Session 1

(SL&HL)

09.20.2022
Irina Kovaleva
 Goals
By the end of this chapter, you should be able to:
• HL Understand the income and substitution effects
➔ Define a market • HL Understand the concept of rational consumer
➔ Define demand choice
➔ Explain the Law of Demand • HL Define and explain behavioral economics
➔ Identify and explain the non-price • HL Explain some limitations of the assumptions of
determinants of demand rational consumer choice
• HL Define and explain bounded rationality, bounded
➔ Distinguish between a shift of a self-control, bounded selfishness and imperfect
demand curve and a movement information
along a demand curve • HL Define and explain cognitive biases
➔ Understand the relationship • HL Define, explain and give examples of choice
between an individual consumer’s architecture
• HL Define, explain and give examples of nudge
demand and market demand theory
 What is a market?
A market is where buyers and sellers come together to carry out an
economic transaction.
Markets may be physical places where goods and services are
exchanged for money, but there are other ways that economic
transactions may be made. In modern times, products are increasingly
sold in on-line markets, through the use of credit cards or money
transfers. There are many different forms of markets, such as:
 product markets, where goods and services are bought and sold
 factor markets, where factors of production are bought and sold, such
as the labour market
 stock markets, where shares in companies are bought and sold
 international financial markets, where international currencies are
traded, such as the foreign exchange market.
At the core of standard market theory are the concepts of demand and
supply.
Match each type of market to the appropriate definition or
explanation.

Definitions
A. A market where prices are expected to
Types of markets climb higher and higher
1. Informal market
B. market where transactions are not officially
2. Emerging market recorded and so taxes are not paid
3. Foreign exchange or C. A market relating to developing nations
currency market exhibiting rapid growth
4. Bull market D. A market where the buyer is at the same
time a seller
 What is demand?
• Demand is the quantity of а good or service that consumers are willing and
able to purchase at different prices in а given time period.
• For example, а group of people may buy 150 cans of а soft drink at $1.20
each, each afternoon. We would say that their demand for soft drinks at а
price of $1.20 would be 150 units per afternoon.
• The important phrase here is "willingness and ability".
• It is not enough for consumers to be willing to purchase а good or service.
They must also have the financial means to buy the product; that is, the
ability to buy.
• This is known as "effective demand" and it is this that economists consider
when discussing demand. It is not effective demand if you would like to
purchase а motorcycle, but you do not have the financial means to do so.
 Exercise 3.1
ATL Thinking and Communication
1. Make а list of twenty goods or services that you would like to buy.

2. Separate the list into two columns - effective demand and ineffective demand.

3. Briefly explain why the goods and services are in the columns that they are.

Effective demand Ineffective demand

1 6 11 16
2 7 12 17
3 8 13 18
4 9 14 19
5 10 15 20
 Price of soft drinks Quantity demanded
How does the Law ($ per can) of soft drinks (cans
per day)
of Demand work? 2.00 100
• The Law of Demand simply states 1.20 150
that "as the price of а product falls, 0.80 225
the quantity demanded of the
product will usually increase, ceteris 0.40 400
paribus". It is sometimes expressed
even more simply as "the demand
curve normally slopes downwards".
• The Law of Demand may be
illustrated using either а demand
schedule or а demand curve.
• The example in the table illustrates
the effective demand for soft drinks
at а sports event.
 Price of soft drinks Quantity demanded
How does the Law ($ per can) of soft drinks (cans
per day)
of Demand work? 2.00 100
• The quantity of soft drinks demanded 1.20 150
increases as the price falls. 0.80 225
• The table showing these changes is 0.40 400
known as а demand schedule.
• The same information can be shown
in graphical form, using а demand
curve.
• This is а curve that shows the
relationship between the price of а
product, which is placed on the
vertical axis, and the quantity
demanded of the same product over
time, which is placed on the
horizontal axis.
 How does the Law of
Demand work?
As we can see from the diagram, demand curves are
normally convex (выпуклый) to the origin. However,
for ease of analysis, economists usually draw them as
straight lines, although they still call them curves! We
will do the same.
• As we saw in the example, in the Law of Demand, а change in the price of the
product itself will lead to а change in the quantity demanded of the product, ie а
movement along the existing demand curve.
• The phrase "change in the quantity demanded" is important, since it differentiates
а change in price from the effect of а change in any of the other determinants of
demand.
• On diagram, а change in the price of soft drinks from $1.20 to $0.80 leads to an
increase in the quantity demanded of soft drinks from 150 cans to 225 cans.
 What are the non-price determinants of
demand?
• When economists talk about а change in demand, they are actually referring
to а shift of the demand curve to the right or left.
• This is different to the phrase change in the quantity demanded, which we
came across earlier.
• There are а number of factors that determine demand and lead to an actual
shift of the demand curve to either the right or the left:
1. Income
2. The price of related goods
3. Tastes and preferences
4. Future price expectations
5. Number of consumers
 1. lncome
• There are two types of products to consider when we are attempting to understand
how а change in income affects the demand for а product. These are normal and
inferior goods.
Normal goods
• As income rises, the demand curve for а normal
• For most goods, as
good will shift to the right.
income rises, the
• The size of the shift in demand will depend upon
demand for the product
the good itself.
will also rise.
• An increase in income may cause а small shift to
• When people have higher
the right in the demand curve for salt, but а larger
incomes, they can afford
increase in the demand for cinema tickets.
to buy more goods, so
• The demand curve for air travel is shown on the
the demand will increase.
figure. In this case, an increase in income shifts the
Such goods are known as
demand curve for air travel to the right (D to D1 ),
normal goods.
so more air travel is demanded at every price.
 1. lncome
• There are two types of products to consider when we are attempting to understand
how а change in income affects the demand for а product. These are normal and
inferior goods.
Normal goods Inferior goods
• For most goods, as • If а product is considered to be "inferior", then
income rises, the demand for the product will fall as income
demand for the product rises and the consumer starts to buy higher
will also rise. priced substitutes in place of the inferior good.
• When people have higher • Example of inferior good is cheap wine. When
incomes, they can afford income gets to а certain level, the consumer
to buy more goods, so will be buying only the higher priced goods
the demand will increase. and the demand for the inferior good will
Such goods are known as become zero. Thus the demand curve will
normal goods. disappear.
 2. The price of related goods
There are three possible relationships between products. They may be
substitutes for each other, complements to each other, or unrelated.

• If products are substitutes for each other, then а

change in the price of one of the products will
lead to а change in the demand for the other
product.
• For example, if there is а fall in the price of
chicken in an economy, then there will be an
increase in the quantity demanded of chicken and
а fall in the demand for beef, which is а
substitute. This would lead to а movement along
the demand curve for chicken and а shift to the
left of the demand curve for beef.
 2.1. Substitutes
• А fall in the price of chicken from р to p1 leads to an
increase in the quantity demanded of chicken from q to
q1.
• This change in the price of а substitute means that some
consumers will switch from buying beef to buying
chicken and there will be а fall in the demand for beef,
at all prices.
• Therefore, the demand curve for beef will shift to the
left from D to D1. Even though the price of beef has not
changed from р, there is а fall in demand from q to q1.
• In the same way, an increase in the price of а substitute
product will lead to а fall in the quantity demanded of
that product and an increase in demand (shift of the
demand curve to the right).
 2.2. Complements
• Complements are products that are often
purchased together, such as printers and
cartridges.
• If products are complements to each other, then
а change in the price of one of the products will
lead to а change in the demand for the other
product.
• For example, if there is а fall in the price of games
consoles in an economy, then there will be an
increase in the quantity demanded of games
consoles and an increase in the demand for the
games themselves, which are complements.
• This would lead to а movement along the
demand curve for games consoles and а shift to
the right of the demand curve for games.
 2.2. Complements
• A fall in the price of games consoles from р to р1 leads to an
increase in the quantity demanded of consoles from q to q1.
• This change in the price of а complement means that
consumers will now buy more games to go with the
additional consoles that they are buying and there will be an
increase in the demand for games, at all prices, and the
demand curve for games will shift to the right from D to D1.
• Even though the price of games has not changed, there is an
increase in demand from q to q1.
• In а similar fashion, an increase in the price of а
complementary product will lead to а fall in the quantity
demanded of that product and а fall in demand (shift of the
demand curve to the left) for the complements whose prices
have not changed.
 2.3. Unrelated goods
• If products are unrelated, then а change in the price of one product will
have no effect upon the demand for the other product.
• For example, an increase in the price of toilet paper will have no effect
upon the demand for pencils.
• We say that the two products are unrelated.
 3. Tastes and preferences
• Consumer tastes and preferences have а powerful influence on consumer demand.
• If tastes change in favour of а particular product, then more will be demanded at every price.
• When tastes change so that а given product becomes less popular, then demand will fall and the
demand curve shifts to the left.
• Clearly, there are many forces acting on tastes and preference, including marketing and
advertising, peer pressure and media influence.
• The demand curve for skateboards is shown
on the figure.
• If there is an advertising campaign to
encourage the purchase of skateboards, or if
the world skateboarding championships are
televised and this leads to more people
wishing to skateboard, then there will be а
shift of the demand curve for skateboards to
the right. This means that more skateboards
will be demanded at every price.
 Ketchup tries to
keep up with
changing tastes
https://www.market
place.org/2019/07/
03/ketchup-flat-sale
s-condiment-alterna
tives/