Chapter 2: The Law of Demand

Preferences

all of your wants and how intense each want is

Demand

consumers willingness and ability to pay for a particular product or service

• For any choice, what you are willing to pay or give up depends on the cost and availability of substitutes

Marginal benefit

additional benefit from a choice

• Changes with circumstances

• Explains the diamond/water paradox

  • Willingness to pay depends on marginal benefit, not total benefit

    • Water is abundant; marginal benefit is low

    • Diamonds are scarce; marginal benefit is high

Quantity demanded

the amount you actually plan to buy at a given price, taking into account everything that affects your willingness to pay

Market demanded

the sum of the demands of all individuals willing and able to buy a particular product or service

Law of demand

inverse relationship between price and quantity demanded

ex. if the price of a product or service rises, quantity demanded decreases, other things remaining the same

Demand curve

shows the relationship between price and quantity demanded, when all other influence on demand, besides price, do not change

• downward sloping left to right

• combines willingness and ability to pay

• the price product itself is not kept constant along a demand curve

Reading the demand curve as a demand curve

over and down

Reading the demand curve as a marginal benefit curve

up and over

Increase in demand

• increase in consumers willingness and ability to pay

• rightward shift of demand curve

Decrease in demand

• decrease in consumers willingness to pay

• leftward shift of demand curve

5 ways to change and shift the demand curve

1. Preferences

2. Prices of related products

3. Income

4. Expected Future Prices

5. Number of Consumers

For the first four factors, the description for an increase in demand is; This is the marginal benefit reading of the demand curve.

For the fifth factor, number of consumers, the description for an increase in demand is; This is the demand curve reading of the demand curve.

1. Preferences

• increase in preferences = increase in demand

• decrease in preferences = decrease in demand

2. Prices of Related Products

Substitutes: products or services that can be used in place of each other to satisfy the same want

Complements: products or services that are used together to satisfy the same want

3. Income

Normal Good: products and services that you buy more of when your income

Inferior Good: products and services you buy less of when your income increases

4. Expected Future Prices

• An expected future price fall decreases demand today.

• An expected future price rise increases demand today.

5. Number of Consumers

• The increased number of consumers increases demand.

• A decrease in the number of consumers decreases demand.