Lecture 03 - Demand

Lecture 3

READING MATERIAL • Sloman – Ch.2 pp. 30-36, Ch.4 pp. 87-97 (material on marginal utility optional).

Wants and Demand

DEMAND

Wants are unlimited

Demand is constrained by income levels While we might all want to fly to the moon, most of us do not have sufficient income and therefore our effective demand for moon flights is zero.

The Law of Demand

DEMAND

there is typically an inverse relationship between the price of a product and the quantity of that product demanded graphically it is represented by a downward sloping D-curve

Price of X

Demand Curve for X £100

£20

D-curve 3

8

Quantity of X Demanded

Why is a demand curveDEMAND downward sloping ? Three reasons: • real income effect of a price change • substitution effect of a price change • law of diminishing marginal utility Real Income Effect • an increase in the price of X, reduces the real income (purchasing power) of consumers whom have fixed money income • consumers cannot buy as many goods and services with the same money income and therefore quantity demand contracts

DEMAND Substitution Effect • an increase in the price of X, assuming the price of all other products remains constant, will make X relatively more expensive than substitute products for X • Consumers will switch from X to substitutes and therefore there will be a contraction in demand for X • For example: If the price of butter increase, and the price of margarine remains constant, people will switch from butter to margarine

UTILITY Law of diminishing marginal utility Utility is the amount of satisfaction a consumer derives from consuming a product

Coke

Coke

Coke

Coke

Marginal utility is the amount of satisfaction derived from each additional unit of a product consumed

UTILITY

1st Drink

1 Recycle Bin

Satisfaction Metre

Enough

OK

Good

Very Good

Excellent

UTILITY

2nd Drink

2 Recycle Bin

Satisfaction Metre

Enough

OK

Good

Very Good

Excellent

UTILITY

3rd Drink

3 Recycle Bin

Satisfaction Metre

Enough

OK

Good

Very Good

Excellent

UTILITY

4th Drink

4 Recycle Bin

Satisfaction Metre

Enough

OK

Good

Very Good

Excellent

UTILITY

5th Drink

5 Recycle Bin

Satisfaction Metre

Enough

OK

Good

Very Good

Excellent

UTILITY

6th Drink

6 Recycle Bin

Satisfaction Metre

Enough

OK

Good

Very Good

Excellent

UTILITY Satisfaction Metre

Drink Consumed 1st 2nd 3rd 4th 5th 6th Enough

OK

Good

Very Good

Excellent

UTILITY Satisfaction Metre Excellent

Price Prepared To Pay

£1.00

Very Good

£0.75

Good

Drink Consumed

6th

5th

4th

3rd

2nd

1st

Enough

As the quantity consumed increases, the amount of satisfaction (utility) derived from each additional unit eventually declines.

£0.25

Therefore the amount one is prepared to pay for each additional unit will also fall as the quantity consumed increases.

0

The Law of Demand. Demand

£0.50

OK

Law of Diminishing Marginal Utility

THE LAW OF DEMAND Demand Curve

Price £1.00

There is an inverse relationship between the price of a Product and the Quantity demanded. OR …. Since the satisfaction derived from each additional unit diminishes, the price consumers are prepared to pay is less for each additional unit.

£0.75

£0.50

£0.25

0

1

2

3

4

5

6

Qty Consumed (Cans)

THE LAW OF DEMAND

Demand Schedule

A B C D E F G

Demand equation: P = 24 – 4Q De m and & Re ve nue 40 36

Price & Revenue (£)

32 28 24

Q 0 1 2 3 4 5 6

P 24 20 16 12 8 4 0

TR = 0 20 32 36 32 20 0

A

20

B

16

C

12

D

8 4

E

0 0

1

2

3 Qua ntity

4

5

6

F G

THE LAW OF DEMAND

Total Revenue (TR) = P x Q Demand equation: P = 24 – 4Q So TR = PxQ = 24Q – 4Q2

A B C D E F G

Demand & Revenue

40 36 32 Price & Revenue (£)

Q 0 1 2 3 4 5 6

28

P 24 20 16 12 8 4 0

24 20 16 12 TR

8 4 0

D-Curve 0

1

2

3 Quantity

4

5

6

TR = P 0 20 32 36 32 20 0