03 Law of Demand

7/21/2019 03 Law of Demand

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Lecture 3Lecture 3

The Law of DemandThe Law of Demand

Our objectives:Our objectives:

Explain individual choices amongExplain individual choices amongunlimited wants in a world of limitedunlimited wants in a world of limited

resourcesresources

Develop a theory that helps us betterDevelop a theory that helps us better

understand and predict human actionsunderstand and predict human actions

What do people our customers! want"What do people our customers! want"


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A Very Dicult IssueA Very Dicult Issue

What we measure in demand is aWhat we measure in demand is arefectionrefectionof individual desires#of individual desires#

Daniel $ernoulli% a mathematical geniusDaniel $ernoulli% a mathematical geniuswho lived in $asel% noted% in &'()% thatwho lived in $asel% noted% in &'()% thatpeople see* goodness or pleasurepeople see* goodness or pleasureutility!#utility!#

+hat is% we do not see* cellphones+hat is% we do not see* cellphonesbecause they are cellphones but becausebecause they are cellphones but becausethey are useful and give us pleasure# ,sethey are useful and give us pleasure# ,seand pleasure cannot be measured% onlyand pleasure cannot be measured% only

approximated#approximated#


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A Note on Value, Scarcity,A Note on Value, Scarcity,

and Price as Related toand Price as Related to

DemandDemandWhy do people want what they want"Why do people want what they want"

+he diamond-water paradox#+he diamond-water paradox#

.carcity need not mean highly valued/.carcity need not mean highly valued/thin* of sna*e meat#thin* of sna*e meat#

0ar*ets re1ect what people value in0ar*ets re1ect what people value in

relationship to current availability#relationship to current availability#

Demand is our best understanding ofDemand is our best understanding of

what people value2given currentwhat people value2given current

conditions#conditions#


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The Law of DemandThe Law of Demand

3olding all other relevant factors constant%3olding all other relevant factors constant%the lower higher! the price of a good% thethe lower higher! the price of a good% thegreater lower! will be the 4uantitygreater lower! will be the 4uantity

demanded#demanded#

5i*e all scienti6c propositions% it is a5i*e all scienti6c propositions% it is a ceterisceterisparibusparibus 7other things e4ual8 or 7other7other things e4ual8 or 7other

things constant8! statementthings constant8! statement

9ote9otethetheterminologyterminology

- rice means opportunity cost- rice means opportunity cost

- ;ood means anything people value- ;ood means anything people value


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!hy focus on the Law of!hy focus on the Law of

Demand"Demand"

This is the most #owerful #ro#osition in economics$This is the most #owerful #ro#osition in economics$


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The Demand %unctionThe Demand %unction

Some De&nitionsSome De&nitions+he relationship between 4uantity consumed and the+he relationship between 4uantity consumed and the

factors determining that: D = f % factors determining that: D = f % ..% % >>%


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The Role of TastesThe Role of Tastes

+hey are very hard to measure% so we+hey are very hard to measure% so wegenerally ignore them% but we *nowgenerally ignore them% but we *now

they exist#they exist#

5oo* to mar*eting and psychology for5oo* to mar*eting and psychology forguidance here% not economists?guidance here% not economists?

@or economists% tastes are often the@or economists% tastes are often theunexplained portion of consumptionunexplained portion of consumption


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'(#ectations'(#ectations

Also diBcult to measure 2 but importantAlso diBcult to measure 2 but important

When measurable% include in the analysis#When measurable% include in the analysis#$ut experience shows2measures are very$ut experience shows2measures are verypoor predictors of actions#poor predictors of actions#

5i*e tastes% these can be used to5i*e tastes% these can be used to7explain8 anything7explain8 anything DonCt fall into this trapDonCt fall into this trap


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This or that"This or that"

.ubstitutes:.ubstitutes:

Essentially% goods used in place of each other2Essentially% goods used in place of each other2

same geographic mar*et/ similar performancesame geographic mar*et/ similar performance

characteristics# What is a substitute in onecharacteristics# What is a substitute in onemar*et may not be seen by consumers as suchmar*et may not be seen by consumers as such

in another mar*et2orange juice and orangein another mar*et2orange juice and orange

soda#soda#

Dierent brands of gasoline/ robots in enaultDierent brands of gasoline/ robots in enaultfactory in @rance v# wor*ers in enault factory infactory in @rance v# wor*ers in enault factory in

ussia former 5ada! paid FGHH a month/ movieussia former 5ada! paid FGHH a month/ movie

theater v# movie rentals/ corn or sugar intheater v# movie rentals/ corn or sugar in

ethanol#ethanol#


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Related )oodsRelated )oods

>omplements:>omplements:

Essentially% goods used togetherEssentially% goods used together

>omputer hardware and software/>omputer hardware and software/

tennis balls and rac*ets/ airplanetennis balls and rac*ets/ airplane

travel and hotel rooms/ ;oogletravel and hotel rooms/ ;oogle

maps and discount coupons/maps and discount coupons/growing corn for ethanol and Deeregrowing corn for ethanol and Deere

tractorstractors


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*han+es in the Price of Related*han+es in the Price of Related

)oods)oods

Goods X and Y areGoods X and Y are substitutessubstitutesif:if:

A change in price of I changes demand for J insame direction

- x up implies Dy up Dy shifts to the right!

- x down implies Dy down Dy shifts to the left!

Eect of change in y on Dx is also in samedirection


12/23

ore on the Prices of Relatedore on the Prices of Related

)oods)oods

Goods V and W areGoods V and W are complementscomplementsif:if:

A change inA change in price of Vprice of Vchangeschanges demanddemandfor Wfor Win opposite direction:in opposite direction:

- Pv up implies D don !D shifts to left"- Pv up implies D don !D shifts to left"

- Pv don implies D !D shifts to right"- Pv don implies D !D shifts to right"

#ffect of a change in P on Dv is also in#ffect of a change in P on Dv is also inoppositeoppositedirectiondirection


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*han+es in Income*han+es in Income

Normal Goods:Normal Goods:

>hange in income changes demand in same direction

- 3igher income causes increase in demand

- 5ower income causes decrease in demand 8.uperior8 good is a variant: change in demand due

to income change is 4uite large

Inferior goods:

>hange in income changes demand in oppositedirection

- 3igher income causes decrease in demand

- 5ower income causes increase in demand


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Terminolo+yTerminolo+y-sed to a.oid confusion-sed to a.oid confusion

>hanges in>hanges in 4uantity demanded:4uantity demanded:

>aused by changes in>aused by changes in own priceownpriceof goodof good

meansmeans movement along a given demandcurve

$hanges in demand:

>aused by changes in other factors:

- rices of other goods

-


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*han+e in Price*han+e in Price

A change in the price of a goodA change in the price of a good

means a movement along ameans a movement along a

demand curve#demand curve#

KuantityLtimeKa Kb

Demand

rice

a

b


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*han+e in Demand*han+e in Demand

A change in a factor that determines demand%A change in a factor that determines demand%

besides the price of the good itself% causes thebesides the price of the good itself% causes the

Demand curve to shift#Demand curve to shift#

Example:


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Deri.in+ a Real DemandDeri.in+ a Real Demand

*ur.e*ur.e

De&ne your mar2etDe&ne your mar2et

oulder, *olorado, o.er time4oulder, *olorado, o.er time4

consum#tion of water 1y #eo#leconsum#tion of water 1y #eo#le

ser.ed 1y city water4 #rice #erser.ed 1y city water4 #rice #er5,666 +allons4 1illions +allons0yr$5,666 +allons4 1illions +allons0yr$

consumed 1y demanders$consumed 1y demanders$

7ear7ear PricePrice /uantity/uantity

589:589: ;6$


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!hat else would you want to 2now"!hat else would you want to 2now"

+he Demand curve plots the relationship+he Demand curve plots the relationship

between price and 4uantity demanded Mbetween price and 4uantity demanded M

nothing else M everything else is held constantnothing else M everything else is held constant

$ut in the real world% other things are not$ut in the real world% other things are not

constant% so what else would you want toconstant% so what else would you want to

*now if you wanted to understand that mar*et*now if you wanted to understand that mar*et

better"better"

9ame li*ely relevant factors:9ame li*ely relevant factors:


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@ard Test@ard Test

!hich )oods Are *om#lements,!hich )oods Are *om#lements,

!hich Are Su1stitutes"!hich Are Su1stitutes"

Wine and beer#Wine and beer#

G#G# Domestic shirts and importedDomestic shirts and importedshirts#shirts#

(#(# Oil from hina#Oil from hina#

N#N# aper and pencils#aper and pencils#

## late glass and bric*Lconcretelate glass and bric*Lconcrete


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Demand analysisDemand analysis

3ow would demand for hair3ow would demand for hair

replacement be li*ely to changereplacement be li*ely to change

if the following occurs"if the following occurs" A fall in the price of hairpieces#A fall in the price of hairpieces#

G#G# A rise in income#A rise in income#

(#(# A rise in the divorce rate#A rise in the divorce rate#


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*le.er sales #itch*le.er sales #itch

A $ritish cellphone companyA $ritish cellphone company

promised new subscribers inpromised new subscribers in

9ovember and December that all9ovember and December that allcalls on >hristmas Day%calls on >hristmas Day%

December G% would be free#December G% would be free#

What would you expect happenedWhat would you expect happenedto the volume of calls that day"to the volume of calls that day"


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/uestion on chan+in+/uestion on chan+in+

demanddemand

+rying to predict future demand% ;E+rying to predict future demand% ;E

research showed that the averageresearch showed that the average

siPe of the American family wassiPe of the American family wasdeclining and so was the averagedeclining and so was the average

s4uare footage of houses#s4uare footage of houses#

3ow would you thin* this impacted3ow would you thin* this impactedthe demand for the design of% say%the demand for the design of% say%

refrigerators"refrigerators"


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ey Point from Peterey Point from Peter

Druc2erDruc2er

0ost important 4uestion sellers must as*:0ost important 4uestion sellers must as*:

BB!hat is .alue to the customer"C!hat is .alue to the customer"C

.ellers often thin* they *now% but do not#.ellers often thin* they *now% but do not#+he customers do not buy a product/+he customers do not buy a product/

they buythey buy .alue$.alue$

Demanders are buying a product to satisfyDemanders are buying a product to satisfy

a want# Do nota want# Do not guessguesswhat customerswhat customerswant2always carefully evaluate whatwant2always carefully evaluate what

theytheywant#want#

03 Law of Demand

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