chapter 2 demand
TRANSCRIPT
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Demand of Goods and Services
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Classification of Goods and Services
From conventional perspectiveFree goodsPublic goodsEconomic goods
From Islamic perspectivesAl-tayyibatAl-Rizq
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Conventional PerspectivesFree Good
Goods that have no production cost (air, sunlight, rain
water).
Public Goods
Goods that have a common use and are benefit to
everyone (public clinics, schools, hospital and others.)
Economic goods
Goods which supply is limited and require costs to
purchase them (books, clothes, houses, movies)
Price is involved in obtaining them.
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Islamic Perspective
Al-Tayyibat• Al-tayyibat means good things, clean and pure things, and
sustenance of the best.• Bad goods are not considered as goods in Islam.
Al- Rizq• Al-rizq is used to denote the following meanings;
- Godly sustenance, godly provision and heavenly gifts
• All these meanings denote that Allah s.w.t is the only sustainer and provider for all creatures.
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Hierarchy of needs• Dharuriyah
• Goods that are classified as basic needs and necessary for a living. eg: food, cloth
• Hajiyat• Goods that will improve the quality of human life eg:
refrigerator, radio• Kamaliat
• Goods that contribute towards the perfection of human life (luxury goods). Eg: bungalow house, Mercedes cars
• Tarafiat• Not permissible (haram). Bring negative impact on society.
Not only extravagant and wasteful, but also cause harm to man. Eg: liquor
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DEMAND OF GOODS AND SERVICES
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Definition of demand
•The quantity of various goods that people are willing and able to buy at a particular time and at a given
range of prices.
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DEMAND SCHEDULE AND DEMAND CURVE
• Demand Schedule • The demand schedule is a table that shows the relationship
between the price of the good and the quantity demanded
• Demand Curve • A demand curve is a graphical representation of a demand
schedule.• A graph of the relationship between the price of a good
and the quantity demanded. • slopes downward and to the right.
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Figure 1 Siti’s Demand Schedule and Demand Curve
Copyright © 2004 South-Western
Price ofIce-Cream Cone
0
2.50
2.00
1.50
1.00
0.50
1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones
$3.00
12
1. A decrease in price ...
2. ... increases quantity of cones demanded.
A
B
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The Individual Demand Curve andthe Law of Demand
Demand Schedule for Pizza
Price ($) Quantity of pizzas
per month2 13
4 10
6 7
8 4
10 1
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The Individual Demand Curve andthe Law of Demand
• The individual demand curve shows the relationship between the price of a good and the quantity that a single consumer is willing to buy, or quantity demanded.
• The The law of demandlaw of demand states that states that the higher the price, the the higher the price, the smaller the quantity smaller the quantity demanded, ceteris paribus demanded, ceteris paribus (Other thing remain constant).(Other thing remain constant).
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WHY?
The Substitution Effect• consumers react to an increase in a good’s price
by consuming less of that good and more of other goods.
The Income Effect• a person changes his or her consumption of
goods and services as a result of a change in real income.
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Market Demand
• Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.
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• From Individual Demand to Market Demand
• market demand curveA curve showing the relationship between price and quantity demanded by all consumers, ceteris paribus.
Table 1.1 From Individual to Market Demand
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Price Ind.1 Ind. 2 Market Demand
RM 2.00 600 300 (600 + 300) = 900
RM 3.00 400 200
RM 4.00 200 100
RM 5.00 100 50
How to calculate market demand?
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0
D
Price of Ice-Cream Cones
Quantity of Ice-Cream Cones
A tax that raises the price of ice-cream cones results in a
movement along the demand curve.A
B
8
1.00
$2.00
4
Changes in Quantity Demanded Change in Quantity Demanded
Movement along the demand curve. Caused by a change in the price of the
product.
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SHIFTS IN THE DEMAND CURVE
TastesTastes
IncomeIncomeNumber of buyers Number of buyers
ExpectationsExpectationsPrices of related goodsPrices of related goods
♥Shift factors of demand are factors that cause shifts in the demand curve
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Shifts in the Demand Curve
Recall our assumption• hold other things constant – ceteris paribus allow only price to
change
• But what if other factors do change?• change in demand• shift to a new demand curve, either to the left or right.• alters the quantity demanded at every price.
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Figure 3 Shifts in the Demand Curve
Copyright©2003 Southwestern/Thomson Learning
Price ofIce-Cream
Cone
Quantity ofIce-Cream Cones
Increasein demand
Decreasein demand
Demand curve, D3
Demandcurve, D1
Demandcurve, D2
0
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DD11 DD22
PP
QDQD11 QDQD22
More incomeMore incomeresults inresults in
more demandmore demandfor new cars;for new cars;less demandless demandfor used cars.for used cars.
New CarsNew Cars Used CarsUsed Cars
Less incomeLess incomeresults inresults in
more demandmore demandfor used cars;for used cars;less demandless demandfor new cars.for new cars.
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The Impact of a Change in Income
• Higher income decreases the demand for an inferior good
• Higher income increases the demand for a normal good
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Change in Income
• An increase in income will lead to an increase in demand for most goods & services because the amount of purchasing power increases, vice versa
• As consumer’s income rises, the demand for higher quality goods will certainly increase (shown by the shift of dd curve to right) normal good
• Products for which demand declines as income rises inferior good
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ComplementComplement[[InverseInverse]]
SubstituteSubstitute[[DirectDirect]]
MilkMilk CerealCereal Pop TartsPop Tarts
DD11 DD22
PPPP11
QDQD11
P2
DD11
DD22
DD
PP
QDQD22
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Prices of Related Goods
• Changes in the price of substitutes• Rise in prices of one good lead to a contraction in the quantity of the
good demanded & increase in the demand for its substitutes
• Changes in the price of complements• Goods that are consumed together. When demand for one good rises, so
does demand for the other.
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DD11 DD22
PP
QDQD11 QDQD22
An increase in tasteincrease in tastefor DVDs results in an
increase in demandincrease in demand.
A decrease in tastedecrease in tastefor videos results in a
decreasedecrease in in demanddemand.
DD33
QDQD33
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DD11 DD22
PP
QDQD11 QDQD22
iPhoneiPhone
$399$399
Buy it now to save money.Buy it now to save money.
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DD11 DD22
PP
QDQD11 QDQD22
If there is expected to be a major shortage of toilet tissuemajor shortage of toilet tissue,then consumers will stock up now or risk not getting any.
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DD11 DD22
PP
QDQD11 QDQD22
Let’s say that we are coming out of recessioncoming out of recession & consumersfeel secure about their jobs. [Positive future incomePositive future income]
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DD11
DD22
PP
QDQD11QDQD22
Let’s say that we are going into a recessiongoing into a recession and consumersdon’t feel secure about their jobs. [NegativeNegative future income future income]
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DD11 DD22
PP
QDQD11 QDQD22
More demandMore demandfor both normalfor both normal& & inferior goodsinferior goods
New CarsNew Cars
Used CarsUsed Cars
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When price changes, what happens?
•The curve does not shift.•There is a change in the quantity demanded
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When something changes other than price, what happens?
The whole curve shifts,there is a change
in demand
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Change in Quantity Demanded vs. Change in Demand
Change in quantity demanded Change in demand
Refer to a movement along a given demand curve
As a result of a change in the commodity price (price of the good itself whereas other factors influencing demand remains unchanged)
Refer to a shift in the demand curve (left / right)
As a result of a change in the economics variable and not the price of the good itself
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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, orprices of other goods or services
leads to
Change in demand(Shift of curve).
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The Exceptional Demand Curve
• Normal dd curve is always downward sloping showing inverse relationship between price of a good and quantity demanded
• However, there is a possibility that price increases, the quantity demanded also increases @ quantity demanded of a good decreases when its price falls
• Divided into 2• Regressive at high prices
• Happens to luxury goods like antique and jewellery items• Bought by the rich to show off their status• Higher price more goods would be demanded
• Regressive at low price• Happens to inferior goods like broken rice and salted fish• Lower the price offered, fewer would be demanded by the poor substitute the
existing goods to better quality goods
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Luxuries goods• Those products that
have an income elasticity of demand greater than 1.
• The more expensive the goods, the greater will be the demand.
• Jewellery, antique furniture, picture of Mona Lisa etc
Q
Pd
Exceptional dd curve regressive at high price
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Exceptional Demand
• Doesn't follow the law of demand
• Giffen goods• The demand curve for
giffen goods is normally upward sloping.
• Purchasing power has increase, which allowed people to replace with better quality goods
P
Q
d
Exceptional dd curve regressive at low price
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ELASTICITY OF DEMAND
• Definition:Elasticity means responsiveness or sensitivity. Therefore elasticity of demand means the responsiveness of demand due to the changes of the factors that influence demand.
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Types of Elasticity:
• Price elasticity of demand• Cross elasticity of demand• Income elasticity of demand• Price elasticity of supply
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i. Price Elasticity of Demand (Ed)
• Ed measures the responsiveness of the quantity demanded due to the change in its price.
• Ed tries to measure how much does demand has decreased when price increased
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• Calculating price elasticity of demand;Formula:
Ed = (% ∆ in Qd for product X) % ∆ in P of product X
= % ∆ in Q % ∆ in P
= (∆ Q) x P0
Q0 ∆P = (Q1 – Q0) x P0
Q0 (P1 – P0)
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• Example: Price(RM) Quantity Demanded
2.00 103.00 5
• Calculate the price elasticity of demand when price increases from RM2.00 to RM3.00.
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Ed = ∆ Q x P0
Q0 ∆ P = (Q1 – Q0) x P0
Q0 (P1 – P0) = (5 – 10) x 2
10 (3 – 2)= -1
# If price of good X increases by 1%, quantity of good X demanded will decrease by 1%
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Degrees of Price Elasticity of Demand
• Elastic demand (Ed > 1)
Percentage change in quantity demanded is greater then the percentage change in price.
• %Δ Q > %Δ PP
Q
D
D
Smooth line dd curve
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ii. Inelastic demand (0<Ed<1) or (Ed < 1)
• Percentage change in quantity is less than the percentage change in price.
• %Δ Q < %Δ P
P
Q
D
D
Steep line dd curve
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iii. Unitary elastic (Ed = 1)
• Percentage change in quantity demanded is equal to the percentage change in price.
• %Δ Q = %Δ P
D
P
X
Hyperbola line dd curve
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iv. Perfectly Elastic (Ed = ∞)
• Percentage change in quantity demanded is infinite in relation to the percentage change in price small % change in price of a good would lead to infinite changes in its quantity demanded
P
Q
DP0
Horizontal line demand curve
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v. Perfectly Inelastic (Ed = 0 )
• Quantity demanded does not change as the price changes.
P
QQ0
D
P1
P2
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Determinants of Price Elasticity of Demand
• Availability of substitutes
many substitutes more elastic ddless/no substitutes less elactic/ inelastic ddEg: petrol and detergents (liquid, soap)
• Relative importance of the goods in the budget
greater the income spent more elastic ddEg: dd for house is more elastic compared to demand for detergents because money spent on houses is greater than money spent on detergents.
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• Time frame
In short run less elastic/ inelastic dd
In the long run demand more elastic because consumers can make adjustment and find other substitutes.
• The importance of goods – necessity or luxury
Necessity good inelastic dd eg: rice (great increase in price will not reduce the demand for rice very much).
Luxury goods/ less important goods elastic dd
• The number of usage
many number of usage more elastic compared to goods that have fewer usage. Eg: demand for rubber is more elastic because it can be processed into rubber hoses, tyres, gloves, & etc
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• Income level
higher income people inelastic dd.
lower income group elastic dd (sensitive to price changes)
• Habits
habits inelastic dd. Eg: demand for cigarette by smokers.
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Relationship between price elasticity of demand and total revenue (TR)
• Important for producers to decide whether they should increase, decrease or maintain the price of the good they sold in the market to enable them to maximize their profit
• TR = price x quantity• TR increases or decreases when there is price changes depend on
the price elasticity of demand.
i. If demand is elastic, to increase TR, price should be decreased.
ii. If demand is inelastic, to increase TR, price should be increased.
iii. If demand is unitary elastic, change in price would not affect and change in TR.
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(i) Inelastic demand (Ed<1)Assume price increases from RM10 to RM15
Price (RM)
Quantity (units)
8 10
10
15Steep line demand curve
TR before = RM10 x 10 = RM100
TR after = RM15 x 8 = RM120
(TR increases)
# If demand is inelastic, an increase in price will lead to an increase total revenue & vice versa
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ii) Elastic demand (Ed>1)Assume that price increases from Rm10 to RM11
Smooth line demand curve
P
Q7 10
10
11
TR before = RM10 x 10 = RM100
TR after = RM11 x 7 = RM77
(TR decreases)
# If demand is elastic, an increase in price will lead to a decrease in total revenue.
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20
10
10 20
P
Q
iii) Unitary elastic demand (Ed=1)Assume that price increases from RM10 to RM20
TR before = RM10 x 20 = RM200
TR after = RM20 x 10 = RM200
(TR remains the same)
# If demand is unitary elastic, an increase in price will make total revenue remains the same
Hyperbola line dd curve
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The R/ship between TR & Price Elasticity of Demand when Price Increases
Elasticity Coefficient
Price Elasticity of Demand
Price Quantity Demanded
Total Revenue
Ed>1 Elastic Increases Decreases more than
proportionate
Decreases
Ed=1 Unitary elastic Increases Decreases in exact
proportion
Remain the same
Ed<1 Inelastic Increases Decreases less than
proportionate
Increases
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The R/ship between TR & Price Elasticity of Demand when Price Decreases
Elasticity Coefficient
Price Elasticity of Demand
Price Quantity Demanded
Total Revenue
Ed>1 Elastic Decreases Increases more than
proportionate
Increases
Ed=1 Unitary elastic Decreases Increases in exact
proportion
Remain the same
Ed<1 Inelastic Decreases Increases less than
proportionate
Decreases
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Cross Elasticity of Demand (Exy)
• Exy measures the responsiveness of quantity demanded for one product to a change in the price of another product.
Formula:
Exy = % ∆ in Qx
% ∆ in Py
= ∆ Qx x Py0
∆ Py Qx0
= (Qx1 – Qx0) x Py0
(Py1 – Py0) Qx0
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i) Exy < 0 product X is a complement of product Y
ii) Exy > 0 product X and Y are substitutes for one another
iii) Exy = 0 product X and Y are independent for one another
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• Example:Price of Y Quantity x Quantity Y
RM10 60 15RM18 40 25RM25 20 30
• Calculate the cross elasticity of demand for good x when the price of y increases from RM18 to RM25
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Answer:Formula :
= ∆ Qx x Py0
∆ Py Qx0
= (Qx1 – Qx0) x Py0
Qx0 Py1 – Py0
= 20 - 40 x 18 40 25 - 18
= -1.29
• Conclusion;Goods x and y are complement
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Income Elasticity of Demand (Ey)
• Ey measures the responsiveness of quantity demanded to a change in income.
• Three possibilities:i. If Ey is positive = normal goods -
Ey >1 - luxury Ey ≤ 1 – necessity
ii. If Ey is negative = inferior goodsiii. If Ey is zero = essential goods
Eg. Ey = 5 if income increase 1%, quant. demanded for good X will increase by 5%
Ey = 0 if income changes, quant. demanded for good B remains unchanged
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• Formula:Ey = % ∆ in Q
% ∆ in Y= ∆ Q x Y0
∆ Y Q0
= (Q1 – Q0) x Y0
(Y1 – Y0) Q0
= (Q1 – Q0) x Y0
Q0 (Y1 – Y0)
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• Example:Income Qty A Qty B Qty C 100 10 20 20 120 15 20 18 150 17 20 14
Calculate the income elasticity of demand for goods A, B and C when income increases from RM120 to RM150.
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• Good A:Ey = (QA1 – QA0) x Y0
QA0 (Y1 – Y0)
= (17 – 15) x 120 15 (150 – 120)
= 0.53
• Since Ey is positive and < 1, good A is a necessity good• When Y increase by 1%, quant. demanded for good A
increase by 0.53%
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• Good B:Ey = (QB1 – QB0) x Y0
QB0 (Y1 – Y0)
= (20 – 20) x 120 20 (150 – 120)
= 0 (Good B is essential good)
# if Y change, q.demanded for good B remains unchanged
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• Good C:Ey = (QC1 – QC0) x Y0
QC0 (Y1 – Y0)
= (14 – 18) x 120 18 (150 – 120)
= - 0.89
• Good C is an inferior good• When Y increase by 1%, quantity demanded for good C
decrease by 0.89%