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03--Law of Demand.ppt

03--Law of Demand.ppt

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Published by Zain Dar
LAW OF DEMAND
LAW OF DEMAND

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Published by: Zain Dar on May 29, 2013
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Lecture 3

The Law of Demand
■ Our objectives:
► Explain individual choices among unlimited wants in a world of limited resources ► Develop a theory that helps us better understand and predict human actions ►What do people (our customers) want?

A Very Difficult Issue
 

What we measure in demand is a reflection of individual desires. Daniel Bernoulli, a mathematical genius who lived in Basel, noted, in 1738, that people seek goodness or pleasure (utility). That is, we do not seek cellphones because they are cellphones but because they are useful and give us pleasure. Use and pleasure cannot be measured, only approximated. This is behind the law of demand.

 Markets reflect what people value in relationship to current availability.  Scarcity need not mean highly valued.A Note on Value. Scarcity.  Demand is our best understanding of what people value—given current conditions. and Price as Related to Demand Why do people want what they want?  The diamond-water paradox. think of snake meat. .

Good means anything people value . it is a ceteris paribus (―other things equal‖ or ―other things constant‖) statement ► Note the terminology: .The Law of Demand ■ Holding all other relevant factors constant. the greater (lower) will be the quantity demanded. ► Like all scientific propositions. the lower (higher) the price of a good.Price means opportunity cost .

etc. .Why focus on the Law of Demand? This is the most powerful proposition in economics... ► Irrigation design in arid and wet climates ► Building heights in cities compared to small towns ► The seasonal pattern of vegetable prices ► Why many stand in crowded trains to go visit family ► The shape of waterfront properties ► Electricity prices and automatic switches ► Etc. etc.

PC. I. etc.) ■ Price of the good in question—determines the location along a demand curve ■ Other variables (relevant factors) determine the placement of a demand curve: ► Prices of related goods (substitutes and complements) ► Income of buyers ► Tastes (preferences) of buyers ► Expectations held by buyers. T. E. PS. regarding the future ► Other matters particular to a certain good .The Demand Function: Some Definitions The relationship between quantity consumed and the factors determining that: D = f (P.

tastes are often the unexplained portion of consumption . not economists! ■ For economists. but we know they exist.The Role of Tastes ■ They are very hard to measure. ■ Look to marketing and psychology for guidance here. so we generally ignore them.

include in the analysis.Expectations ■ Also difficult to measure — but important ■ When measurable. these can be used to ―explain‖ anything ► Don’t fall into this trap . But experience shows—measures are very poor predictors of actions. ■ Like tastes.

similar performance characteristics. . ► Different brands of gasoline. goods used in place of each other— same geographic market. movie rentals. robots in Renault factory in France v. corn or sugar in ethanol.This or that? ■ Substitutes: Essentially. workers in Renault factory in Russia (former Lada) paid $200 a month. movie theater v. What is a substitute in one market may not be seen by consumers as such in another market—orange juice and orange soda.

growing corn for ethanol and Deere tractors .Related Goods ■ Complements: Essentially. Google maps and discount coupons. tennis balls and rackets. airplane travel and hotel rooms. goods used together ► Computer hardware and software.

Px down implies Dy down (Dy shifts to the left) ► Effect of change in Py on Dx is also in same direction .Changes in the Price of Related Goods ■ Goods X and Y are substitutes if: ► A change in price of X changes demand for Y in same direction .Px up implies Dy up (Dy shifts to the right) .

More on the Prices of Related Goods ■ Goods V and W are complements if: ► A change in price of V changes demand for W in opposite direction: .Pv up implies Dw down (Dw shifts to left) .Pv down implies Dw (Dw shifts to right) ► Effect of a change in Pw on Dv is also in opposite direction .

Lower income causes increase in demand .Higher income causes decrease in demand .Lower income causes decrease in demand ► ‖Superior‖ good is a variant: change in demand due to income change is quite large ■ Inferior goods: ► Change in income changes demand in opposite direction .Changes in Income ■ Normal Goods: ► Change in income changes demand in same direction .Higher income causes increase in demand .

Expectations.Income . ► Means a shift of the entire demand curve .Terminology: Used to avoid confusion ■ Changes in quantity demanded: ► Caused by changes in own price of good means movement along a given demand curve ■ Changes in demand: ► Caused by changes in other factors: . etc.Prices of other goods .

Price Pa Pb Demand Qa Qb Quantity/time .Change in Price  A change in the price of a good means a movement along a demand curve.

Change in Demand A change in a factor that determines demand. causes the Demand curve to shift. Example: Increase in price of substitute or increase in income causes an increase in demand. besides the price of the good itself.  Price Da Pa Db Qa Qb Quantity/time .

.28 $0. over time.Deriving a Real Demand Curve Define your market: Price Boulder. .36 $0.50 $0.50 consumed by demanders. Colorado.28 0 9 13 19 29 Quantity . billions gallons/yr.74 Quantity 29 19 13 9 Demand . price per 1. consumption of water by people .74 served by city water.000 gallons.36 Year 1968 1972 1977 1982 Price $0.

other things are not constant.What else would you want to know? The Demand curve plots the relationship between price and quantity demanded – nothing else – everything else is held constant But in the real world. so what else would you want to know if you wanted to understand that market better? Name likely relevant factors: .

4. 2. Wine and beer. Plate glass and brick/concrete .Hard Test: Which Goods Are Complements. Paper and pencils. 3. Domestic shirts and imported shirts. Oil from Iran and coal from China. 5. Which Are Substitutes? 1.

A rise in the divorce rate. 3. How would demand for hair replacement be likely to change if the following occurs? A fall in the price of hairpieces.Demand analysis  1. A rise in income. . 2.

would be free. What would you expect happened to the volume of calls that day? . December 25.Clever sales pitch  A British cellphone company promised new subscribers in November and December that all calls on Christmas Day.

How would you think this impacted the demand for the design of. refrigerators? .Question on changing demand  Trying to predict future demand. say. GE research showed that the average size of the American family was declining and so was the average square footage of houses.

Key Point from Peter Drucker Most important question sellers must ask: “What is value to the customer?” Sellers often think they know. . Demanders are buying a product to satisfy a want. Do not guess what customers want— always carefully evaluate what they want. The customers do not buy a product. but do not. they buy value.

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