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Chapter 2

DEMAND
THEORY
(Week 1)

DPB 1023
MICRO
ECONOMICS
Objective 1
Define demand
Demand does not
necessarily mean a
consumer WILL buy, but
refers to a good or
service they WOULD LIKE
to buy
Introduction to Demand
The forces of supply and demand work together
to set prices.
Demand is the

Based on that definition, which of the following do


you have a demand for?
Objective 2
Define law of demand
The Law of Demand
According to the law of
demand, quantity
demanded and price
move in opposite
directions.

This means that


demand curves slope
downward.
What does an inverse
relationship between price &
quantity mean?
It means that the
two move in
opposite
directions
Assumptions of law of Demand
(1)Income of the consumer remains constant.
(2)There is no change in the taste and preference of the
consumer.
(3)No change in price of the related good.
(4)The commodities are normal.
(5)There is no expectations of change in price in near future.
(6)No new substitute of the commodity are available.
(7)No change in the distribution of income and wealth.
(8)Other relevant factors like size and composition of
population, seasonal and climate factors, economic
condition of the country etc. remain unchanged.
Objective 3
Sketch demand curve
Sketch the Demand Curve in
Output Markets
A demand schedule
is a table showing how
much of a given
product a household
would be willing to
buy at different prices.
Demand Curve Demand curves are usually
derived from demand
schedules.
The demand curve is a
graph illustrating how
much of a given product a
household would be willing
to buy at different prices.
The demand curve is the
line that connects these
points.
The graph lists prices on the
vertical axis and quantities
demanded on the horizontal
axis.
Each point on the graph shows
how many units of the product or
service an individual will buy at a
particular price.
Catherines Demand Schedule
Figure 1 Catherines Demand Schedule and Demand Curve

Price of
Ice-Cream Cone
$3.00

2.50

1. A decrease
2.00
in price ...

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ...increases quantity
of cones demanded.
Copyright 2004 South-Western
Demand Schedule
(Demand for coffee monthly)
(1) (2) (3) (4)
Price Chriss Davids Total market
(cent per g) demand demand demand
(g) (g) (kgs: 000s)

A 20 28 16 700
B 40 15 11 500
C 60 5 9 350
D 80 1 7 200
E 100 0 6 100
Point Price per g Market Demand

A 20 cent 700 kilogrammes


Price (cent per g)

Demand
A

Quantity (kilogrammes: 000s)


Point Price per g Market Demand
A 20 cent 700 kilogrammes
B 40 cent 500 kilogrammes
Price (cent per g)

Quantity (kilogrammes: 000s)


Point Price per g Market Demand
A 20 cent 700 kilogrammes
B 40 cent 500 kilogrammes
C 60 cent 350 kilogrammes
Price (cent per g)

Quantity (kilogrammes: 000s)


Point Price per g Market Demand
A 20 cent 700 kilogrammes
B 40 cent 500 kilogrammes
C 60 cent 350 kilogrammes

D D 80 cent 200 kilogrammes


Price (cent per g)

Quantity (kilogrammes: 000s)


Point Price per g Market Demand
A 20 cent 700 kilogrammes
E
B 40 cent 500 kilogrammes
C 60 cent 350 kilogrammes

D D 80 cent 200 kilogrammes


E 100 cent 100 kilogrammes
Price (cent per g)

Quantity (kilogrammes: 000s)


Demand Curve
P

At higher prices, consumers are


generally willing to purchase less than at
lower prices
Demand curve is said to have a negative
slope - downward sloping from left to
right
The Law of Demand
Explanations
There are at least three accepted
explanations of why demand curves
slope downwards:
- The law ofdiminishing marginal utility
- Theincome effect
- Thesubstitution effect
Utility = Satisfaction/Benefit
Marginal = Always means Extra
Diminishing Marginal Utility means that the extra
satisfaction is falling as you consume an additional
product.
E.g. If you eat 1 bar of chocolate you get quite a lot of
benefit = YUM YUM
If you continue eating and you begin your 5 th Bar, Do
you get the same benefit?? = BARF
Therefore the Law of Diminishing Marginal
Utility states that as more of a product is
consumed the marginal (extra) benefit to the
consumer falls, hence consumers are prepared
to pay less.
Theincome effect
Theincomeandsubstitutioneffect can also be used
to explain why the demand curve slopes downwards.
If we assume that money income is fixed, the income
effect suggests that, as the price of a good falls,real
income -that is, what consumers can buy with
theirmoney income(Their Spending Power)-
rises and consumers increase their demand.

Therefore, at a lower price, consumers can buy more


from the same money income, and,ceteris paribus
(with other things the same) demand will rise.
Conversely, a rise in price will reduce real income and
force consumers to cut back on their demand.
Thesubstitution effect
In addition, as the price of one good falls, it
becomesrelatively less expensive. Therefore,
assuming other alternative products stay at the
same price, at lower prices the good appears
cheaper, and consumers will switch from the
expensive alternative to the relatively cheaper
one.
It is important to remember that whenever the
price of any resource changes it will trigger both
an income and a substitution effect.
Why do demand curves
have a negative slope?
At a higher price consumers
will buy fewer units, and at a
lower price they will buy
more units
Objective 4
Compare between
individual and market
demand
Types of Demand
Individualdemand: the quantity
of a good an individual consumer
demands at different prices.

Market demand: total quantity of


a good that all consumers
demand at different prices.
From Household to Market Demand
From Household Demand to
Market Demand
Assumingthere are only two households in the
market, market demand is derived as follows:
(ii) Explain, with the aid of labelled diagrams, the
relationship between individual (consumer) demand
and market demand.
(ii) Explain, with the aid of labelled diagrams, the
relationship between individual (consumer) demand
and market demand.

To derive the market demand add the quantity demanded


by each individual consumer at each price to calculate the
overall quantity demanded by the market at each price.
An Increase in Demand

P
Price

D1 D2

Q1 Q2
Quantity
A Decrease in Demand

P
Price

D2 D1

Q2 Q1
Quantity
Objective 5
Discuss factors
influencing demand
Factors affecting the demand
for a good

The Demand Function

Dx = f ( Px, Pog, Y, T, E, G, U)
The Demand Function
Dx = f ( Px, Pog, Y, T, E, G, U)

Px = Goods which obey and do not obey the


Law of Demand
Pog = Price of Complimentary Goods and
Cost of Substitute Goods
Y = Income of consumer
T = Consumer tastes and preferences
E = Consumers expectations regarding future
prices
G = Government regulations
U = Unplanned factors
These all affect DEMAND
Demand for a good depends on its own price
NOTE: Price only causes a movement along the demand curve not a SHIFT

If price rises quantity demanded falls


If price falls quantity demanded rises

P2

P1

Q2 Q1 Quantity Demanded
Demand for a good depends on the price
of other goods

Complimentary Goods
Goods which are used jointly. The use of one
involves the use of the other - E.g. bread and
butter, cars and petrol

Substitute Goods
Goods which satisfy the same needs and thus can
be considered as alternatives to each other E.g.
Coke and Pepsi or Tea and Coffee
Complimentary Goods

D1
D2
D2 D1
An increase in price of a An fall in price of a
complementary good causes the complementary good causes
demand for good X to fall the demand for good X to
rise
Substitute Goods
(The Substitute Effect)

D2
D1
D1 D2
An increase in price of a substitute An fall in price of a
good causes the demand for good X to substitute good causes the
rise demand for good X to fall
Demand for a good depends on level of
income (The Income Effect)
Normal Goods
P P

D2
D1
D1
Q D2 Q
A rise in income causes the demand for An fall in income causes the
a normal good to increase from D1 to demand for a normal good
D2 to fall from D1 to D2
Inferior Goods
P P

D1
D2
D2
Q D1 Q
An increase in income causes the A decrease in income causes
demand for an inferior good to fall the demand for an inferior
from D1 to D2 good to rise from D1 to D2
4. TASTE: Demand depends on
Consumer Tastes

If the movement in taste or preferences is


in favour of the good it causes an increase
in demand which shifts the demand curve
to the right

If the movement in taste or preferences is


against the good it causes a fall in demand
which shifts the demand curve to the left

E.g. Fashion Styles etc.


Movement in Taste
P P

D2
D1
D1
Q D2 Q
A movement in taste in favour of a A movement in taste against
good causes demand to increase a good causes demand to
fall
5. Demand for a good depends on the
expectations of consumers

Demand for a good will shift to the


right if consumers expect:
1. The price of good X to be higher in the future
e.g. property
2. A scarcity of good X in the future e.g. oil
3. Their incomes to be higher in the future e.g.
promotion

Demand for a good will shift to the left


if consumers expect:
1. The price of good X to be lower in the future
2. A plentiful supply of good X in the future
3. Their incomes will be lower in the future
Consumer Expectations

D2
D1
D1 D2
Demand for Good X will rise if Demand for Good X will fall
consumers expect higher future prices, if consumers expect lower
scarcity or higher future incomes future prices, abundance or
lower future incomes
6. Demand for a good depends on
government regulations

If the government implement a programme


which reduces/increases consumption of a
particular product than demand for this good will
be affected

E.g. The smoking ban / educational campaign


to reduce alcohol consumption (Cause
demand to shift left)
The cycle to work scheme cause demand for
bicycles to shift right
Government Regulations

Example:
The Smoking Ban

D1

D2

If the government implement a


policy to restrict consumption
demand for Good X will fall
Government Regulations

Example:
The Cycle to Work
Scheme
D2

D1
7. Demand for a good depends on
unplanned factors
If there is a sudden heat wave an
unplanned factor this may result in an
increase in demand for sunscreen and a
decrease in the demand of home heating
oil

If flash floods occur across the country


an unplanned factor this may result in an
increase in the demand for Wellingtons.
Unplanned Factors

Factors such as weather


D2 can effect the demand
for goods e.g. a sudden
heat wave would
D1
increase the demand for
sunscreen
Price rises when quantity supplied
is scarce and demand increases

Price decreases when quantity


supplied increases and as a result
demand increases
(EQ) Two factors that would cause
a shift in a demand curve for
concert tickets:
To Summarize
When price changes
- what happens?
When the price of a product changes
while all other factors remain the same,
there will be a change in the quantity
demanded.

Price of hamburger decreases at


McDonalds, people will buy more
hamburgers.
Increase in
Quantity
Demanded

Decrease in
Price
When price changes
- what happens?
The curve does not shift - there
is a change in the quantity
demanded.
When something
changes other than
price, what happens?
When other factors change while
the price remains the same,
there will be a change in
demand.
If McDonalds redesigns its
restaurants to appeal to more
people, they will have more
customers.
When something
changes other than
price, what happens?
The whole curve
shifts, there is a
change in demand.
Increase in
Quantity
Demanded

Decrease in
Price
When the ceteris paribus assumption
P
Rs20
is relaxed, the whole curve can shift

Rs15 A B
Rs10
D
Rs5
D12
Q
10 20 30 40 50
What does
ceteris
paribus mean?
All else remains the
same
Objective 6
Calculate demand
function
Demand function
A table, a graph, or an equation that
shows how quantity demanded is
related to product price, holding
constant the five other variables that
influences demand.
Linear demand function:

Qd = a+ bP + cM + dPr + eT+ fPe


The intercept a shows the value of Qd
when the variables P, M, Pr , T , Pe are
all simultaneously equal to zero.
Linear Demand Function
Qd = a+ bP + cM +dPr +eT+fPe

The other parameters, b,c,d,e and


f are slope parameters.
Slope Parameters- Parameters in a
linear function that measure the
effect on the dependent variable
(Qd) of changing one of the
independent variables (P,M,Pr, T,
Pe )while holding rest of these
variables constant.
Summary Of the Linear
Demand Function
When the slope parameter of a specific
variable is positive( negative ) in sign,
quantity demanded is directly
(inversely) related to that variable.
b is negative because the relationship
between price and quantity demanded
is inverse.
c will be +ve if it is normal good and
ve if the good is inferior. d will +ve for
substitute good and ve for complement
good, e will be +ve for favourable
change and ve for unfavourable
change, f will be + always.
Example Linear Demand
Equation
Qd = 1,800- 20P + 0.6 M 50 Pr
Suppose consumers income is RM
20,000 and the price of related good is
RM 250. Find the demand function and
calculate quantity demanded when
price for the good is RM 50, RM 40 and
RM 30.
Objective 7
Distinguish between
movement along the
demand curve and shift
in the demand curve
IMPORTANT

KNOW THE DIFFERENCE BETWEEN A


CHANGE IN THE QUANTITY DEMANDED
AND A CHANGE IN DEMAND
Quantity Demanded vs. Demand
Quantity Demanded
The quantities of a good or service
that people will purchase at a
specific price over a given period
of time.
Demand

Demand for product is the amount


that consumers are willing and able
to purchasers good or service at
different prices at a given time
DIFFERENCE

Base of
Sr.no difference Change in Quantity Demand Change in Demand

Change in Quantity demanded Change in Quantity


Definition
1 refers to increase or decrease demanded refers to
In quantity purchased of a increase or decrease In
commodity in response to quantity purchased of a
decrease or increase in its commodity in response to
price other than its change in other
determinants. determinants of demand,
other than price of the
Movements along the same commodity.
2 Alternative Demand curve
Name Shifting of the Demand
curve
(1)Extension of Demand (1)Increase in Demand
(2)Contraction of Demand (2)Decrease in Demand
Shift of Demand Versus Movement Along a
Demand Curve
A change in demand is not the
same as a change in quantity
demanded.

In this example, a higher price


causes lower quantity
demanded.

Changes in determinants of
demand, other than price, cause
a change in demand, or a shift
of the entire demand curve, from
DA to DB.
A Change in Demand Versus a Change in
Quantity Demanded
When demand shifts to the right,
demand increases. This causes
quantity demanded to be greater
than it was prior to the shift, for
each and every price level.
Variables That Influence Buyers
Decrease in
quantity
demanded

Upward
movement
along the
demand curve
Price
increases
Increase in
quantity
demanded

Downward
movement
along the
demand curve
Price
decreases
Decrease or
increase in
demand

Leftward or
rightward shift in
the demand curve

Nonprice
determinant
A Change in Demand Versus a Change in
Quantity Demanded
To summarize:

Change in price of a good or service


leads to

Change in quantity demanded


(Movement along the curve).

Change in income, preferences, or


prices of other goods or services
leads to

Change in demand
(Shift of curve).
Price rises when quantity supplied
is scarce and demand increases

Price decreases when quantity


supplied increases and as a result
demand increases
EQ: Distinguish between the economic meanings of a
movement along a demand curve and a shift in a
demand curve for concert tickets. Illustrate your answer
using diagrams
Objective 8
Explain exceptional
demand curve
Exceptional Demand Curve

Giffen Goods
Goods of ostentatious consumption
(snob goods)
Goods affected by consumers
expectations
Addictive Goods
Giffen Goods
Giffen goods are those which are consumed in greater
quantities when their price rises.

Giffen good is a staple food, such as bread or rice, which


forms are large percentage of the diet of the poorest sections
of a society, and for which there are no close substitutes.

From time to time the poor may supplement their diet with
higher quality foods, and they may even consume the odd
luxury (E.g. Meat), although their income will be such that
they will not be able to save. A rise in the price of such a
staple food will not result in a typical substitution effect,
given there are no close substitutes.

If the real incomes of the poor increase they would tend to


reallocate some of this income to luxuries, and if real
incomes decrease they would buy more of the staple good,
meaning it is aninferior good.
Goods of ostentatious consumption (Snob/Veblen Goods)

Snob goods are a second possible exception to the general law of demand.

A rise in the price of high status luxury goods might lead members of this
leisure class to increase in their consumption, rather than reduce it. The
purchase of such higher priced goods would confer status(make these
people seem Cool/Wealthy/Rich) on the purchaser - a process which
calledconspicuous consumption.

Some commodities by their exclusiveness or


expensiveness are attractive to some buyers. A rise in
price makes them more exclusive, and therefore, more
attractive to those with the incomes to purchase them. A
fall in price may lead to a fall in quantity demanded as
they may no longer appear as exclusive to the rich and
are still outside the price range of the poor.
Goods the purchase of which is
influenced by expectations as to
future prices
/ Speculative goods
If prospective buyers think that prices
are likely to be even higher in the future,
the current level of demand may not fall
even if prices increase
E.g. if a person is considering
buying a house the possibility that
prices are likely to be even higher in
the future will probably stimulate
demand at current prices.
Goods of Addiction
In the case of those goods to which a
person becomes addicted e.g.
drugs, they no longer act rationally.
They become so addicted to the drug
that in order to get the same 'buzz'
from consumption of the drug,
demand for the commodity may
increase, even when the price of the
commodity increases.
DISCUSSION
Key Concepts
What is the law of demand?
Why do demand curves have a negative slope?
When price changes, what happens?
When something changes other than price, what
happens?
What can cause a shift in a demand curve?

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