Law of Demand Flashcards
Consumer Sovereignty
- the theory that consumer preferences determine the production of g/s
- consumers can use their spending power as ‘votes’ for g/s
- producers respond to those preferences and produce those goods
Law of Demand
Conditional on all else being equal, as the price of a good increases, quantity demanded decreases.
Conversely, as the price of the a good decreases, quantity demanded increases.
There is an inverse relationship between price and quantity demanded of a good
Demand Curve
- depicts the relationship between the price of a certain commodity and the amount of it consumers are willing and able to purchase at any given time
Characteristics of Demand Curve
- demand curve usually slopes downwards from left to right —> negative gradient
Why the Negative Gradient
- the negative gradient indicates the inverse relationship between quantity demanded and price
- Law of diminishing marginal utility
- The income effect
- The substitution effect
Law of diminishing marginal utility
- as more of a product is consumer the marginal benefit to the consumer falls, hence consumers are prepared to pay less
- when the cost outweighs the benefit, a rational consumer is prepared not to pay as much for the extra units or not pay at all
Income Effect
- as the price of a good falls, real income rises and consumers increase their demand
- at a lower price, consumers can buy more from the same money income, and demand will rise
- a rise in price will reduce real income and force consumers to cut back on their demand
Substitution Effect
- as the price of one good falls, it becomes relatively less expensive
- assuming other alternative products stay at the same price, at lower prices the good appears cheaper, and consumers will switch from the expensive alternative to the relatively cheaper one
How and Why does demand change
- A change in the price of the product –> quantity demanded
- Every other factor –> demand
Change in QD –> Price of product changes –> movement along the demand curve
Change in Demand –> Any other factor changes –> shift in the demand curve
Changes in Price
- a movement along a demand curve when a change in price causes the QD to change
- increase in price –> contraction in demand
- decrease in price –> expansion in demand
Changes in any other variable
- shift in the demand curve when there is a change in any non-price determinant of demand –> new demand curve
Non-price determinants –> things whose changes might cause a consumer to buy more/less of a good even if it’s own price is unchanged
Important factors:
- price of related goods –> substitutes/complements
- income
- population
Circumstances causing demand curve to shift
- Changes in the price of a substitute
- Changes in the price of a complement
- Change in income if good is normal good
- Change in income if good is inferior good
- Changes in the price of a substitute
- when two goods are substitutes, there is an adverse/positive relationship between the price of one good and the demand for the other good
Substitutes –> goods that aren’t consumed together but is rather a choice about which to consumer –> Pepsi and Coke
Price of substitute increases = demand increases
- Changes in the price of a complement
- when two goods are complements, there is an inverse relationship between the price of one good and the demand for the other good
Complements –> two goods typically consumed together –> bagels and cream cheese
Bagel price increases –> less cream cheese is needed
Price increases = demand decreases
- Change in income if good is normal good
- there is a positive/adverse relationship between a consumer’s income and the amount of the good that one is willing able to buy
- when income rises, the demand for the product increases –> vice-versa
