Reading Essentials and Study Guide...Reading Essentials and Study Guide Lesson 2 Factors Affecting...

Chapter 4: Demand

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Lesson 2 Factors Affecting Demand

Reading Essentials and Study Guide

ESSENTIAL QUESTIONWhat are the causes for a change in demand?

Reading HELPDESKAcademic Vocabularyprinciple a fundamental law or ideaillustrated shown with an image or example

Content Vocabulary change in quantity demanded movement along the demand curve showing that a different

quantity is purchased in response to a change in price income effect that portion of a change in quantity demanded caused by a change in a

consumer’s income when the price of a product changes substitution effect the portion of a change in quantity demanded that is due to a change in the

relative price of the good change in demand different amounts of a product are demanded at every price, causing the

demand curve to shift to the left or the rightsubstitutes competing products that can be used in place of one another; products related in

such a way that an increase in the price of one increases the demand for the other complements products that increase the use of other products; products related in such a way

that an increase in the price of one reduces the demand for both

TAKING NOTES: Key Ideas and DetailsMany factors affect demand. Using a mind map with “demand” at the center like the one shown below, illustrate the various influences on demand.

Demand

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Chapter 4: DemandReading Essentials and Study Guide

Lesson 2 Factors Affecting Demand, Continued

A Change in the Quantity DemandedGuiding Question What is the effect of a change in price on quantity demanded?Let’s say the price of a product changes and all other factors remain the same. In that case, the demand curve doesn’t move, but the quantity demanded changes. But sometimes the entire demand curve shifts (moves to the left or right) because of a factor other than price. This factor might be an advertising campaign or a change in consumer income. Look at Figure 4.3 to see what happens when only the price changes and everything else stays constant. Point a on the demand curve shows that at $5, 24 burritos are sold. When the price falls to $3, the number of burritos purchased goes up to 40. On the other hand, when the price goes up, fewer burritos are demanded. This movement from point a to point b or from b to a is a change in quantity demanded. This change is shown on the graph as a movement along the demand curve. This result is an important principle in economics.

Only Price Changes the Quantity DemandedA change in quantity demanded can be caused by only one event—a change in price. Lots of other things can affect the demand curve. But price is the only factor that can cause a movement along the demand curve, as we see in Figure 4.3.

The Income EffectWhen the price of a product drops, consumers pay less. As a result, they have some extra income to spend. For example, we can see from Figure 4.3 that consumers spent $120 to buy 24 burritos when the price was $5 per burrito. If the price drops to $3, they would spend only $72, or $3 times 24, on the same quantity. This leaves them $48 “richer” because of the lower price. They may even spend some of this extra income on more burritos. As a result, part of the increase from 24 to 40 units purchased, or the movement from point a to point b on the demand curve, happens because consumers feel richer.

If the price had gone up, consumers would have felt a bit poorer and would have bought fewer burritos. This illustrates the income effect. This is the change in quantity demanded because of a change in price that alters consumers’ income.

The Substitution EffectWhen the price of a burrito drops from $5 to $3, burritos become less expensive, compared to other goods and services. Consumers tend to replace a more costly item, such as pizza, with a less costly one. The substitution effect is the change in quantity demanded because of a shift in relative prices. In other words, if a burrito becomes less expensive than a slice of pizza, people will buy the burrito instead of the pizza. Together, the income and substitution effects explain why consumers buy more burritos when the price drops from $5 to $3.

Whenever a price change causes a change in quantity demanded, we see a movement along the demand curve. This is illustrated in Figure 4.3. Regardless of whether the quantity demanded increases or decreases, the demand curve itself does not shift.

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A Change in DemandGuiding Question What factors, excluding price, affect demand?Sometimes other factors change while the price remains the same. When this happens, people may decide to buy different amounts of a product at the same price. This is known as a change in demand. As a result, the entire demand curve shifts to the right to show an increase in demand. Or it will shift to the left to show a decrease in demand. This is different from a change in quantity demanded, a movement along the demand curve caused by a change in price.

Demand can change because of changes in various factors. This might include consumer income, consumer tastes, the price of related goods such as substitutes or complements, future expectations, and the number of consumers.

Consumer IncomeConsider how an increase in the minimum wage might affect the market demand schedule and curve in Figure 4.4. When people earn more, they are willing to buy different amounts at all possible prices. We can now add a third column to Panel A to show these increases. At a price of $9, for example, consumers are now willing to buy 16 burritos instead of 3. At a price of $7, consumers are now willing to buy 28 burritos instead of 12. This is a change shown by movement from point a to point a´. When the rest of the information in the schedule is plotted on the graph in Panel B, the demand curve will have increased, or shifted to the right.

A decrease in consumer income would have the opposite effect. Instead of buying 3 burritos at $9, they might buy 2. Similarly, instead of buying 12 burritos at $7, they might buy 9, and so on down the column. Once these new quantities are plotted, the demand curve will have shifted to the left. This shows a decrease in demand.

Consumer TastesConsumers often change their minds about which products to buy. Advertising, fashion trends, peer group pressure, and even changes in the season can affect consumer choices. For example, when a product is successfully advertised, its popularity increases and people tend to buy more of it at all possible prices. As a result, the demand curve shifts to the right.

On the other hand, people will buy less of a product if they get tired of it, or if they have a reason to worry about whether it’s a good choice. This is exactly what happens when a rumor or negative report about a product appears. When fewer people want the product at all possible prices, the demand curve shifts to the left, showing a decrease in demand.

Reading Progress CheckDescribing How is a change in the quantity demanded illustrated on the demand curve?

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Substitutes A change in the price of related products can cause a change in demand. Some products are known as substitutes because they can be used in place of other products. For example, suppose that people treat butter and margarine as substitutes. Then, a rise in the price of butter will cause an increase in the demand for margarine. Likewise, a rise in the price of margarine would cause an increase in the demand for butter, shifting the demand curve for butter to the right.

In general, the demand for a product tends to increase if the price of its substitute goes up. The demand for a product tends to decrease if the price of its substitute goes down.

Complements Other related goods are known as complements. This is because the use of one increases the use of the other. Personal computers and software are two complementary goods. When the price of computers decreases, consumers buy more computers and more software. If the price of computers rises, consumers buy fewer computers and less software.

In general, an increase in the price of a good usually leads to a decrease in the demand for its complement. A decrease in the price of a good tends to increase the demand for its complement.

Expectations The way people think about the future can also affect demand. For example, suppose that a company announces a breakthrough (new change) in the cost and quality of televisions. Even if the new product won’t be available for a year, some consumers might wait to buy a TV now because of their expectations, or hopes, about the new product. Their hopes would cause fewer TVs to be purchased at every price, and the demand curve would shift to the left.

Of course, expectations can also have the opposite effect. Imagine if the weather service predicts a bad year for crops. People might stock up on some foods today, before these items might become scarce. The willingness to buy more today because of expected shortages later would cause an increase in current demand. This is shown by a shift of the demand curve to the right.

We can predict, or guess, the change in demand caused by a change in the price of a good’s substitute or complement. However, we can’t predict the effect of a change in expectations without other details.

Number of ConsumersA change in income, tastes, expectations, and prices of related products affects individual demand schedules and curves. Therefore, the change affects the market demand curve. The market demand curve can also change if there is a change in the number of consumers.

Generally, when more consumers enter the market, market demand increases, and the curve shifts to the right. Suppose that a building near a store that sells burritos needs repairs. A large group of workers comes to the neighborhood. Many of them buy burritos for lunch. We would add the number of burritos that they buy at all possible prices to those the store used to sell. When the work is finished and the workers leave, market demand might decrease. So, the market demand curve shifts to the left.

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Lesson 2 Factors Affecting Demand

Reading Progress CheckExplaining How do changes in consumer income and tastes affect movements of the demand curve?

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