The Price SystemChapter 2: Core

DEMAND

Learning objectives• To be able to understand and

describe demand and demand curve.• Analyse how aggregate demand

created and factors influence demand.

BLP objectives Absorption Questioning Listening

Starter• Solve the following situation.

The tickets to a concert are sold out, but you go anyway and hope to find a scalper. There is, alas, but one scalper, and she has but one ticket to sell. Since there are about 25 people trying to buy the ticket, she announces that she will auction it by sealed bid, and that she will award the ticket to the highest bidder--but the winner need only pay the second highest amount bid. As you prepare to write down your bid, you decide that the most the ticket is worth to you is $56. How much should you bid--$56, more than $56, or less than $56?

Demand• Demand refers to the quantity of a product

that consumers are willing and able to buy at a particular price and over a given period of time.

• The law of demand states that more is bought at a lower price than at a higher price.

• In other words, the law of demand postulates an inverse relationship between the price and quantity demanded of a commodity, all other factors affecting demand remain constant (ceteris paribus).

Movement along in demand curve

0 1 2 3 4 5

0

10

20

3

0

40

50

60

Price

Quantity

Shift of Demand Curve

Shift in demand curve

• At the same price, a different quantity is demanded.

0 1 2 3 4 5

0

10

20

3

0

40

50

60

Price

Quantity

Causes of shift in demand curve

•Changing prices of a substitute good•Changing price of a complement•Changes in the income of consumers

FACTORS INFLUENCING DEMAND

1. Change in the price of the commodity itself.

2. Change in real income

3. Tastes and fashion

4. Changes in the prices of complements and substitutes

5. Changes in population

6. Expectation of future changes in price

7. Changes in distribution of income

8. Government policy – income tax

9. Saving and Rate of interest

Practice

• Self Assessment 2.2 & 2.3• Using a diagram, explain briefly why the demand curve slopes

downwards from left to right. [3]• Using a diagram, explain briefly why the supply curve slopes upwards

from left to right. [3]

ELASTICITY OF DEMAND

Learning Objective•Learners to understand the concept of elasticity. (Basic)•Able to describe, calculate, the factors affect the elasticity. (Extended)

ELASTICITY OF DEMAND

•Price elasticity of demand.•Income elasticity of demand.•Cross elasticity of demand.

Price elasticity of demand

• Price elasticity of demand measures the responsiveness of quantity demanded to a change in the price of the commodity. In other words, it shows by how much quantity demanded has changed given a change in price. Price elasticity of demand is calculated as follows:

pricein change Percentage

demandedquatity in change Percentagedemand of elasticity Price

Price elasticity of demand

• Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as:

210

20

10000.2

)20.220.2(

10010

)810(

percent

percent

Ranges of ElasticityInelastic DemandPercentage change in price is

greater than percentage change in quantity demand.

Price elasticity of demand is less than one.

Quantity

4

$51. A 25%increasein price...

Demand

100902. ...leads to a 10% decrease in quantity.

Price

Elastic DemandElastic Demand Percentage change in

quantity demand is greater than percentage change in price.

Price elasticity of demand is greater than one

Quantity

4

$51. A 25%increasein price...

Demand

100502. ...leads to a 50% decrease in quantity.

Price

Unitary DemandUnitary DemandPercentage change in

quantity demand is equal to percentage change in price.

Price elasticity of demand is equal to one

Quantity

Price

4

$51. A 25%increasein price...

Demand

100752. ...leads to a 25% decrease in quantity.

FACTORS INFLUENCING PRICE ELASTICITY OF DEMAND• Nature of commodity• Availability of substitutes• Number of uses of a product• Habit• Time period• Price of commodity itself

USEFULNESS OF A KNOWLEDGE OF PRICE ELASTICITY OF DEMAND

• See the print out / hand out

Practice

• Self assessment 2.5 – 2.7