Econ topic 2.0

Price Theory (Part 1) -

Demand

Principles of Economics (ECN30205)

A Quick Reminder

• Recall that most countries practice the capitalistic or free market system these days.

• In this system, buyers and sellers are free to buy & sell goods with each other.

Free Market

Businesses sellGoods & Services

Consumers decidewhat to buy & at what price

A Quick Reminder

• For example, the restaurants at Lakeside campus are sellers and the people who work and study there are the buyers.

Sellers Buyers

Buyer Demand

• In this topic, we’ll learn how buyers decide when buying goods and services, and other factors that influence their decisions.

• In other words, we’ll look at market demand or buyer demand.

The Individual Demand Curve


• Imagine that you have received a $2000 cash gift from your parents for your 18th birthday. Being a pet lover, you have decided to spend all your money to buy puppies.


• Question: Given your $2000, how many puppies could you buy at the following prices below?

PriceQuantity

demanded

$150 ??

$500 ??

$1000 ??


• If you have to plot the table earlier on a graph, what would it look like?

Price, $

??

0 Quantity


• The downward sloping line is the main characteristicof the individual (and also market) demand curve.

Price, $

Quantity0

d

d


• And this brings us to the law of demand - whichstates that as the price of a product increases, the quantity demanded will become lower, and vice versa.


• The demand curve only explains the relationship between price of a product and its quantity of demand.

• It assumes that everything else that can affect demand for a product - such as income, taste, etc. - is ceteris paribus (or constant).


• So why do we buy less when the price is higher?

• Reason 1: the price of a product is an obstacle.

• This means a higher price makes the product less affordable to us and therefore harder to obtain. As a result, demand is less.


• Reason 2: Opportunity costs.

• When we decide to buy a product, we give up the benefits (i.e. opportunity cost) obtainable from an alternative product.

• If the product we bought is expensive, then we have chosen to give up more benefits from the alternative product (since we could, instead, have used the money to buy more of the alternative products).


• Reason 2: Opportunity costs.

• As a result, people will demand less when a product is expensive because they know they must give up lots of benefits from the alternative products (if they decided to buy the expensive product), and vice versa.


• Example: The price of a Big Mac is $9 but the price of Char Keow Teow is $3 each.

• Each Big Mac has a high opportunity cost (i.e. you must give up 3 CKTs). Therefore, people demand less Big Macssince people must give up 3 CKTs just to get one.

If purchase

Opportunity

cost


• In contrast, if the price of Big Mac is cheaper, say $3, then its opportunity cost is also lower (assuming CKTs are still $3 each):

• This will motivate people to demand more Big Macs(since you give up fewer CKTs to obtain them)

If purchase

Opportunity cost


• Quick Recap Questions:– What is the law of demand?

– How does the demand curve look like?

– Why do we buy less when the product becomes more expensive? Provide 2 explanations.

The Market Demand Curve


• Since each buyer follow the law of demand (i.e. buy less when goods are expensive and vice versa), therefore the market demand curve (for all buyers) must also be downward-sloping.


• For example, if a market has a total of 3 buyers, then the total demand can be computed and subsequently plotted on a graph.

Price You Lisa Jamal Total

$20 20 22 40 82

$30 13 15 30 58

$45 8 7 22 37

===


• The market demand curve:

Price, $

Quantity

$45

37

$20

820

d

d


• Economists who research a market often can formulate a demand equation for that market’s product.

• For example: the demand equation for textbooks in a campus may be expressed as:

Qd (per year) = 20000 – 100 p

where,

Qd is quantity demanded

P is the price of the product


• So at $100, the quantity of textbooks demanded per year will be:

= 20000 – 100 ($100)

= 20000 – 10000

= 10000 copies

• At a higher price of $150, the quantity demanded per year :

= 20000 – 100 ($150)

= 20000 – 15000

= 5000 copies


• Therefore the market demand curve for textbooks is as follows:

d

d

Price $

Quantity

150

100

5000 10000


• Review Exercise:

– The demand equation for blueberries in USJ city is expressed as Qd (in Kg per week) = 34000 – 1750 (p).

– Prepare a table to show how Qd changes as prices rise from $8 to $12 (use $1 intervals). Then draw the demand curve.

Other Factors (besides Price) that Affect Demand

Factors that Affect Demand

• So far, the demand curves only indicate the relationship between price and quantity demanded.

• However, there are other forces that also can affect demand:– Buyers’ income

– Number of buyers in the market

– Consumer taste or popularity

– Prices of related goods

– Expectations


• The 1st Factor: Buyers’ Income

– Households with higher income can buy moregoods and services.

– For example, a higher monthly allowances would increase your consumption of food, entertainment, etc.


• The 1st Factor: Buyers’ Income

– Of course, a fall in income would have an opposite effect.

– These goods and services, whose demand changes directly with the rise and fall income, are called normal goods.

– Can you name 2 more examples of normal goods?


• The 1st Factor: Income

– On the other hand, there are goods whose demand falls as income rises and vice versa. They are called inferior goods.

– For example, as a person’s income rises, her demand for a bus service would decrease (as she decides to buy a car instead).


• 2nd Factor: Number of buyers

– A rise in number of buyers would increase the number of goods demanded and vice versa.

– For example, the population growth over time has steadily increase the demands on various goods and services.


• 3rd Factor: Consumer Tastes or Popularity

– Consumers’ tastes in a particular good or services change over time.

– For example, the demand for tablet PC is very high presently due to its strong popularity.


• 3rd Factor: Consumer Tastes or Popularity

– Conversely, a product which is “out of fashion” will see its demand fall.

– Example: Consumers changing perception about eating healthful foods have seen demand for fast food decreased.


• 4th Factor: Price of Related Goods– The demand for a product can also rise or fall due

to changes in price of other goods.

– There are 2 types of related goods:• Substitute goods

• Complementary goods


• 4th Factor: Price of Related Goods– Substitute goods – goods that can replace one

another.

– Example: When beef increases in price, people will switch over to chicken and thereby increase its demand, even though the price of chicken didn’t change.

Price $$ Demand


• 4th Factor: Price of Related Goods

• Complementary goods - goods that are used together with another product.

• Examples include petrol and car; French fries and ketchup; gun and bullets.



• Because these goods are used together, therefore if the price of one product goes up, it will reduce the demand of both products, and vice versa.

• For example, the price of cars has increased, therefore the demand for both cars and petrolreduces.



• Why? When the price of cars increase, the demand for cars decreases (as per the law of demand).

• With fewer cars demanded/purchased by buyers, less petrol will be consumed as well, since fewer number of cars on the road leads to lower petrol consumption.


• 5th Factor: Expectations– Changes in consumers’ expectation about the

future can affect a product’s demand.

– Example: if people think that the price of gasoline will go up soon, they may demand more gasoline now to avoid paying a higher price in the future.


• 5th Factor: Expectations– Another example: A person who has just received

a job promotion may decide to buy a new car noweven though he doesn’t receive his pay raise until end of the month.

Movements & Shifts of Demand Curve


• Now that we have looked at the factors (other than price) that can affect demand, we want to know next how these factors can affect the demand curve.

Price, $

`

Quantity0

d

d


• First some terms: if the demand quantity changes as a result of changes in price, then this is known as “a movement” along the demand curve (see graph below):

$45

$20

37 820

Price $

Quantity

d

d


• On the other hand, a change in the factors (other than price) is represented by “a shift” in the demand curve i.e. from “d” to “d1”.

Price $

Quantity0

d

d

d1

d1


• Going back to the example on puppies, what if you receive another $1000 from an uncle (on top of the $2000 cash gift)?

• Obviously the number of puppies that you can buy have increased!

Puppies

Prices

Original

Demand

New Demand

(w/ Uncle’s $)

$150 13 20

$500 4 6

$1000 2 3


• In this case, the increase in demand for puppies due to the extra cash gift lead to a rightward shift of the demand curve.

Price $

Quantity0

d

d

d1

d1


• The shift in the demand curve represents an overall increase in demand, and it is not affected by price changes.

d

d

d1

d1

Price $

Quantity

$500

4 6


• But what if your total cash gift was only $1000? How would that be represented on the graph?

Price $

Quantity0

??


• Obviously a decrease in cash gift would have an opposite effect i.e. a leftward shift.

Price $

Quantity0

d

d

d1

d1


• A few quiz questions:– Show the shifts in the demand curve(s) for:

• Fast food as it is becoming unpopular with consumers.

• Chicken as the price of lamb increases.

• Steak sold at Ali’s Steakhouse as residents surrounding his restaurant has moved elsewhere.

• Bullets as prices of gun decreases.


• A few quiz questions:– Draw the shifts in demand curve(s) for:

• Cheap/budget clothes when the income of city dwellers have increased.

• Michael Jackson CDs as it is expected to sell out soon.

• Ogawa massage chairs as the income of Malaysian’s have increased.

• Diapers as the number of babies given birth this year is more than last year.

Summary

• The Individual and Market Demand Curve

• Factors that Affect Demand (other than Price)

– Income

– Preference or Consumer Tastes

– Prices of Related Goods

– Number of Buyers

– Expectations

• Shifts and Movements in the Demand Curve.

Econ topic 2.0

Healthcare

Transcript of Econ topic 2.0