1.2 The Nature of Demand Flashcards
How do rational consumers act?
- Rational consumers aim to maximising utility from purchasing and consuming goods and services using a limited budget
- Consumers choose independently
- Consumers have fixed and consistent tastes and preferences
- Consumers gather complete information on the alternatives
- Consumers always make the optimal choice given their preferences
What is utility?
Utility is the quantified value of total satisfaction received from consumption, measured in utils - the psychological satisfaction gained from a good or service
What are the 2 types of utility and the law of diminishing marginal utility?
Total utility - total amount received from all consumption, marginal utility is marginal
The law of diminishing marginal utility states that the more you consume the less satisfaction you receive and so there is a decline in marginal utility derived from consuming each additional unit of such product.
What is demand? What are the 4 key types?
The quantity of a good or service that consumers are willing and able to buy at a given price in a given period of time.
Effective demand is when demand is backed up by the ability to pay.
Derived demand is the demand for a factor of production used to produced another good or service e.g. if there is an increase in demand for cars there will be derived demand of steel
Joint demand - when demand for a product is related to demand for another good or service, called complements e.g. fish and chips
Composite demand is when goods may have multiple uses and so an increase in demand for one use may reduce supply of another e.g. dairy - increase in milk demand may lead to fall in cheese
What is the law of demand?
There is an inverse relationship between price and demand. As prices fall, we see an extension of demand and as prices rise there is a contraction
What are the 3 reasons for the law of demand?
Substitution effect - if the good is more expensive than alternatives, consumers will switch
The income effect - when prices fall, the consumer has more real income and so demand rises and vice versa.
May also relate to law of diminishing marginally utility as when more is consumed the utility may fall.
What may cause a shift in demand?
PASIFIC
Population - demographics (includes age structure)
Advertising
Substitutes - price of competition
Incomes - changes in distribution of income
Fashion and trends - seasonal, social, emotional
Interest rates
Complements - price of
What is PED?
Measures responsiveness of quantity demanded after a change in the good’s own price, calculated by percentage change in demand over percentage change in price.
When may the PED be used?
- know the responsiveness of consumers before changing prices
- impact on total revenue when prices change
- price discrimination
What do the different values of PED indicate?
The values of PED are between 0 and -infinity
If PED = 0, it is perfectly inelastic and so no matter what the price changes to demand will not change
If it is between 0 and -1, it is relatively inelastic and so a change in demand is smaller than the change in price
If PED = -1 it is unitary elastic, so demand and price are proportional
If PED is less than -1 then quantity demand rises more than a change in price, so it is price elastic
If PED is -infinity it is perfectly elastic so if prices changes even slightly demand will fall to 0
What factors affect PED?
SPLAT
Substitutes - more substitutes, more elastic demand is because they can switch - also cost of switching may make it inelastic
Proportion of income - if take up lots of income there will be more elastic demand
Luxury/necessity - necessities are inelastic and luxuries more elastic
Addictive - addictive goods are inelastic - may involve habits
Time - long running items are more elastic such as subscription payments
What are some evaluation points for PED?
- Estimate so imperfect
- Hard to calculate
- Changes over time
- Tastes and preferences change
- Technological advancements may remove switching costs
- Internet enables consumers to compare prices
How does PED affect revenues?
If demand is price inelastic a rise in price leads to a rise in total revenue as a rise in price causes a small loss of consumers
If demand is elastic then a fall in price leads to a rise in total revenue as there is only a small fall in price but great rise in demand
What is income elasticity of demand?
The responsiveness of demand when there is a change in the consumers real income
percentage change in quantity demanded over percentage change in incomes
What are normal goods?
Normal goods are goods which demand rises for when incomes rises, so they have a positive income elasticity of demand.
Normal necessities have low YED and so are income inelastic as a rise in income does not really increase demand
Luxuries have a higher YED and are income elastic
