice 1 2

Name QuantityMaximum pricewilling to pay

Mary 1 4Bob 1 1Jane 1 5Ed 1 3

Alice 1 2

Name Quantity

Demand ScheduleDemand Schedule

Total QuantityDemanded

5 1 14 1 23 1 32 1 41 1 5

Price QuantityTotal Quantity

Demanded5 1 14 1 23 1 32 1 41 1 5

Price Quantity

The Demand CurveThe Demand Curve The demand curve shows how much of a The demand curve shows how much of a

good consumers are willing to buy as the good consumers are willing to buy as the price per unit changes holding non-price price per unit changes holding non-price factors constant.factors constant.

The Demand CurveThe Demand Curve

Quantity

Horizontal axis measures quantity (Q) demanded innumber of units per time period

Vertical axis measures price (P) paidper unit in dollars

Price($ per unit)

The Demand CurveThe Demand Curve

D

The demand curve slopesdownward demonstrating that consumers are willing

to buy more at a lower priceas the product becomes

relatively cheaper and the consumer’s real income

increases.

Quantity

Price($ per unit)

They intersect the quantity (X) axis, a result of time limitations and

diminishing marginal utility.

They intersect the quantity (Y) axis, a

result of time limited

incomes and wealth.

Total QuantityDemanded

5 1 14 1 23 1 32 1 41 1 5

Price QuantityTotal Quantity

Demanded5 1 14 1 23 1 32 1 41 1 5

Price Quantity

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Quantity demanded

Pri

ceExample:Example:

Law of Supply and DemandLaw of Supply and Demand

Term was first used Term was first used When Price rises, quantity demand fallsWhen Price rises, quantity demand falls When Price falls, quantity demand risesWhen Price falls, quantity demand rises

““There is thus a negative, or inverse, There is thus a negative, or inverse, relationship between quantity demanded relationship between quantity demanded

and price.”and price.”

Exception: A Exception: A Giffen goodGiffen good is a product for which a is a product for which a rise in rise in priceprice of this product makes people buy of this product makes people buy even more of the product.even more of the product.

Changes in Quantity Changes in Quantity Demanded vs. Change in Demanded vs. Change in

DemandDemand

““Ceteris Paribus” – all things equalCeteris Paribus” – all things equal

Changes in the price of a product affect Changes in the price of a product affect the the quantity demandedquantity demanded per period per period

Changes in any other factor, income or Changes in any other factor, income or preferences, affect preferences, affect demanddemand..

Demand Curve Demand Curve

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Quantity demanded

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Change in quantity demanded Change in quantity demanded due to change in price due to change in price

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Quantity demanded

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Non-Price determinants of Non-Price determinants of DemandDemand

Income and WealthIncome and Wealth Normal goods – higher demand when income is higherNormal goods – higher demand when income is higher Inferior Goods – lower demand when income is higherInferior Goods – lower demand when income is higher

Size of market (population)Size of market (population) Prices of Other Goods and ServicesPrices of Other Goods and Services

SubstitutesSubstitutes Complementary goodsComplementary goods

Taste and PreferencesTaste and Preferences ExpectationsExpectations Special InfluencesSpecial Influences

Non-Price determinants of Non-Price determinants of DemandDemand

Income and WealthIncome and Wealth Income – Is the sum of all wages, salaries, profits, interest Income – Is the sum of all wages, salaries, profits, interest

payments, rents and other form of earnings received in a given payments, rents and other form of earnings received in a given period of time.period of time.

Wealth- Total Value of what a household owns less what it Wealth- Total Value of what a household owns less what it owes.owes.

Size of market (population)Size of market (population) Prices of Other Goods and ServicesPrices of Other Goods and Services

Substitutes – when an increase of one good causes demand for Substitutes – when an increase of one good causes demand for another good to increase (positive relationship)another good to increase (positive relationship)

Complementary goods – decrease in the price of one results in Complementary goods – decrease in the price of one results in increase in demand for the otherincrease in demand for the other

Taste and PreferencesTaste and Preferences ExpectationsExpectations Special InfluencesSpecial Influences

Demand is determined by non-price Demand is determined by non-price demand-determining variables, such as, demand-determining variables, such as, income, price of related goods, and tastes.income, price of related goods, and tastes.

Changes in quantity demanded Changes in quantity demanded are shown are shown by movements along the demand curve.by movements along the demand curve.

Changes in demandChanges in demand are shown by shifting are shown by shifting the entire demand curve.the entire demand curve.

Demand curve shifts to the Demand curve shifts to the rightright

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Demand curve shifts to the Demand curve shifts to the left left

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Individual Market and Market DemandIndividual Market and Market Demand

Market demand is simply the sum of all the Market demand is simply the sum of all the quantities of a good or service demanded per quantities of a good or service demanded per period by all the households buying in the market period by all the households buying in the market for that good or service.for that good or service.

Individual Market and Market DemandIndividual Market and Market Demand

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