What Is Demand?

Factors Affecting Demand

Elasticity of Demand
Lecture Notes

82
 What Is Demand?

Demand, like many of the other topics discussed in part 1,

is a microeconomic concept.

Combination of desire, ability, and willingness

to buy a product.

Part of economics that studies small units, such

as individuals and firms.

Part of economic theory that deals with

OR behavior and decision making by individual
units, such as people and firms.

83
In a market economy people and firms act in their own
best interests to answer the basic WHAT, HOW, and FOR
WHOM questions. Demand is central to this process, so
an understanding of the concept of demand is essential if
we are to understand how the economy works.

An economic system in which people and firms

make all economic decisions.

84
 The demand schedule shows the various quantities
demanded of a particular product at all prices that might
prevail in the market at a given time.

EX.

Table (2) shows the amount of a product that the consumer

(Eyad) would be willing and able to purchase over a range of
possible prices that go from $5 to $25. As you can see, Eyad
would not buy any CDs at a price of $25, but he would buy one if
the price fell to $20, and he would buy three if the price was $15,
and so on. Just like the rest of us, he is generally willing to buy
more units of a product as the price gets lower.

85
Lecture Notes

86
 price

Quantity A
Points price 25
demanded
B
20
A 25 0
C
15
B 20 1 D
10 E
C 15 3
5 D
D 10 5
0
E 5 8 1 3 5 8 Quantity
demanded

Table (2): demand schedule Figure (11): demand curve

87
Lecture Notes

88
 Demand curve is a graph (curve) showing the quantity
demanded at each and every price that might prevail in the
market.

The demand schedule in (table 2) can also be shown

graphically as the downward-sloping line in (figure 11). All we
have to do to is to transfer each of the price-quantity
observations in the demand schedule to the graph, and then
connect the points to form the curve.

The demand schedule and the demand curve are similar in

Note that they both show the same information—one in the form
of a table and the other in the form of a graph.

89
The market demand curve is the curve that shows the
quantities demanded by everyone who is interested in
purchasing the product.

Figure (12-c) shows the market demand curve for Eyad and
Renad, the only two people (for simplicity) whom we
assume to be willing and able to purchase CDs. To get the
market demand curve, all we do is add together the number
of CDs that Eyad and Renad would purchase at every
possible price. Then, we simply plot the prices and quantities
on a separate graph.

90
 Points A B C D E
price 25 20 15 10 5
Quantity demanded (Eyad) 0 1 3 5 8
Quantity demanded (Renad) 1 2 3 5 7
Quantity demanded (Market) 1 3 6 10 15
Table (3): Individual and market demand schedule

price price price

A - Eyad B- Renad c- Market

A
A A 25
25 25
B B
20 20 B 20
C C 15 C
15 15
D D D
10 E 10 E 10 E
5 5 5

0 0 0
1 3 5 8 Quantity 1 2 3 8 Quantity 1 3 6 10 15 Quantity
5
demand demand
demand
ed ed
ed
Figure (12): Individual and market demand curve

91
Lecture Notes

92
 The market demand curve is very similar to the
individual demand curve. Both show a range of possible
prices that might prevail in the market at a given time,
Note and both curves are downward sloping. The main
difference between the two is that the market demand
curve shows the demand for everyone in the market.

The law of demand states that the quantity demanded

varies inversely with its price. When the price of something
goes up, the quantity demanded goes down. Likewise, when
the price goes down, quantity demanded goes up.

93
Lecture Notes

94
 quantity When the
When the quantity
demanded price goes
price goes demanded
goes down down
up goes up

Figure (13): the law of demand

The amount of usefulness or satisfaction that

someone gets from the use of a product.

The extra usefulness or additional satisfaction a

person gets from acquiring or using one more unit
of a product.

95
The reason we buy something in the first place is because we
feel that the product is useful and will give satisfaction.
However, as we use more and more of a product, we
encounter diminishing marginal utility.

The principle which states that the extra satisfaction

we get from using additional quantities of the
product begins to decline.

decrease in satisfaction or usefulness from having

OR one more unit of the same product.

96
 Because of our diminishing satisfaction, we usually are
not willing to pay as much for the second, third, fourth,
and so on, as we did the first unit. This is why our
Note
demand curve is downward-sloping, and this is why
Eyad and Renad won’t pay as much for the second CD as
they did for the first.

Diminishing satisfaction happens to all of us at some

time. For example, when you buy a drink because you
are thirsty, you get the most satisfaction from the first
Note purchase. Since you are now less thirsty, you get less
satisfaction from the second purchase, and even less
from the next, so you are not willing to pay as much for
the second and third purchases.

97
Lecture Notes

98
 Factors Affecting Demand

When it comes to demand, there are two types of changes. When

the price of a product changes while all other factors remain the
same, we have a change in the quantity demanded. Sometimes
other factors change while the price remains the same. When this
happens, we see a change in demand.

The change in quantity demanded refers to the change that is

graphically represented as a movement along the demand curve.
When the price goes up, fewer CDs are demanded. When the
price goes down, more are demanded. As we will see, the income
and substitution effects also help us understand this principle.

99
Lecture Notes

100
 Income effect refers to that part of a change in quantity
demanded due to a change in the buyer’s real income when a
price changes.

When the price of a product drops, consumers pay less and,

as a result, have some extra income to spend.

If the price had gone up, consumers would have felt a bit
poorer and would have bought fewer CDs.
EX.
If consumers spent $90 to buy six CDs when the price was $15 per
CD. If the price drops to $10, they would spend only $60 on the
same quantity, leaving them $30 “richer” because of the drop in
price. They may even spend some of this extra income on more CDs.

101
 price

A
25

B
20

C
15
D
10 E
5

0
1 3 6 10 15 Quantity
demanded
Figure (14): change in quantity demand

Only a change in price can cause a change in quantity demanded.

When the price goes down, the quantity demanded increases.
When the price goes up, the quantity demanded decreases. Both
changes appear as a movement along the demand curve.

102
Substitution effect refers to that part of a change in quantity
demanded due to a price change that makes other products
more or less costly.

A lower price also means that CDs will be relatively less

expensive than other goods and services such as concerts
and movies. As a result, consumers will have a tendency to
replace a more costly item— say, going to a concert—with
a less costly one—more CDs.

Together, the income and substitution effects explain why

consumers increase their consumption of CDs from 6 to 10
when the price drops from $15 to $10.

103
Lecture Notes

104
 The change in demand refers to the change that is graphically
represented as a shift of the demand curve, when people buy
different amounts at every price. The entire demand curve shifts
to the right to show an increase in demand, or to the left to show
a decrease in demand.

A change in demand results in an entirely new demand curve,

Note while a change in quantity demanded is a movement along the
original demand curve.

When demand changes, a new schedule or curve must be

constructed to reflect the new quantities demanded at all possible
prices. (look at table 4 and figure 15)

105
 price

price D D1 A A1
25

25 1 3 B B1
20

20 3 6 15 C C1

D D1
15 6 10 10
E E1
5
10 10 15
0
5 15 22 1 3 6 10 15 22 Quantity
demanded

Table (4): demand schedule Figure (15): change in demand

106
Demand can change because of changes in the determinants of
demand: consumer income, consumer tastes, the price of related
goods, expectations, and the number of consumers.

Changes in consumer income can cause a change in demand. An

increase in income means people can afford to buy more at all
possible prices.

If there is an increase in income , the demand curve would

then shift to the right, showing an increase in demand.

If there is a decrease in income , the demand curve would

then shift to the lift, showing a decrease in demand.

107
Lecture Notes

108
Consumers sometimes change their minds about the products they
buy. Advertising, fashion trends, and even changes in the season
can affect consumer tastes.

when a product is successfully advertised, its popularity

increases and people tend to buy more of it. As a result, the
demand curve shifts to the right.

when a rumor or unfavorable report about a product

appears, people will buy less, . As a result, the demand curve
shifts to the lift.

The development of new products can have a dramatic and

relatively sudden impact on consumer preferences.

109
Lecture Notes

110
 A change in the price of related products can cause a change in
demand. Some products are known as substitutes, and others are
known as complements.

Substitutes Complements

Refers to competing products that can Refer to products that increase

be used in place of one another the use of other products.

a rise in the price of coffee will cause an When the price of computers
increase in the demand for tea. decreases, consumers buy more
Likewise, a rise in the price of tea would computers and more software.
cause the demand for tea to coffee.

111
Lecture Notes

112
The demand for a product tends to increase, if the price of
its substitute goes up.

The demand for a product tends to decrease, if the price of

its substitute goes down.

The demand for a product tends to increase, if the price of

its complement goes down.

The demand for a product tends to decrease, if the price of

its complement goes up.

113
If a company announces a technological breakthrough in television
picture quality, some consumers might hold off buying a TV today
due to their expectations. Purchasing less (from current TV) at
every price would cause demand to decline, illustrated by a shift of
the demand curve to the left.

If the weather service forecasts a bad year for crops, people might
stock up on some foods before these items actually become
scarce. The willingness to buy more because of expected future
shortages would cause demand to increase, shown by a shift of the
demand curve to the right.

114
Suppose that Omar, one of Eyad’s and Renad’s friends, decides to
purchase CDs. We would add the number of CDs that Omar would buy
at all possible prices to those for Eyad and Renad. The market demand
curve would shift to the right to reflect an increase in demand.

If Eyad or Omar should leave the market, the total number of CDs
purchased would decrease, shifting the market demand curve to the
left.

115
Lecture Notes

116
 Demand shifts to lift (decrease) if: Demand shifts to right (increase) if:
Income falls Income rises
The price of a complement rises The price of a complement falls
The price of substitute falls The price of substitute rises
Consumers does not prefer the good Consumers prefer the good
The price is expected to fall in the future The price is expected to rises in the future
Number of consumers decreases Number of consumers increase
Table (5): change in demand
price

D2

D1
D3

Quantity demanded
Figure (16): change in demand

117
 Consumer
income

Number of Consumer
Consumers Tastes
Change in
demand

The price of
Expectations related
products

Figure (17): factors affecting demand

demand
118
 Elasticity of Demand

a measure of responsiveness that shows how one

Elasticity
variable responds to a change in another variable

degree a sensitivity or responding a dependent variable

OR to change in an independent variable.

Ex. price Ex. Quantity

demanded

119
Lecture Notes

120
 A measure that shows how a change in quantity
Demand Elasticity
demanded responds to a change in price.

The extent to which a change in price causes a

OR
change in the quantity demanded.

When the price of an item changes, the change

OR
in quantity demanded can vary a little or a lot.

121
Lecture Notes

122
Price elasticity of demand =
If price increase from 10 to
Percentage change in quantity demanded 12, this led to decrease
Percentage change in price
quantity from 5 to 4, then:

Δ𝑄 Δ𝑃 𝑄 2 –𝑄 1 𝑃1
= ÷ E= x
Q P 𝑃 2 − 𝑃1 𝑄1
Δ𝑄 𝑃 4−5 10
= ÷ = x
Δ𝑃 Q 12−10 5

=
𝑄 2 –𝑄 1
x
𝑃1 = -1
𝑃 2 − 𝑃1 𝑄1
Unit elastic demand

123
Lecture Notes

124
price E=∞

A
E˃1 Price elasticity of demand =

𝒅𝒐𝒘𝒏 𝒑𝒂𝒓𝒕 𝒇𝒓𝒐𝒎 𝒅𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆

E=1 𝒉𝒊𝒈𝒉𝒆𝒓 𝒑𝒂𝒓𝒕 𝒇𝒓𝒐𝒎 𝒅𝒆𝒎𝒂𝒏𝒅 𝒄𝒖𝒓𝒗𝒆

B
E˂1 𝐵𝐴
Elasticity at point B = =1
𝐵𝐶
E=0 0
Elasticity at point C = =0
𝐴𝐶

C
Quantity demanded
Figure (18): demand elasticity by geometrical formula

125
Lecture Notes

126
 Types of demand elasticity

price demand elasticity income demand elasticity cross demand elasticity

Price demand degree of sensitivity or responding the quantity

elasticity demanded of a good to a change in its price.

𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅

=
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆

127
Lecture Notes

128
Income demand degree of sensitivity or responding the quantity
elasticity demanded of a good to a change in income.

𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅

=
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒊𝒏𝒄𝒐𝒎𝒆

Cross demand degree of sensitivity or responding the quantity

elasticity demanded of a good to a change in price of a
substitute or complement.

𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅

= 𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇 𝒂 𝒔𝒖𝒃𝒔𝒕𝒊𝒕𝒖𝒕𝒆 𝒐𝒓 𝒄𝒐𝒎𝒑𝒍𝒆𝒎𝒆𝒏𝒕

129
Lecture Notes

130
 There are five degrees for elasticity of demand

price

P2
when a given change in price does
not cause any change in quantity P1
demanded. (look at figure 19)
Ex. Some drugs especially (Insulin). Q1 Quantity demanded

Figure (19): Perfectly Inelastic Demand

131
 when a given change in price causes a relatively smaller change in
quantity demanded.

the percentage change in quantity demanded is relatively smaller

than the percentage change in price.

price
A change in the price for salt does not bring about
much change in the quantity purchased. Even if
the price was cut in half, the quantity demanded P2

would not increase by much because people can

P1
consume only so much salt. Similarly, if the price D
doubled, we would still expect consumers to
Quantity demanded
demand about the same amount, because people Q2 Q1
spend such a small portion of their budget on salt. Figure (20): Inelastic Demand

132
 when a given change in price causes a proportional change in
quantity demanded.

the percentage change in quantity demanded is equals the

percentage change in price.

price

Examples of unit elasticity are difficult to

P2
find because the demand for most
P1
products is either elastic or inelastic. Unit
D
elasticity is more like a middle ground
that separates the elastic and inelastic. Q2 Q1 Quantity demanded

Figure (21): Unit Elastic Demand

133
 when a given change in price causes a relatively larger change in
quantity demanded.

the percentage change in quantity demanded is relatively larger

than the percentage change in price.

price

The demand for products like green beans,

corn, or other fresh garden vegetables. Because P2
prices of these products are lower in the
P1
summer, consumers increase the amount they D

purchase during that time. When prices are

considerably higher in the winter, consumers Quantity demanded
Q2 Q1
tend to buy canned or frozen products instead.
Figure (22): Elastic Demand
134
 In a market that has perfectly elastic demand for a product, even a
small change in price causes an infinite change in the quantity
demanded.

-If consumers have access to a large price

number of substitute goods.
-If a supplier faces strong
competition from firms that produce
P1 D
the exact or a very similar product
and can sell at a lower price.
Q1 Quantity demanded
Q2

Figure (23): Perfectly Elastic Demand

135
Lecture Notes

136
 To estimate elasticity, it is useful to look at the impact of a price
change on total expenditures, or the amount that consumers
spend on a product at a particular price. This is sometimes called
the total expenditures test.

We can summarize the relationship between changing prices and

total expenditures in the next three cases.

When demand When demand When demand

is elastic is inelastic is unit elastic

137
Lecture Notes

138
Suppose that the price declines by one-third, or from $3 to $2. At the
same time, the quantity demanded doubles from 20 to 40 units.

The demand is elastic (Because the percentage change in quantity

demanded is relatively larger than the percentage change in price).
Then, when the price drops by $10 per unit, the increase in the
quantity demanded is large enough to raise total expenditures.
Total expenditures at price $3 = $60 ($3 x 20).
Total expenditures at price $2 = $80 ($2 x 40).

The relationship between the change in price and

total expenditures for the elastic demand curve is
described as “inverse.”

139
Suppose that the price declines from $3 to $2. At the same time, the
quantity demanded increase from 20 to 25 units.

The demand is inelastic (Because the percentage change in quantity

demanded is relatively smaller than the percentage change in price).
Then, when the price drops by $1 per unit, the increase in the
quantity demanded is so small that the total expenditures fall.
Total expenditures at price $3 = $60 ($3 x 20).
Total expenditures at price $2 = $50 ($2 x 25).

The relationship between the change in price and

total expenditures for the elastic demand curve is
described as “positive.”

140
Suppose that the price declines from $3 to $2. At the same time, the
quantity demanded increase from 20 to 30 units.

The demand is unit elastic (Because the percentage change in quantity

demanded is equal to the percentage change in price).
Total expenditures at price $3 = $60 ($3 x 20).
Total expenditures at price $2 = $60 ($2 x 30).

If demand is unit elastic, total expenditures remain

unchanged when the price change.

141
If the changes in price and expenditures move in opposite
directions, demand is elastic.

If the changes in price and expenditures move in the same

direction, demand is inelastic.

If the change in price does not cause change in

expenditure, demand is unit elastic.

142
Knowledge of demand elasticity is extremely important to most
businesses. Suppose, for example, that you run your own business
and want to do something that will raise your revenues. You could
try to stay open longer, or you could try to advertise in order to
increase sales. You might, however, also be tempted to raise the price
of your product in order to increase total revenue from sales.

Does increase the price always lead total revenue to increase?

This might actually work in the case of table salt or medical services,
because the demand for both products is generally inelastic. However,
in the case of a product with elastic demand, If you raise the price,
your total revenue will go down instead of up.

143
Lecture Notes

144
 price

E˃1
P1

P2 E=1

E˂1 When demand is elastic,

price cut (from P1 to P2)
increases total revenue
(from TR1 to TR2).
Quantity demanded
Total Revenue

TR2

When demand is inelastic,

TR1
raising price increases
total revenue.

Q1 Q2 Quantity demanded
Figure (24): Elasticity and Revenue
145
Lecture Notes

146
What makes the demand for a specific good elastic or inelastic? To find
out, we can ask three questions about the product. The answers will
give us a reasonably good idea about the product’s demand elasticity.

Can the Purchase Be Delayed?

Sometimes consumers cannot postpone the purchase of a product. This

tends to make demand inelastic, meaning that the quantity of the
product demanded is not especially sensitive to changes in price.

Persons with diabetes need insulin to control the disorder.

An increase in its price is not likely to make diabetes
sufferers delay buying and using the product.

147
Lecture Notes

148
 Are Adequate Substitutes Available?

With Adequate substitutes, even small changes in the price of a product will
cause people to switch, between the product and its substitute, making the
demand for the product elastic. The fewer substitutes available for a product,
the more inelastic the demand.

If the price of beef goes up, buyers can switch to chicken.

Does the Purchase Use a Large Portion of Income?

If the amount of income, required to make the purchase, is large, then demand
tends to be elastic. If the amount of income is small, demand tends to be
inelastic.

Increase the price for salt does not bring about much decrease in the quantity
purchased, because people spend such a small portion of their budget on salt.

149
Lecture Notes

150