Markets and Prices
is the desire to have some good or service and the ability to pay for it.
Their willingness and ability to purchase vary in response to price.
Demand is a record of how people's buying habits change in response to price. It is a whole series of quantities that consumers will buy at the different prices level at which they will make these purchases.
Hence, a demand schedule:
1.1 Law of demand
As the price goes down, quantity demanded goes up. This inverse relationship is called the law of downward-sloping demand.
In any time period, consumer will derive less satisfaction (utility) from each successive unit of a good consumed. This is Diminishing Marginal Utility. Each successive unit brings less utility and consumer will only buy more at lower prices.
At higher prices, consumers are more willing and able to look for substitutes. The substitution effect suggests that at a lower price, consumers have the incentive to substitute the cheaper good for the more expensive.
A decline in the price of a good will give more purchasing power to the consumer and he can buy more now with the same amount of income. This is the income effect.
1.2 Change in quantity demanded
Movement along the same demand curve caused by a change in price!
1.3 Change in demand
9 10 Q
1.4 Determinants of demand
T - Consumers’ tastes and preferences: What was once perceived as useful or useless, stylish or ugly, healthy or dangerous now can become its opposite.
R - The price of related goods:
Substitutes: Demand for the substitute will increase if the price of the original item rises.
Complementary: if a decrease in the price of one good increases demand for the other good.
I - Income:
Normal goods: an increase in income leads to a rightward shift in the demand curve.
Inferior goods: an increase in income leads to a leftward shift in the demand curve, since these are usually low-quality items that people will avoid when they have more to spend.
B - The number of buyers in the market: demand depends on the size of the market.
E - Consumer expectations: If you expect that there will be a sharp increase in prices for a particular goods in the near future, you may increase your demand for that good now.
2. Explanations of the Law of Demand
2.1 The Income and Substitution Effect
Combine to make a consumer able and willing to buy more of a specific good at a low price than at a high price.
Income Effect is the term used for a change in the amount of a product that a consumer will buy because the purchasing power of his or her income changes – even though the income itself does not change.
Substitution effect is the pattern of behavior that occurs when consumers react to a change in the price of a good or service by buying a substitute product – one whose price has not changed and that offers a better relative value.
2.2 Law of Diminishing Marginal Utility
Can be stated as the more a specific product consumer obtain, the less they will want more units of the same product.
Utility is want-satisfying power - it is the satisfaction or pleasure one gets from consuming a good or service.
Total Utility is the total amount of satisfaction or pleasure a person derives from consuming some quantity.
Marginal Utility is the additional utility you get from the consumption of an additional unit of that product.
Total Utility increases at a diminishing rate, reaches a maximum and then declines.
Marginal Utility diminishes with increased consumption, becomes zero when total utility is at a maximum, and is negative when total utility declines.
From the graphs above, we can conclude that when total utility is at its peak, marginal utility is below zero. Marginal utility reflects the change in total utility so it is negative when total utility declines.
3. Theory of Consumer Behavior
3.1 Consumer Choice and Budget Restraints
Rational Behavior - derive the greatest satisfaction
Preferences - based on marginal utility
Budget Restraints - money income is limited
Prices - signal scarcity, consumer must compromise
3.2 Utility-Maximizing Rule
The consumer's money income should be allocated so that the last dollar spent on each product purchased yields the same amount of marginal utility.
The rational consumer must compare the extra utility with its added cost.
Utility-Maximizing with Income of $10