Unit 3

• Demand is the quantity of a good or service that consumers are able and willing to buy at a given price during a given period of time
• Demand varies with price. Generally, the lower the price, the more affordable the good and so consumer demand increases
• Movements along the demand curve


  Changes in quantity demanded due to price changes along the demand curve
• Movements along the demand curve

  At price P1, a quantity of Q1 is demanded. At the lower price of P2, a larger quantity of Q2 is demanded. This is an expansion of demand. At the higher price of P3, a lower quantity of Q3 is demanded. This is a contraction of demand. Only changes in price will cause these movements along the demand curve
• Price changes do not shift the demand curve
• Shifting the demand curve

  A shift from D1 to D2 is an inward shift in demand, so a lower quantity of goods is demanded at the market price of P1. A shift from D1 to D3 is an outward shift in demand. More goods are demanded at the market price of P1
• Factors that shift the demand curve

  • Population
  • Income
  • Related goods
  • Advertising
  • Tastes and fashions
  • Expectations
  • Seasons
• Factors that shift the demand curve (PIRATES)

  • Population
  • Income
  • Related goods
  • Advertising
  • Tastes and fashions
  • Expectations
  • Seasons
• Population


  The larger the population, the higher the demand
• Income


  If consumers have more disposable income, they are able to afford more goods, so demand increases
• Related goods


  Substitutes or complements affect demand
• Advertising


  Increases consumer loyalty to the good and demand
• Tastes and fashions


  Consumer demand shifts with changing tastes
• Seasons


  Demand changes according to the season
• Diminishing marginal utility


  The law stating that as an extra unit of a good is consumed, the marginal utility falls
• Diminishing marginal utility


  Consumers are willing to pay less for a good as they consume more units of it
• Diminishing marginal utility example

  • Consuming chocolate bars and the decrease in utility with each additional bar
• The price elasticity of demand is the responsiveness of a change in demand to a change in price
• Price elastic good


  Very responsive to a change in price, the change in price leads to an even bigger change in demand, PED is >1
• Price inelastic good


  Demand is relatively unresponsive to a change in price, PED is <1
• Unitary elastic good


  Change in demand is equal to the change in price, PED = 1
• Perfectly inelastic good


  Demand does not change when price changes, PED = 0
• Perfectly elastic good


  Demand falls to zero when price changes, PED = infinity
• If the price of bread increased by 15% and the quantity demanded decreased by 20%, the PED of bread is -1.33, making it relatively price inelastic
• Factors influencing PED


  • Necessity
  • Substitutes
  • Addictiveness or habitual consumption
  • Proportion of income spent on the good
  • Durability of the good
  • Peak and off-peak demand
• Elasticity of demand and tax revenue

  The burden of an indirect tax falls differently on consumers and firms depending on the elasticity of demand
• Taxes shift the supply curve, not the demand curve
• If a firm sells a good with inelastic demand


  They are likely to put most of the tax burden on the consumer as a price increase will not cause demand to fall significantly
• If a firm sells a good with elastic demand


  They are likely to take most of the tax burden upon themselves as they know a price increase will significantly reduce demand
• An increase in tax

  • Decrease supply from S1 to S2
  • Increase price from P1 to P2
  • Demand contracts from Q1 to Q2
• If a firm sells a good with an elastic demand


  • They are likely to take most of the tax burden upon themselves
  • If the price of the good increases, demand is likely to fall, lowering their overall revenue
• If a government wants to reduce the demand of a particular good, it is effective
• Elasticity of demand and subsidies

  • A subsidy encourages the production of a good and lowers average costs
  • It increases supply
• The benefit of the subsidy can go to both the producer, in the form of increased revenue (C-P1), or to the consumer, in the form of lower prices (P1-P2)
• Total revenue is equal to average price times quantity sold. TR= P x Q
• If a good has an inelastic demand


  The firm can raise its price, and quantity sold will not fall significantly, increasing total revenue
• If a good has an elastic demand and the firm raises its price


  Quantity sold will fall, reducing total revenue
• Income elasticity of demand is the responsiveness of a change in demand to a change in income
• Inferior goods see a fall in demand as income increases. YED < 0
• Normal goods have demand increasing as income increases. YED > 0