Demand

Real World Issue: How do consumers and producers make choices in trying to meet their
economic objectives?
Market
 In economic theory, a market is where buyers and sellers come together to
carry out an economic transaction.
 Kinds of markets:
 product market: where goods and services are bought and sold
 factor market: where factors of production are bought and sold
 stock market: where shares in companies are bought and sold
 International financial market: where international currencies are traded
(foreign exchange market)

 At the core of market theory are the concepts of demand and supply
 https://youtu.be/kUPm2tMCbGE
Demand

Definition of demand:
 Demand for a good or service is the quantity that purchasers are willing
and able to buy at a given price in a given period of time.
 “willingness and ability to purchase” are critical to one another.
 This is also known as effective demand and is expressed as the demand
curve.
 It’s not effective demand if you would like to purchase a motorcycle,
but you don’t have the financial means to do so.
 'what determines your demand for a good or service?' 
The Law of Demand

 The basic law of demand is that demand varies inversely with price –
lower prices make products more affordable for consumers.
 Simply stated “as the price of a product falls, the quantity demanded of
the product will usually increase, ceteris paribus.”
 Or: A change in the price of a product will lead to a change in the
quantity demanded of the product, i.e. a movement along the existing
demand curve.
 Or: the demand curve normally slopes downwards.

 May be illustrated using either a demand schedule or a demand curve.

Demand Curve
 Demand curve: This is a curve that shows the relationship between
the price of a product, which is on the vertical axis, and the quantity
demanded of that product over time, which is placed on the horizontal
axis.
 Saying a “change in quantity demanded” is important since it
differentiates a change in price from the effect of a change in any of
the other determinants of demand.
A demand schedule for soft drinks

A change in the price of soft drinks from 1.20 dollars to 0.80 dollars
leads to an increase in the quantity demanded of soft drinks from 150
cans to 225 cans.
The Demand Curve: Price & Quantity Demanded
Price of Only changes in market price cause a
Coffee movement along the demand curve

P2
A higher price leads to a
contraction of quantity demanded

P1
A lower price leads to an expansion
of quantity demanded

P3

Demand for Coffee

Q2 Q1 Q3 Quantity demanded
of coffee
 Non-Price Determinants of
Demand (Shift Factors!)
 Change in Demand (Shift of the demand curve to the right or left) –
NOT THE SAME THING WITH THE CHANGE IN THE QUANTITY
DEMANDED
 Non-Price Determinants of Demand (Shift
Factors!)
1. Income
 Normal Goods
o As income rises, demand for the product will also rise
o Income up = Demand up
o Example: air travel
 Inferior Goods
o As income rises, demand for the product falls
o Income up = Demand down
o Example: cheap wine, “own brands” supermarket detergents

vs.
Non-Price Determinants of Demand (Shift
Factors!)
2. The Price of Related Goods: Three possible relationships: substitutes, complements, and
unrelated goods.
Substitutes
o If products are substitutes for each other, then a change in the price of one good will lead to a change in
the demand for the other product.
o Example: Chicken and Beef
 If Price of Chicken Up = Demand of Beef Up
 If Price of Chicken Down = Demand for Beef Down
Non-Price Determinants of Demand (Shift
Factors!)
• Complements
o Are often products that are purchased together, like Kindles and eBooks.
o If products are compliments of each other, then a change in the price of one of the products will
lead to a change in the demand for the other product.
o Example: Kindles and eBooks
 If Price of Kindle Up = Demand for eBooks Down
 If Price of Kindle Down = Demand for eBooks Up
Non-Price Determinants of Demand (Shift
Factors!)
• Unrelated Goods
o If products are unrelated, then a change in the price of one product will have no effect upon the demand
for the other product.
o Example: Toilet Paper and Pencils
Non-Price Determinants of Demand (Shift
Factors!)
3. Tastes and Preferences
 A change in tastes will lead to a shift in the demand for a product at every price point.
 For us, it is enough to know that marketing may alter tastes & that firms attempt to influence
tastes so that they can shift the demand curve for their product to the right.
 Example: Skateboard advertising campaign.
 Non-Price Determinants of
Demand (Shift Factors!)
4. Future Price Expectations
 If consumers think that the price of a product will increase in the
future, then they will demand more of that product in the present,
taking advantage of the current lower prices.
 Lead a shift to the right
 Ex: Announcement are made about increased taxes being places
on cigarettes from a certain date in the future, there’s a a bulk
buying of cigarettes before that day.

 Black Friday: postponement of present consumption, waiting for

the lower prices that will be available
 Demand curve for those products shift to the left
Non-Price Determinants of Demand (Shift
Factors!)
5. Number of consumers:
o If population grows = logical right shift of demand curve (or the
opposite).
• Changes in the structure of the population
o If population ages = logical right shift of demand curve for products such
as canes and walkers, left for skateboards and rollerblades.
 Non-Price Determinants of
Demand (Shift Factors!)
6. Other Factors:

• In summer = logical right shift of demand for bathing suits.

In winter = logical right shift of demand for winter coats.

• Seasonality refers to fluctuations in output and sales related to the seasonal of

the year.
Easter chocolate Summer fruits
• For most products there will be seasonal peaks and troughs in production
and/or sales

• Demand for slippers peaks in the run up to Christmas

• Demand for plants at garden centres is linked to the planting season

• High street retailers such as jewellery companies may sell as much as 80-
Winter clothing Ski season
90% of their products over Xmas products
Non-Price Determinants of Demand (Shift
Factors!)
 These will shift the demand curve to the right or to the left
 Determinants of Demand = Changes in these will end up with the demand curve shifting!
 Distinction between Movement Along Demand
Curve & Shift In Demand Curve
 Movement Along Demand Curve
 Change in price = movement along demand curve because price is one of the axes.
 Shift in Demand Curve
 A change in any other determinant = shift in demand curve to right or left
Quantity Demanded vs. Demand

 Quantity Demanded represents an exact quantity (how much) of a good or service is

demanded by consumers at a particular price. 

 Demand refers to the graphing of all the quantities that can be purchased at different

prices. On the contrary, quantity demanded, is the actual amount of goods desired at a
certain price.
 Individual vs. Market Demand

 Demand curve for a whole market: Horizontal summing

 The increase in quantity demanded is
for 2 reasons: (HL)
 Reasons for movement along demand curve:
1. Income Effect: when the price of a product falls, then people will have an increase in their “real
income” or purchasing power, which reflects the amount that their income will buy, thus
making it more likely people will buy the product.
The increase in quantity demanded is for 2
reasons:

20 TL 15 TL
The increase in quantity demanded is for 2
reasons:
2. Substitution Effect: People receive a certain amount of satisfaction when they consume a
product – utility
 When the price of a product falls, people will still gain the same amount of satisfaction
from the product as before, but they will be paying less for it.
 So, their ratio of satisfaction to price will improve.
 The product will be relatively more attractive to people than other products, whose prices
have stayed unchanged
 Thus it’s likely that people will buy more of the product, substituting it for products that
have a poorer satisfaction to price.
The increase in quantity demanded is for 2
reasons:
Substitution Effect:
 Utils – measurement of satisfaction
 Ex: 10 utils from a package of m&m which costs 30 TL
 Ratio of satisfaction to price is 1 util to 3 TL
 If price is decreased to 20 TL, then the ratio of 1 util will be 2 TL
 Consumer is paying less to get the same amount of satisfaction and so the m&m will be more
attractive.
BETTER DEAL!
The increase in quantity demanded is for 2
reasons:

 The Final Outcome of a Fall in Price in the Quantity Demanded of a Product

Income Effect + Substitution Effect

 Key Assumptions of NeoClassical Model

Remember!

 economics is a study of assumptions made about human behavior

 if you change the assumptions, things change dramatically
 Key Assumption of NeoClassical Model
 neoclassical model assumes a rational thinking human
 Consumers as the economic agents make their choices and behave rationally
 consumers will always maximize utility
 producers will always maximize profits

 it is assumed that consumers will always work in their self-interest

 it is assumed that consumers have access to all of the relevant information they need
 perfect information
 the rational economic agent sis known as homo economicus
 so...
 – “when faced with choices, it is assumed that homo economicus will make intelligent, logical and
well-considered decisions that give them the most utility”
 Which phone should I buy?
 Know exactly what she wants from her phone
 Research the capabilities of all the different phones
 Understand all the information provided
 Be able to compare all the models
 Know the prices of each and every phone on the market
 Know how long each phone will last
 Kknow what she will need from her phone in two years
 Be able to know which phone makes her happiest
Key Assumption of NeoClassical Model

 so...
 – “when faced with choices, it is assumed that homo economicus will make intelligent,
logical and well-considered decisions that give them the most utility”
Behavioral Economics – Where economy
meets psychology
 Challenges the assumptions that we as humans acting in an “economically rational”
manner when given choices in the market place
 Branch of economics that “incorporates the insights of psychology and recognizes that the
choices consumers make are governed by many factors that are not consistent with the
assumptions behind the neoclassical models”
 Pioneered by Richard thaler who won the nobel price in 2017
Behavioral Economics – Where economy
meets psychology
 richard thaler argued that “rational choice” humans don’t even exist!
 we are homo sapiens, not homo economicus
 he reduced it down to “econs” (neoclassical economics view) and “humans”
Behavioral Economics – Where economy
meets psychology
 Behavioral Economics- Critiques of Rational
Consumer Model
 imperfect information : all economic agents can’t have full access to every information
– challenges the assumption of perfect information
 bounded rationality: the rationality of consumers is limited by the information they have and the
fact that they don’t have the time nor the cognitive abilities to weigh up all the options.
– challenges the assumption of rational choice
 bounded selfishness: humans don’t always act in their own self interest.
– challenges the assumption of self-interest
Ex: volunteer work-free labor
Ex: giving money to a charity

 bounded self-control: consumers are unlikely to demonstrate perfect willpower.

– challenges the assumption of rational thinking
Ex: hot day- ice cream – calories - not healthy
Economic Man vs Humanity: a Puppet Rap Battle

 https://www.youtube.com/watch?v=Sx13E8-zUtA&feature=youtu.be
The Dual System Methods - how “humans” make
decisions differently than “econs”
 based on the experimental work of psychologists, Daniel Kahneman and Amos Tversky
 Individual have two different systems of thinking
• system 1: the fast thinking system
• system 2: the slow thinking system

 Richard Thaler, in his book, Nudge, renames the systems

• system 1: The Automatic System – involves fast, subconscious decisions
• system 2: The Reflective system – involves slow, controlled decisions
The Dual System Methods
- how “humans” make decisions differently than “econs” -
Dual System Model – The Automatic System

 What is 3 plus 4?
 Get home from school on the route that
you have taken everyday for the last
year?
 Speak in your mother language
 Do your grocery shopping
Dual System Model- The Reflective Model

 What is 1989 times 31?

 Choose your IB subjects
 Have a conversation in a second
language in which you are not fluent.
 Cognitive Biases and Decision Making
 Behavioral economics uses the understanding of cognitive biases to help consumers make better
choices.
 Cognitive Biases
 How cognitive biases affect our decision making process?
 Human beings are far more complex than the neo classical economists think.
 Types of cognitive biases:
 availability bias
 anchoring bias
 framing bias
 social conformity
 status quo or inertia bias
 loss aversion bias
 hyperbolic discounting
 Cognitive Biases
 availability bias
– the availability of information that people have to make a decision
 examples: health dangers, smoking
 Ex: 75 year old family member, smoking for 50 years – based on information available to us we can say
that smoking is not so bad and then that would create a bias for us to go and buy a cigarette.

 anchoring bias (anchor is something keeps us in place – anchor-boat)

– the “anchor” is information about the value of one thing, and this serves as our reference
point for other choices and decisions
 examples: sales in stores, offering an overly high price to start
 Ex: 20 TL sweater, %50 off – 10 TL sweater on sale
Since consumers don’t know the real value of the sweater,
they think that they made a good deal by buying this sweater
at half price.
 Cognitive Biases
 framing bias
– the way in which we learn about something—the way it is framed to us initially—frames
(impacts) our decisions
 examples: all over the place in marketing – “90% fat free vs contains 10% fat”

 social conformity/herd behavior

– we want to fit in – there, you get it – even if it’s against our best interest
 examples: trends, bandwagon effect, being cool
 ex: Crocs, Uggs
 Cognitive Biases
 status quo (inertia bias)
– there are so many choices, we do nothing
 examples: cell phone company (mobile phone contract expiry) bank choice

 loss aversion bias

– people may make choice based on not losing something even if the decision is not well-informed
 Ex: buy now before stocks run out
 Ex: only 4 seats left at this price

 hyperbolic discounting
– tendency for humans to prefer short-term rewards over larger later rewards

vs.
How can Behaviroal Econ be used to help consumers make better
choices-Choice Architecture
 choice architecture is the “theory that the decisions that we make are heavily influenced by the way
someone, referred to as a “choice architect” presents the choices to us”
– examples: the supermarket check out line options
 Choice architects created the idea in your mind to buy the products on the checkout line

 Choice architects create default choice

– an example of when choice architecture can be observed
• google search (default browser- you use it even though you really make the choice)
• going to starbucks (not because the coffee is qualified or cheap, because you
feel happy, to associate)
 Default Options
 key points
 though not always bringing the best outcomes, they are popular
  status quo bias is alive here
 consumers may not have the time, or interest, or cognitive skills to understand the alternatives
 they may lack the courage to change and are comfortable with what they already know

 case study: organ donation programs

 opt-in vs. opt-out (driver’s options)
 Mandated Choice
 mandated choice – another example of choice architects influencing consumers
 these are situations where consumers are required by law to make a choice in advance
 organ donation is a good example of this
– they must click a box when they get their drivers license - forcing a choice
 these are both examples of “choice architects” making decisions for us
 You’re mandated a choice, you have to choose, it’s required.
Choice architecture is the ways in which outside people influence our decisions and what
behavioral economists say is that our behavior as consumers is NOT based on rational
consumer behavior.
 Nudge Theory (Richard Thaler)
 nudge theory suggests that “the choice architecture offered to people can be carefully designed to
gently encourage (nudge) the people to voluntarily choose the option which is better for them
 pioneered by richard thaler and cass sunstein’s book,
nudge: improving decisions about health, wealth, and happiness
 Nudge Theory
 the key to nudge theory!
 consumers keep their consumer sovereignty but are encouraged to make better choices
 Consumers are not forced to choose healthy option,
but they do it themselves
• example: healthy foods at check out lines

 Consumers can still choose but they get more information

•example: Nutritional value labels

 a kin to your parents (government in our case!) suggesting something but not mandating a decision – over time you
will begin to choose it

 you keep the power to choose, but the options are made by choice architects
 Nudge Theory
 the key to nudge theory!
– when designing the choices, “architects” must help people override their cognitive
biases
• change the system 1 choice structure (automatic system)
Ex: Vegetable love at young/old ages
Ex: snack: cookie vs. fruit
 examples
– private retirement savings
• save more tomorrow (SMT) – long term, opposite of hyperbolic
discounting
 Nudge Theory
 nudge theory is not not without its critics
 taking away of individual rights – you’re nudged towards certain things, democracy is threatened
 redefines role of government – governments taking advantage of power and not using it for good
historically
 sets up debate between free market economies and those with government intervention

 has shown however, that psychology can show us much about how economic models work and
function

 We’re human beings and we can’t make the same decision every time in the same way