demand and elasticity

• The demand curve is downward sloping and shows the relationship between price (what a buyer pays) and quantity (number of units purchased at that price). This means that as the price of a good increases, the quantity demanded decreases.
• Substitute goods: an increase in the price of one good will lead to an increase in the quantity demanded of another good.
• Complement goods: an increase in the price of one good will lead to a decrease in the quantity demanded for another good.
• Income effect: when there is a change in income, it affects how much consumers are willing or able to spend on different products
• Substitution effect: when the price of one good rises, demand for other competing goods will rise as consumers buy more of the good with the lower price.
• The demand curve will shift right when demand for a good increases at each price level and will shift left if there is a decrease in demand at each price level.
• For a normal good, increased income will lead to increased demand, while for an inferior good, increased income might lead to decreased demand (in favour of better, more expensive alternatives).
• Rational choice theory makes the assumption that all individuals make logical decisions that will maximise their personal benefit or self-interest.
• Extension in a demand curve - quantity demanded increases across all price levels.

  
• The factors influencing demand include price, consumer income, prices of other goods and services, consumer tastes & fashion and others, such as advertising.
• Price elasticity of demand measures the responsiveness of the

  quantity demanded of a good or service to changes in its price, or how sensitive consumer demand is to changes in price.
• Price Elasticity of Demand (PED) = (% Change in Quantity Demanded) / (% Change in Price)
• The number of close substitutes is the most important factor in determining price elasticity of demand.
• Factors affecting price elasticity of demand include:

  • cost of switching between products
  • proportion of income allocated to spending on the good
  • degree of necessity
• When PED is greater than one, the product has elastic demand. When PED is less than one, it has inelastic demand.

  A) perfectly inelastic

  B) high

  C) decrease

  D) increase

  E) lower

  
• A change in demand is also referred to as a shift in the demand curve, either inward or outward.
• A change in quantity of demand is shown by movement along the demand curve, either upward or downward, caused by a change in price.
• A rise in price will cause a fall in revenue for price elastic products and a rise in revenue for price inelastic products.
• A fall in price will cause revenue to rise for price elastic products and to fall for price inelastic products.
• The law of diminishing marginal utility states that as we consume more of any good, the extra satisfaction gained from consuming an additional unit decreases.
• Time also affects the price elasticity of demand of a product. In the short run, products are more price inelastic as consumers struggle to adjust to changing prices, while in the long run, products are more price elastic as consumers are able to adapt their shopping habits.
• A market exists wherever there are buyers and sellers of a particular good. Buyers demand goods from the market whilst sellers supply goods to the market. Demand is the quantity of goods or services that will be bought at any given price over a period of time.
• When price changes, there is said to be movement along the curve, from one point to another. When the quantity demanded rises, there is said to be an extension of demand, and there is a contraction of demand when the quantity demanded falls.
• The number and closeness of available substitutes will help to determine PED. If there are no close or available substitutes, consumers will be forced to continue buying the product despite price changes and thus the product is likely to be very price-inelastic.
• Inferior are goods that see a fall in demand as incomes rise. Kingsmill bread would be an example of an inferior good, because if people have more disposable income they will instead spend it on higher-quality bakery bread.
• Luxury goods are goods for which demand increases more than expected in accordance with a rise in incomes, and include some cars, watches and clothing from luxury brands.
• Giffen goods are non-luxury products for which demand increases when price increases and vice versa. Rice and wheat are examples of Giffen goods, because they have few close substitutes.
• Price Elasticity of Demand (PED) is calculated using:

  % change in quantity demanded/ % change in price = price elasticity of demand
• Income Elasticity of Demand (YED) is a measure of the responsiveness of demand to a change in income, calculated by the formula:

  % change in quantity demanded / % change in income = yed
• A good can be both a normal and inferior good depending on the level of income. For example, bread might be a normal good for people on low incomes, who will buy more bread if their income increases, but an inferior good to people on higher incomes, who will instead buy more expensive food such as meat.
• Cross Elasticity of Demand (XED) is a measure of the responsiveness of demand for one good (good x) to a change in price of another good (good y). It is calculated by the formula:

  % change in quantity demanded of good x / % change in price of good y = XED
• For substitute products, if the price of product y rises, the demand for product x will also increase. For example, if the price of an iPhone rises, the demand for Samsung will increase. If the price of McDonalds rises, demand for Burger King will increase.
• For complement products, if the price of product y rises, the demand for product x will decrease. For example, if the price of new houses rises, the demand for building materials will decrease. If the price of beach holidays rises, demand for sunscreen will decrease.
• Inferior goods have a negative YED.
• A good with a YED that is higher than +1% is a luxury good.
• A good with a YED between 0 and +1 is a normal good.
• YED is determined by:

  • whether the good is a necessity or a luxury
  • income of the consumer
• Wealthier countries are likely to have consumers with higher disposable incomes. This means that they have greater spending power and are likely to use some of this greater income to buy luxury goods and services. Therefore, firms will produce superior products that meet the needs of these consumers e.g. high technology goods and complex financial services.
• When the economy is in recovery mode and leading into boom, disposable incomes increase and consumers spend a greater proportion of this increase in income firstly on necessities and then on luxury goods.
• When the economy is in decline and leading into slump, disposable incomes decrease and consumers spend a lesser proportion of their incomes on luxury goods, moving to necessities and then inferior goods.