chapter 4 consider demand

100 UNIT 2 THE MARKET ECONOMY

CONSIDER ...

5 Why are newspapers sold in vending machines that allow you to take more than one copy?

5 How much chocolate do you eat when you can eat all you want?

5 What cures spring fever?

5 What economic principle is behind the saying, “Been there, done that”?

5 Why do higher cigarette taxes cut smoking by teenagers more than by other age groups?

CHAPTER 4

Demand

4.1 The Demand Curve

4.2 Elasticity of Demand

4.3 Changes in Demand

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Chapter 4 D e m a n d

demand A relation showing the quantities of a good that consumers are willing and able to buy per period at various prices, other things constant

law of demand The quantity of a good demanded per period relates inversely to its price, other things constant

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4.1 T H E D E M A N D C U R V E

Learning Objectives

L 1 Explain the law of demand.

L 2 Interpret a demand schedule and a demand curve.

In Your WorldTh e primary building blocks of a market economy are demand and supply. Consumers demand goods and services that maximize their utility, and producers supply goods and services that maximize their profi t. As a consumer in the U.S. market economy, you demand all kinds of goods and services. You buy less of a good when its price increases and more when the price decreases. Th is section draws on your own experience as a consumer to help you understand demand, particularly the demand curve.

Key Termsdemand 101

law of demand 101

marginal utility 103

law of diminishing marginal utility 103

demand curve 105

quantity demanded 106

individual demand 107

market demand 107

LAW OF DEMANDHow many 12-inch pizzas do people buy each week if the price is $12? What if the price is $9? What if it’s $6? Th e answers reveal the relationship between the price of pizza and the amount purchased. Such a relationship is called the demand for pizza.

Demand indicates how much of a product consumers are both willing and able to buy at each price during a given time period, other things constant. Because demand pertains to a specifi c period—a day, a week, a month—you should think of demand as the amounts purchased per time period at each price. Also, notice the emphasis on willing and able. You may be able to buy a rock con-cert ticket for $50 because you can aff ord one. However, you may not be willing to buy one if the performers don’t interest you enough.

Th is relation between price and quantity demanded refl ects an economic law. Th e law of demand says that quantity demanded varies inversely or negatively, with price, other things constant. Th us, the higher the price, the smaller the quantity demanded. Th e lower the price, the greater the quantity demanded.

Demand, Wants, and NeedsConsumer demand and consumer wants are not the same thing. Wants are

unlimited. You may want a new Mercedes-Benz SL600 Roadster convertible,

L 1Explain

the law of

demand.


UNIT 2 THE MARKET ECONOMY102

but the $139,100 price tag is likely beyond your budget. (Th e quantity you demand at that price is zero.) Nor is demand the same as need. You may have outgrown your winter coat and need a new one. But if the price is $200, you may decide your old coat will do for now. If the price drops enough—say, to $100—then you become both willing and able to buy a new one.

Substitution EffectWhat explains the law of demand? Why,

for example, does the quantity demanded increase when the price falls? Th e explanation begins with unlimited wants meeting scarce resources. Many goods and services help satisfy your particular wants. For example, you can satisfy your hunger with pizza, tacos, burgers, chicken, sandwiches, salads, or hun-dreds of other foods. Similarly, you can satisfy your desire for warmth in the winter with warmer clothing, a home-heating system, a trip to Hawaii, or in other ways.

Some ways of satisfying your wants are more appealing to you than others. A trip to Hawaii is more fun than warmer clothing. In a world without scarcity, everything would be free, so you would always choose the most at-

tractive alternative. Scarcity, however, is a reality, and the degree of scarcity of one good relative to another helps determine each good’s relative price.

Notice that the defi nition of demand includes the other-things-constant assumption. Among the “other things” assumed to remain constant are the prices of other goods. For example, if the price of pizza declines while other prices remain constant, pizza becomes relatively cheaper. Consumers are more willing to buy pizza when its relative price falls. People tend to substitute pizza for other goods. Th is is called the substitution eff ect of a price change. On the other hand, an increase in the price of pizza, other things constant, increases its relative price. Pizza’s opportunity cost increases—that is, the amount of other goods you must give up to buy pizza increases. Th is higher opportunity cost causes some consum-ers to substitute other goods for the now higher-priced pizza, thus reducing their quantity of pizza demanded.

Remember that the change in the relative price—the price of one good relative to the prices of other goods—causes the substitution eff ect. If all prices changed by the same percent, there would be no change in relative prices and no substitution eff ect.

The law of demand applies even to personal choices, such as whether or not to own a pet. For example, after New York City passed an anti-dog-litter law, owners had to follow their dogs around the city with scoopers and plastic bags. The law raised the cost, or price, of owning a dog. What do you think happened to the quantity of dogs demanded as a result of this law, and why?

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Income EffectA fall in the price increases the quantity demanded for a second reason. If you

take home $36 a week from a Saturday job, your money income is $36 per week. Your money income is simply the number of dollars you receive per period, in this case, $36 per week. Suppose you spend all your income on pizza, buying four a week at $9 each. What if the price falls to $6? At that lower price you can now aff ord six pizzas a week.

Your money income remains at $36 per week, but the drop in the price increases your real income—that is, your income measured in terms of how much it can buy. Th e price reduction, other things constant, increases the purchasing power of your income, thereby increasing your ability to buy pizza and, indirectly, other goods. Th e quantity of pizza you demand likely increases because of this income eff ect of a price change. You may not increase your quantity demanded to six pizzas, but you can now aff ord six. If you purchase fi ve pizzas a week when the price drops to $6, you would still have $6 left to buy other goods.

Th us, the income eff ect of a lower price increases your real income and thereby increases your ability to purchase pizza and other goods, making you better off . Th e income eff ect of a lower price is underscored in Walmart’s slogan, which emphasizes the benefi ts of low prices: “Save money. Live better.” Because of the income eff ect, consumers typically increase their quantity demanded after a price decrease. Conversely, an increase in the price of pizza, other things constant, reduces your real income, thereby reducing your ability to buy pizza. Because of the income eff ect of a price increase, consumers typically reduce their quantity demanded after a price increase.

Diminishing Marginal UtilityAfter a long day of school, studies, and sports, you are starved, so you visit a

local pizzeria. Th at fi rst slice tastes great and puts a serious dent in your hunger. Th e second is not quite as good as the fi rst. A third is just fair. You don’t even consider a fourth slice. Th e satisfaction you derive from an additional unit of a product is called your marginal utility. For example, the additional satisfaction you get from a second slice of pizza is your marginal utility of that slice.

Th e marginal utility you derive from each additional slice of pizza declines as your consumption increases. Your experience with pizza refl ects the law of diminishing marginal utility. Th is law states that the more of a good an individual consumes per period, other things constant, the smaller the marginal utility of each additional unit consumed.

Diminishing marginal utility is a feature of all consumption. A second foot-long submarine sandwich at one meal would probably yield little or no marginal utility. You might still enjoy a second movie on Friday night, but a third one is probably too much to take. In fact, almost anything repeated enough can become torture, such as being forced to watch the same movie or listen to the same song over and over. Yes, variety is the spice of life.

marginal utility Thechange in total utility resultingfrom a one-unit change in consumption of a good

law of diminishing marginal utility The moreof a good an individual consumesper period, other things constant, the smaller the marginal utility of each additional unit consumed

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Consumers buy things to increase their satisfaction, or utility. In deciding what to buy, people make rough estimates about the marginal utility, or marginal benefi t, they expect from the good or service. Based on this expected marginal benefi t, people then decide how much they are willing and able to pay. Because of diminishing marginal utility, you would not be willing to pay as much for a second slice of pizza as for the fi rst. Th is is why it takes a decrease in price for you to increase your quantity demanded.

Suppose each slice of pizza sells for $2. How many slices do you buy? You increase consumption as long as the marginal benefi t you expect from another slice exceeds $2. You won’t buy an additional slice if you expect its marginal benefi t is less than $2. Simply put, you aren’t willing to pay $2 for something that’s worth less than that to you.

What if the price of pizza drops to $1 a slice? You buy more as long as the marginal benefi t of another slice exceeds $1. Th e law of diminishing marginal utility helps explain why people buy more when the price declines.

Diminishing marginal utility has wide applications. Restaurants depend on the law of diminishing marginal utility when they off er all-you-can-eat specials. People at all-you-can-eat specials continue to eat as long as the margin-al benefi t of another bite is greater than zero. And no doggie bags—the deal is all you can eat now, not all you can eat now and for as long as the doggie bag holds out.

After a long winter, that fi rst warm day of spring is something special and is the cause of “spring fever.” Th e fever is cured by many warm days like the fi rst. By the time August rolls around, most people get much less marginal utility from yet another warm day.

For some goods, the drop in marginal utility after the fi rst unit is dramatic. For example, a second copy of the same daily newspaper would likely provide you with no marginal utility. In fact, the design of newspaper vending machines relies on the fact that you won’t take more than one.

More generally, the expressions “Been there, done that” and “Same old, same old” convey the idea that, for many activities, things start to get old after the fi rst time. Your marginal utility, or marginal benefi t, declines.

Explain the law of demand in your own words.

How does the law of diminishing marginal utility apply to pizza consumption?

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DEMAND SCHEDULE AND DEMAND CURVEDemand can be expressed as a demand schedule and as a demand curve. Panel (A) of Figure 4.1 shows a hypothetical demand schedule for pizza. When you describe demand, you must spec-ify the units being measured and the period considered. In this example, the price is for a 12-inch regular pizza and the period is a week. Th e schedule in panel (A) lists prices, along with the quantity demanded at each price.

At a price of $15, for example, consumers in this market demand 8 million pizzas per week. As you can see, the lower the price the greater the quantity de-manded, other things constant. If the price drops as low as $3, consumers demand 32 million per week. As the price falls, consumers substitute pizza for other goods. As the price falls, the real income of consumers increases, causing them to increase the quantity of pizza they demand. As pizza consumption increases, the marginal utility of pizza declines, so quantity demanded increases only if the price falls.

Th e demand schedule in panel (A) of Figure 4.1 appears as a demand curve in panel (B), with price measured on the vertical axis and the quantity demanded per week on the horizontal axis. Each combination of price and quantity listed in the demand schedule becomes an individual point on the market demand curve. Point a, for example, indicates that if the price is $15, consumers demand 8 million pizzas per week. Th ese points connect to form the market demand curve for pizza, labeled D. Note that some demand curves are straight lines, some are crooked lines, and some are curved lines, but all of them are called demand curves, and they all slope downward.

L 2Interpret

a demand

schedule

and a demand

curve.

demand curve A curve or line showing the quantities of a particular good demanded atvarious prices during a given time period, other things constant

FIGURE 4.1 Demand Schedule and Demand Curve for PizzaMarket demand curve D shows the quantity of pizza demanded, at various prices, by all consumers.

(A) DEMAND SCHEDULE

Price Quantity per demanded per

pizza week (millions)

a $15 8b 12 14c 9 20d 6 26e 3 32

(B) DEMAND CURVE

$15

8 14 20 26 32 0

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12

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UNIT 2 THE MARKET ECONOMY

A demand curve slopes downward from left to right, refl ecting the law of demand—that is, price and quantity demanded are inversely, or negatively, related, other things constant. Several things are assumed to remain constant along the demand curve, including the prices of other goods. Th us, along the demand curve, the price of pizza changes relative to the prices of other goods. Th e demand curve shows the eff ect of a change in the relative price of pizza—that is, relative to other prices, which do not change.

Demand Versus Quantity DemandedBe careful to distinguish between demand and quantity demanded. An

individual point on the demand curve shows the quantity demanded at a particular price. For example, point b on the demand curve in Figure 4.1 indi-cates that 14 million pizzas are demanded when the price is $12. Th e demand for pizza is not a specifi c quantity, but the entire relation between price and quantity demanded. Th is relation is represented by the demand schedule or the demand curve. To recap, quantity demanded refers to a specifi c amount of the good on the demand schedule or the demand curve, whereas demand refers to the entire demand schedule or demand curve.

quantity demanded The amount demanded at a particular price

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ESSENTIAL QUESTION

What is the result of the interaction between buyers and sellers?

Standard CEE 7: Markets and PricesA market exists when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce goods and services.

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Individual Demand and Market DemandIt is also useful to distinguish between individual demand, which is the

demand of an individual consumer, such as you, and market demand, which sums the individual demands of all consumers in the market. Th e market demand curve shows the total quantities demanded per period by all consumers at various prices.

In most markets, there are many consumers, sometimes millions. To give you some feel for how individual demand curves sum to the market demand curve, assume that there are only three consumers in the market for pizza: Hector, Brianna, and Chris. Figure 4.2 shows how three individual demand curves are summed across to get the market demand curve. When the price of a pizza is $8, for example, Hector demands two pizzas a week, Brianna demands one, and Chris demands none. Th e quantity demanded at a price of $8 is therefore three pizzas. At a price of $4, Hector demands three per week, Brianna two, and Chris one, for a quantity demanded of six. Panel (D) sums horizontally each individual’s demand curve to arrive at the market demand curve.

Th e market demand curve is simply the sum of the individual demand curves for all consumers in the market. Unless otherwise noted, this book focuses on market demand.

individual demand The demand of an individual consumer

market demand The sumof the individual demands of allconsumers in the market

What do a demand schedule and a demand curve show?

FIGURE 4.2 Market Demand for PizzaThe individual demand curves of Hector, Brianna, and Chris are summed across to get the market demand curve. At a price of $8 per pizza, Hector demands 2 per week, Bri-anna demands 1, and Chris demands none. Quantity demanded at a price of $8 is 2 + 1 + 0 = 3 pizzas per week. At a lower price of $4, Hector demands 3, Brianna demands 2, and Chris demands 1. Quantity demanded at a price of $4 is 6 pizzas. The market demand curve D is the horizontal sum of individual demand curves d

H, d

B, and d

C.

Pizzas per week Pizzas per week Pizzas per week Pizzas per week

(A) HECTOR

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(D) MARKET DEMAND FOR PIZZA

1 3 6

dCdH dB

dH + dB + dC = D

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CHANGES THAT SHIFT THE DEMAND CURVEA demand curve isolates the relationship between price and quan-tity demanded when other factors that could aff ect demand are assumed constant. Th ese other factors are often referred to as determinants of demand. Th e determinants of demand include the following:

1. Consumer income

2. Th e prices of related goods

3. Th e number and composition of consumers

4. Consumer expectations

5. Consumer tastes

How does a change in each aff ect demand?

Changes in Consumer IncomeFigure 4.6 shows the market demand curve D for pizza. Consumers’ money

income is assumed to remain constant along a demand curve. Suppose money income increases. Some consumers are then willing and able to buy more pizza at each price, so market demand increases. Th e demand curve shifts to the right from D to D´. For example, at a price of $12, the amount demanded per week increases from 14 million to 20 million, as indicated by the movement from point b on demand curve D to point f on demand curve D´. In short, an increase

4.3 C H A N G E S I N D E M A N D

Learning Objectives

L 1 Identify the determinants of demand, and explain how a change in each affects the demand curve.

L 2 Distinguish between the money price and the time price of a good.

In Your WorldSo far the discussion of demand has been limited to the relationship between price and quantity demanded. Th at is, your focus has been on movements along a particular demand curve. A demand curve isolates the relation between the price of a good and the quantity demanded when other factors that could aff ect demand remain unchanged. Here you will be introduced to these other determinants of demand and will learn how changes in them aff ect demand.

Key Termstastes 123

movement along a given demand curve 124

shift of a demand curve 124

L 1Identify

the deter-

minants of

demand,

and explain

how a

change in

each affects

the demand

curve.


Chapter 4 D e m a n d 121

in demand—that is, a rightward shift of the demand curve—means that consumers are more willing and able to buy pizza at each price.

Normal Goods Goods are classifi ed into two broad categories depending on how the demand for the good responds to changes in money income. Th e demand for a normal good increases as money income increases. Because pizza is a normal good, its demand curve shifts rightward when money income increases. Most goods are normal goods.

Inferior Goods In contrast, the demand for an inferior good actually decreases as money income increases. Examples of inferior goods include bologna sandwiches, used furniture, used clothing, trips to the Laundromat, and bus rides. As money income increases, consumers switch from these inferior goods to nor-mal goods—such as roast beef sandwiches, new furniture, new clothing, a washer and dryer, and automobile or plane rides.

Changes in the Prices of Related GoodsAs you’ve seen, the prices of other goods are assumed to remain constant along

a given demand curve. Now you are ready to consider the impact of changes in the prices of other goods.

Substitutes Products that can be used in place of each other are called substitutes. Consumers choose among substitutes partly on the basis of relative

FIGURE 4.6 An Increase in the Market Demand for PizzaAn increase in the market demand for pizza is shown by a right-ward shift of the demand curve. After the increase in demand, the quantity of pizza demanded increases at each price level. For example, the quantity demanded per week at a price of $12 increases from 14 million (point b) to 20 million (point f ).

0 8 14 20 26 32 Millions of pizzas per week

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prices. For example, pizza and tacos are substitutes, though not perfect ones. An increase in the price of tacos prompts some consumers to buy pizza instead. Th is is shown in Figure 4.6 by a rightward shift of the demand curve. Two goods are substitutes if an increase in the price of one shifts the demand curve for the other rightward.

On the other hand, a decrease in the price of tacos would reduce the demand for pizza, as shown in Figure 4.7, where the demand curve for pizza shifts to the left from D to D". As a result, consumers demand less pizza at every price. For example, at a price of $12, the amount demanded decreases from 14 million to 10 million per week, as indicated by the movement from point b on demand curve D to point j on demand curve D".

Complements Certain goods are often used in combination. Pizza and soft drinks, milk and cookies, computer hardware and software, and airline tickets and rental cars are complements. If two goods are complements, a decrease in the price of one increases the demand for the other. For example, a decrease in the price of soft drinks shifts the demand curve for pizza rightward.

FIGURE 4.7 A Decrease in the Market Demand for PizzaA decrease in the demand for pizza is shown by a leftward shift of the demand curve. After the decrease in demand, the quantity of pizza demanded decreases at each price level. For example, quantity demanded per week at a price of $12 decreases from 14 million (point b) to 10 million (point j).

0 8 14 10 20 26 32

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D D''

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Changes in the Size or Composition of the Population

Th e market demand curve is the horizontal sum of the individual demand curves of all consumers in the market. If the population grows, the number of consumers in the market increases, so demand increases. For example, if the population grows, the demand curve for pizza shifts rightward. Even if the total population remains unchanged, demand could shift as a result of a change in the composition of the population. For example, an increase in the teenage population could shift pizza demand rightward. A baby boom would increase the demand for car safety seats and baby food. A growing Latino population increases the demand for Latino foods.

Changes in Consumer ExpectationsAnother factor assumed to be constant along a given demand curve is consum-

er expectations about factors that infl uence demand, such as incomes and prices. A change in consumer expectations can shift the demand curve. For example, your demand for some goods may increase after you line up a summer job, even before that job begins.

Changes in price expectations also can shift demand. For example, if you expect pizza prices to jump next week, you may buy an extra one today for the freezer, thereby shifting the demand curve for pizza rightward. Or if consum-ers come to believe that home prices will climb next year, some increase their demand for housing this year, shifting the demand curve for housing rightward. Th e expectation of lower prices has the opposite eff ect. For example, during the recession of 2008–2009, people expected home prices to continue falling, so they put off buying one, shifting the demand for housing leftward.

Changes in Consumer TastesDo you like anchovies on your pizza? How about sauerkraut on a hot dog? Is

music to your ears more likely to be rock, country, heavy metal, hip-hop, reg-gae, jazz, Latin, gospel, New Age, or classical? Choices in food, music, clothing, reading, movies, TV shows—indeed, all consumer choices—are infl uenced by consumer tastes.

Tastes are your likes and dislikes as a consumer. Tastes are assumed to remain constant along a given demand curve. What determines your tastes? Your desire to eat when hungry and to drink when thirsty are largely biological. So, too, is your desire for shelter, comfort, rest, companionship, personal safety, and a pleasant

To learn more about the economics of consumption, read Jane Katz’s “The Joy of Consumption” in the Federal Reserve Bank of Boston’s Regional Review. Access this article through the URL shown below. What evidence does Katz cite about how the rising value of time has aff ected consumer spending patterns?

www.cengage.com/school/contecon

Examine changes or trends in the composi-tion of the population of your city or town. What products or categories of products might these changes aff ect?

tastes A consumer’s likes and dislikes

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UNIT 2 THE MARKET ECONOMY

environment. Your family background, surrounding culture, and peer infl uence all shape many of your tastes.

Generally, economists claim no special expertise in understanding how tastes develop and can change over time. Economists recognize, however, that tastes are important in shaping demand. For example, although pizza is popular, some people just don’t like it and others might be allergic to the cheese, tomatoes, or the gluten in the pizza dough. Th us, most people like pizza but some don’t. A change in tastes for a particular good would shift the demand curve. For example, a discovery that the combination of cheese and tomato sauce on pizza promotes overall health could aff ect consumer tastes, shifting the demand curve for pizza to the right.

But a change in tastes is diffi cult to isolate from other economic changes. Th at’s why economists attribute a change in demand to a change in tastes only as a last resort, after ruling out other possible explanations.

Movement Along a Demand Curve Versus a Shift of the Curve

Remember the distinction between a movement along a demand curve and a shift of a demand curve. A change in price, other things constant, causes a movement along a demand curve, changing the quantity demanded. A change in one of the determinants of demand other than price causes a shift of a demand curve, changing demand.

What are the fi ve determinants of demand, and how do changes in

each shift the demand curve?

When analyzing changes in demand for specifi c goods and services, why do you think changes in consumers’ tastes are diffi cult for economists to isolate?

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movement along ademand curve Change inquantity demanded resulting from a change in the price of the good,other things constant

shift of a demand curve Increase or decrease in demand resulting from a changein one of the determinants of demand other than the price of the good

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Chapter 4 D e m a n d 125

THE ROLE OF TIME IN DEMANDBecause consumption does not occur instantly, time plays a role in demand analysis. Consumption involves a money price and a time price. It is not the microwave oven, personal computer, airline trip, or pain medicine that you value but the services each provides. Other things constant, you would pay more to get the same benefi t in less time, as with faster ovens, computers, airline trips, or pain relief. Th at’s also why you are willing to pay more for ready-to-eat foods that you don’t need to prepare yourself.

Your willingness to pay more for time-saving goods and services depends on the opportunity cost of your time. Diff erences in the value of time among consumers help explain diff erences in the consumption patterns observed in the economy. For example, a retired couple has more leisure time than a working couple. Th e retired couple may clip discount coupons and search the newspapers for bargains, sometimes even going from store to store for particular grocery items on sale that week. Th e working couple may ignore the coupons and sales, eat out more often, and purchase more at convenience stores, where they are willing to pay extra for the convenience. Th e retired couple is more inclined to drive across country on vacation, whereas the working couple fl ies to a vacation destination.

Diff erences in the opportunity cost of time among consumers shape consump-tion patterns. Th is adds another dimension to demand analysis.

What’s the difference between the money price of a good

and its time price?

L 2Distinguish

between the

money price

and the time

price of a

good.

Are there goods and services for which you would be willing to pay more money? Explain your answer.

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chapter 4 consider demand

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