Chapter 4 1 Law of Demand Essential

Chapter 4. 1 Law of Demand • Essential Question: How does the law of demand affect quantity demanded? Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 1

Objectives 1. Explain diminishing marginal utility and the law of demand. 2. Describe how the substitution effect and the income effect influence decisions. 3. Create a demand schedule for an individual and a market. 4. Interpret a demand graph using demand schedules. Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 2

Introduction • How does the law of demand affect the quantity demanded? – Price changes always affect the quantity demanded – As the price rises, people will demand buy less of a good or service Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide

Marginal Utility and Demand • Households want to maximize utility • Marginal utility (MU) is the satisfaction you gain from consuming the next unit of a good or service • Law of diminishing marginal utility – MU decreases when more is consumed Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 4

Marginal Utility and Demand • A person’s Willingness-to-pay (WTP) decreases as quantity demanded increases – If I have eaten a lot of pizzas, I have diminishing marginal utility – I’m not WTP very much to get another pizza – Inverse relationship: WTP and Demand Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide

Law of Demand • Demand is the desire to own something (that provides utility) and the willingness to pay for it. • The Law of Demand – Price goes Up, Demand goes Down (Gas Price Hikes) – Price goes Down, Demand goes Up (Black Friday) – The law of demand is the result of both the substitution effect and the income effect Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 6

The Substitution Effect • a consumer reacts to a rise in the price of one good by – consuming less of that good and – more of a substitute good. • The substitution effect can also apply to a drop in prices. Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 8

The Income Effect • The income effect is the change in consumption that results when a price increase causes real income to decline. – If the price of gas rises, you will buy less of it because you can “afford less” – The income effect also operates when the price is lowered. • If the price of something drops, you feel wealthier. Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide

The Law of Demand in Action Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 10

Q(P) decreasing • A demand schedule is a table that lists the quantity of a good that a person will purchase at various prices in the market. • How does market demand change when the price falls from $3 to $2 a slice? Demand Schedules Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 11

Q(P) The Demand Curve decreasing • A demand curve is a graphic representation of a demand schedule. – IT IS ALWAYS DOWNWARD SLOPING (m<0) – Quantity demanded and price are inversely related • Independent and dependent variables are on opposite axes in economics! – The vertical axis represents price (independent variable) – The horizontal axis represents quantity demanded (dependent variable) Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide

Demand Curves Chapter 4, Section 1 Q(P) decreasing Copyright © Pearson Education, Inc. Slide 13

Objectives Qd = Quantity Demanded 1. Explain diminishing marginal utility and the law of demand. 1. Marginal utility is greatest at first and decreases as Qd increases. 2. Willingness-to-pay decreases as Qd increases 3. Law of demand is: price goes up, demand goes down. Price goes down, demand goes up 2. Describe how the substitution effect and the income effect influence decisions. Price rises on Coke. I decide to demand less. The substitution effect means I demand more of Pepsi instead. The income effect means I can afford less Coke now that it is more expensive. 3. Create a demand schedule for an individual and a market. 4. Interpret a demand graph using demand schedules. Demand curves are downward sloping. Price and demand have an inverse relationship Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 14

Related Careers and Looking Ahead • For those interested in psychology, advertising, marketing, media, economics, business – You can learn more by researching Consumer Preference Theory or Consumer Behavior – The field where economics and psychology combine is called Behavioral Economics • Looking Ahead – People who work in marketing/advertising must be aware of shifts in demand for their products • Leading business and marketing people cause favorable shifts in demand • There was no demand for i. Phones. People only wanted and were willing to pay for i. Phones after Apple marketing/ads “created” the demand Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 15

Key Terms • Marginal utility: utility gained from consuming the next unit • Diminishing marginal utility: As consumption of a product increases, marginal utility decreases from consuming each additional unit of that product. • Willingness-to-pay: How much a person is willing to pay for each level of quantity demanded • Demand: the desire to own something (utility) and the ability to pay for it (income) Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 16

Key Terms • law of demand: consumers will buy more of a good when its price is lower and less when its price is higher • substitution effect: when consumers react to an increase in a good’s price by consuming less of that good and more of a substitute good • income effect: the change in consumption that results when a price increase causes real income to decline. The budget constraint Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 17

Key Terms, cont. • demand schedule: a table that lists the quantity of a good a person will buy at various prices in a market • market demand schedule: a table that lists the quantity of a good all consumers in a market will buy at various prices • demand curve: a graphic representation of a demand schedule Chapter 4, Section 1 Copyright © Pearson Education, Inc. Slide 18