The document discusses concepts related to demand, including the law of demand, demand schedules, demand curves, elasticity of demand, and how elasticity affects total revenue. Specifically, it explains that according to the law of demand, as price increases, quantity demanded decreases, and vice versa. It provides examples of demand schedules and how they are used to construct demand curves. It also discusses factors that can cause a shift in the demand curve, such as changes in income, population, or prices of related goods. Finally, it explains the concept of elasticity of demand and how elastic versus inelastic demand impacts a firm's total revenue when price is changed.

1. Chapter 4 Section Main
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Understanding Demand
• What is the law of demand?
• How do the substitution effect and income effect
influence decisions?
• What is a demand schedule?
• What is a demand curve?

2. Chapter 4 Section Main
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Law of Demand
• Demand – the desire to own something and ability to
pay for it
• Law of Demand
– Price goes down = demand goes up
– Price goes up = demand goes down
– Price of a good strongly influences the decision to
buy it
– Example
• How many pieces of pizza would you buy at $1?
• Same piece at $2, $3, and so on

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Law of Demand
• Two separate patterns overlap b/c of Law of Demand
– Substitution Effect and Income Effect
• They describe 2 different ways that a consumer can
change their spending patterns

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Substitution Effect
• When the price of the pizza rises, more people will start
buying other products
– Drops the demand for pizza
– Change in spending is known as the substitution
effect
• Eating pizza on Mondays and Fridays now turns
into pizza on only Mondays and something else
on Fridays
– Reacting to the price change of one good and
substituting it for another

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The Income Effect
• Price of the goods you buy go up, you start to make cut
backs on the purchases you make
– Cut back on buying pizza, clothes, etc.
• Buying fewer products w/o increasing your purchases
of other goods is the Income Effect
• Economists measure consumption in the amount of a
good that is bought, not the price on the good
– Spending more on pizza but you are consuming less
• People spend more money on pizza, the demand still
goes down

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Understanding Demand
• To have demand for a good you must be willing and
able to pay for it at a specified price
– Might want a new car, but you can’t afford it so you
do not demand it
• Demand Schedule
– Table that lists the quantity of a good that a person
will purchase at each price in a market

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Market Demand Schedules
• Adding up the demand schedules for every buyer in the
market, this is creating a Market Demand Schedule
– Shows the quantities demanded at each price by all
consumers in the market
– Businesses use these to predict the total sale of a
product at different prices
• This schedule shows the Law of Demand in play

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Demand Schedules
Individual Demand Schedule
Price of a
slice of pizza
Quantity demanded
per day
Market Demand Schedule
Price of a
slice of pizza
Quantity demanded
per day
$.50
$1.00
$1.50
$2.00
$2.50
$3.00
5
4
3
2
1
0
$.50
$1.00
$1.50
$2.00
$2.50
$3.00
300
250
200
150
100
50
The Demand Schedules

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Market Demand Curve
3.00
2.50
2.00
1.50
1.00
.50
0
0 50 100 150 200 250 300 350
Slices of pizza per day
Priceperslice(indollars)
Demand
The Demand Curve
• A demand curve is a
graphical representation of
a demand schedule.
• Reading a demand curve
–Only price and quantity
are taken into account
–Slopes downward and
right
–Prices rise, quantity
drops
–Prices decrease, quantity
raises

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Limits of a Demand Curve
• Only accurate for one very specific set of market
conditions
• Does not take any other factors into account
– Pizza place near a factory that has layoffs will lose
business b/c those workers will stop coming in

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Shifts of the Demand Curve
• What is the difference between a change in quantity
demanded and a shift in the demand curve?
• What factors can cause shifts in the demand curve?
• How does the change in the price of one good affect
the demand for a related good?

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Changes in Demand
• Demand curves are accurate as long as there are no
other changes other than price that affects decisions
• Ceteris Paribus
– “all other things held constant”
– This was used on the Demand Curve w/ pizza
– Does not take into account any other factors (only
price and quantity)
• When price changes we move along the curve
– Change in quantity demanded
– Up or down the curve

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Changes in Demand
• Get rid of the ceteris paribus rule then we no longer
move along the curve
– The entire curve shifts left or right
• A shift in the demand curve means that at every price,
consumers buy a diff. amount than before
– Called Change in Demand

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Causes for Shifts - Income
• Normal Goods – goods that consumers demand more
of when their income increases
– This would move the curve to the right to show more
demand at each price
• Increase in Demand
• Decrease in Demand – if the curve shifts to the
left
– Inferior Goods – an increase in income causes us to
buy less of these
• Buy name brand stuff once your income rises
instead of store brand

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Causes - Consumer Expectations
• Expectations of a higher price will affect your
immediate demand of the product
– Example
• Go into Best Buy to buy a laptop and the sales
person tells you the price will go up in a week
• Your demand for the product raises and you
would probably purchase it then b/c you expect a
higher price
• Your immediate demand will drop if the laptop
would be on sale next week

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Causes - Population
• Rise in population obviously raises the demand for
food, shelter, etc.
• After WWII
– Record number of men and women married and had
children (“baby boom”) from mid 1940s – 1964
– Initial demand grew w/ baby products, then it
thousands of schools were needed and built
(universities also expanded later)
– Now that they are retiring, the demands among
senior citizens will rise

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Causes – Consumer Tastes and Advertising
• Trends change over periods of time (clothes, music,
etc.)
• Advertising and publicity play an important role
– Companies spend large amounts of money on
advertising to try and raise the demand for their
products

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Prices of Related Goods
• Demand curve for one good can be affected by a
change in the demand for another good
– Complements
• Two goods that are bought and used together
• Buy new skis, need ski boots
• If the price of skis go up, the demand for both
products go down
– Substitutes
• Goods used in place of another
• Price of skis goes up, some people will switch to
snowboarding

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Elasticity of Demand
• What is elasticity of demand?
• How can a demand schedule and demand curve be
used to determine elasticity of demand?
• What factors affect elasticity?
• How do firms use elasticity and revenue to make
decisions?

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Elasticity of Demand
• Elasticity of Demand - Dictates how drastically buyers
will cut back or increase their demand for a good when
price rises or falls
• Inelastic – demand for a good that you will keep buying
no matter the rise in price
– Not too responsive to price change
• Elastic – buy much less of a good when the price
increases
– Very responsive to price change

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Price Range
• Demand for a good can be highly elastic at one price
and inelastic at another
– Example:
• Price of a bottle of Coke goes from $1.00 to $1.50
– Raises 50%, most people will keep buying
almost the same amount
– Inelastic
• If the price went from $2.00 to $3.00
– Still 50% rise, however the demand will go
down more than the first example
– Highly elastic

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Values of Elasticity
• If the elasticity of demand for a good at a certain price
is LESS than 1 it is INELASTIC
• Elasticity is GREATER than 1 it is ELASTIC
• Elasticity = 1, it is called Unitary Elastic
– % change in quantity demanded is exactly equal to
the % change in the price
– Example: Demand for a magazine at $2 is unitary
• Price rises to $3 (50% rise)
• The newsstand will sell exactly half as many
copies as before

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Values of Elasticity
• Pizza Example from before
– Demand schedule showed that when the price rose
from $1 to $1.50, her demand fell from 4 to 3 slices
– Change in price was 50% and the quantity decreased
by 25%
– Dividing 25% by 50% you get .5
– Less than 1 so it is inelastic

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Elasticity of Demand
Elasticity is determined using the following formula:
Elasticity =
Percentage change in quantity demanded
Percentage change in price
Percentage change =
Original number – New number
Original number
x 100
To find the percentage change in quantity demanded or price, use the following formula:
subtract the new number from the original number, and divide the result by the original
number. Ignore any negative signs, and multiply by 100 to convert this number to a
percentage:
Calculating Elasticity

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If demand is elastic, a small change in price
leads to a relatively large change in the quantity
demanded. Follow this demand curve from left to
right.
Price
Quantity
$7
$6
$5
$4
$3
$2
$1
Elastic Demand
0
5 10 15 20 25 30
Demand
The price decreases from $4 to $3, a decrease
of 25 percent.
$4 – $3
$4
x 100 = 25
The quantity demanded increases from
10 to 20. This is an increase of 100
percent.
10 – 20
10
x 100 = 100
Elasticity of demand is equal to 4.0.
Elasticity is greater than 1, so demand is
elastic. In this example, a small decrease
in price caused a large increase in the
quantity demanded.
100%
25%
= 4.0
Elastic Demand

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Price
Quantity
$7
$6
$5
$4
$3
$2
$1
Inelastic Demand
0
5 10 15 20 25 30
Demand
If demand is inelastic, consumers are not very
responsive to changes in price. A decrease in
price will lead to only a small change in quantity
demanded, or perhaps no change at all. Follow
this demand curve from left to right as the price
decreases sharply from $6 to $2.
The price decreases from $6 to $2, a decrease
of about 67 percent.
$6 – $2
$6
x 100 = 67
The quantity demanded increases from
10 to 15, an increase of 50 percent.
10 – 15
10
x 100 = 50
Elasticity of demand is about 0.75. The
elasticity is less than 1, so demand for this
good is inelastic. The increase in quantity
demanded is small compared to the
decrease in price.
50%
67%
= 0.75
Inelastic Demand

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Factors Effecting Elasticity
• Availability of Substitutions
– No good substitutions for a product means when the
price rises for one, you will probably still buy it
• Want to see your favorite band in concert,
probably buy the tickets b/c there is no good sub
(inelastic)
– Lots of substitutes make some products elastic
• Foods at grocery store, just switch brands based
on price

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Factors continued
• Relative Importance
– If you buy a lot of one good and price goes up, you
must make tough decisions
• Reduce consumption of that good or cut back
drastically on other goods in order to keep budget
in control
• Higher the jump, more adjustments
• Spend half of budget on clothes, price goes up,
large cut backs = elastic demand

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Factors continued
• Necessities vs. Luxuries
– Necessities – food, water, gas, clothes, etc.
• Things we buy no matter the price (inelastic)
– Some people feel that Starbucks is a luxury
• Price goes down more people will buy it
• Price its at now and especially if it rises, people
will buy cheaper coffee
• Elastic
• Everyone has different idea of what necessities and
luxuries are

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Change Over Time
• Consumers shopping habits do not change quickly
when prices increase
– Takes time to find substitutes
– Inelastic in the short term, but becomes elastic over
time
• Example
– Person buys an SUV that takes a lot of gas to run
– Work is far away and so is the grocery store
– Factors can’t be changed very easily

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Change Over Time
• Gasoline Example continued
– 1970s – gas prices rose, but at first people kept
buying gas
– Over time the prices stayed high so people bought
more fuel efficient cars or car pooled
– Demand for gas went down
– Inelastic in short term, became elastic over time

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Computing a Firm’s Total Revenue
• Total Revenue – the total amount of money a firm
receives by selling goods/services
– Need to know the price of goods and the amount
sold
– Pizzeria sells 125 slices/day at $2 a slice
– Total revenue is $250/day

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Total Revenue and Elastic Demand
• When a good has an elastic demand (price of each
good raises 20% and the quantity sold drops by 50%)
– Quantity sold drops enough to reduce the total
revenue
• Pizzeria Example
– $2.50/slice will sell 100 slices/day making total
revenue $250
– Increase the price to $3/slice and you only sell 50
slices/day
• Total revenue is now only $150

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Total Revenue and Elastic Demand
• Elastic Demand comes from one or more of these
factors
– 1. Availability of substitute goods
– 2. a limited budget that does not allow price changes
– 3. the perception of the good as a luxury item
• If these are present, then the firm may find a price
increase reduces total revenue

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Total Revenue and Inelastic Demand
• Firm raises its price by 25% and the amount sold falls
by less than 25%
– Firm has greater total revenues
– Higher price makes up for the firm’s lower sales
• A decrease in price will lead to an increase in quantity
demanded (if demand is inelastic)
– Demand will not rise much (in %) as price fell
– Firms total revenue will decrease

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Elasticity and Revenue
• Elastic Demand
– Price is lowered = total revenue rises
– Price raised = total revenue falls
• Inelastic Demand
– Price lowered = total revenue falls
– Price raised – total revenue rises