Chapter 4: Consumer Demand McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved. Patterns of Consumption o About 70% of a household’s budget is spent on housing, transportation, food, and health expenditures. o “Essential” items have changed from years ago. 4-2 LO-1 Determinants of Demand o What determines what we buy? o The Sociopsychiatric Explanation o The Economic Explanation 4-3 LO-1 The Sociopsychiatric Explanation o The desire for goods and services arises from our needs for social acceptance, security, and ego gratification. o “Keeping up with the Joneses” o Self preservation o Expressions of affluence 4-4 LO-1 The Economic Explanation o Prices and income are just as relevant to consumption decisions as more basic desires and preferences. o Demand – The ability and willingness to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus. 4-5 LO-1 Determinants of Market Demand o Tastes - desire for this and other goods: o If a study says ice cream is good for you, the demand for ice cream would increase. 4-6 LO-1 Determinants of Market Demand o Income (of the consumer): o If you won the lottery you might buy more ice cream. o The demand for ice cream would increase, shifting the demand curve to the right. 4-7 LO-1 Determinants of Market Demand o Expectations (for income, prices, tastes) o If you knew you were going to get rich soon you might deplete savings to buy more ice cream now. o This would increase the demand for ice cream. 4-8 LO-1 Determinants of Market Demand o Other goods (their availability and price): o If the price of chocolate candy bars increased, you might buy ice cream instead of a candy bar. o This would increase the demand for ice cream. 4-9 LO-1 Determinants of Market Demand o The number of consumers in the market: o If the number of buyers in the ice cream market increased, the demand for ice cream would also increase. 4-10 LO-1 Market Demand o The total quantities of a good or service people are willing and able to buy at alternative prices in a given time period. o Market demand is the sum of all individual demands. 4-11 LO-1 Utility Theory o Economists assume that the more pleasure a product gives, the higher price buyers are willing to pay. o Students who like butter are willing to pay more for buttered popcorn than nonbuttered popcorn because it offers more total utility. 4-12 LO-1 Total Utility o Utility is the pleasure or satisfaction obtained from a good or service. o Total utility is the amount of satisfaction obtained from entire consumption of a product. 4-13 LO-1 Marginal Utility o Marginal utility is the change in total utility obtained by consuming one additional (marginal) unit of a good or service. change in total utility Marginal utility = change in quantity 4-14 LO-1 Law of Diminishing Marginal Utility o The marginal utility of a good declines as more of it is consumed in a given time period. o A student who enjoys popcorn can eat all he/she wants for free: o The first box consumed is very rewarding. o The second box is good. o The third box is decent, etc. o After eating the sixth box, he/she gets sick. 4-15 LO-1 Law of Diminishing Marginal Utility o Did the sixth box increase his/her satisfaction? o No, it had a negative marginal utility. 4-16 LO-1 Law of Diminishing Marginal Utility o As long as the marginal utility is positive, the consumer receives additional satisfaction and total utility increases. o Additional quantities of a good yield increasingly smaller increments of satisfaction. 4-17 LO-1 Utility Theory o An absolute measure of utility is not possible because the perception of satisfaction differs among individuals. o Diminishing marginal utility is a common experience. o It is a sufficient basis for economic predictions of consumer behavior. 4-18 LO-1 Utility Theory o Why do we waste water even though it is vital to human life? o We consume so much water that additional water offers little (if any) marginal utility. 4-19 LO-1 Price and Quantity o Many forces determine how much we are willing to buy. o Economists focus on the relationship between price and quantity rather than trying to explain all the forces at once. o This is the ceteris paribus (all other things being equal) assumption. 4-20 LO-1 Factors of Demand o The concepts of marginal utility and ceteris paribus explain the downward slope of the demand curve. o With given income, tastes, expectations, and prices of other goods and services, people are willing to buy additional quantities of a good only if its price falls. 4-21 LO-1 Law of Demand o Therefore, according to the law of demand, the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus. 4-22 LO-1 The Demand Curve 4-23 LO-1 Price Elasticity o The response of consumers to a change in price is measured by the price elasticity of demand. 4-24 LO-2 Price Elasticity o The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. percentage change in quantity demanded Price elasticity (E) = percentage change in price 4-25 LO-2 Price Elasticity o The price of popcorn goes up 20% and the quantity demanded goes down 10%. o The price elasticity of demand is: percentage change in quantity demanded –10% (E) = = = – 0.5 percentage change 20% in price 4-26 LO-2 Elastic versus Inelastic Demand o Demand can be elastic, inelastic, or unitary elastic. 4-27 LO-2 Elastic Demand o Demand is elastic if the absolute value of E is greater than 1. o Consumer response is large relative to the change in price. 4-28 LO-2 Inelastic Demand o Demand is inelastic if the absolute value of E is less than 1. o Consumers are not very responsive to price changes. 4-29 LO-2 Unitary Elastic Demand o Demand is unitary elastic if the absolute value of E equals 1. o The percentage change in quantity demanded is equal to the percentage change in price. 4-30 LO-2 Elasticity Estimates o Products that have an elastic demand are airline travel, fresh fish, and new cars. o Products that have an inelastic demand are cigarettes, gasoline, and coffee. 4-31 LO-2 Price Elasticity and Total Revenue o Price elasticity explains why producers cannot charge the highest possible price. o Higher prices may actually lower total sales revenue. 4-32 LO-3 Price Elasticity and Total Revenue o Total revenue - the price of a product multiplied by the quantity sold in a given time period. Total revenue = price x quantity sold 4-33 LO-3 Elasticity and Total Revenue Graph 4-34 LO-3 Elasticity and Total Revenue o A price cut decreases total revenue if demand is price inelastic. • A price cut increases total revenue if demand is price elastic. • A price cut does not change total revenue if demand is unitary elastic. 4-35 LO-3 Determinants of Price Elasticity o Differences in price elasticity are explained by several factors: o Necessities versus Luxuries o Availability of Substitutes o Price Relative to Income 4-36 LO-4 Necessities versus Luxuries o Some goods are so critical to our everyday life that we regard them as necessities. o Demand for necessities is relatively inelastic. 4-37 LO-4 Necessities versus Luxuries o A luxury good is something we’d like to have but aren’t likely to buy unless our income jumps or the price declines sharply. o Demand for luxury goods is relatively elastic. 4-38 LO-4 Availability of Substitutes o The greater the availability of substitutes, the higher the price elasticity of demand. o The smaller the availability of substitutes, the lower the price elasticity of demand. 4-39 LO-4 Price Relative to Income o If the price of a product is very high relative to the consumer’s income, the demand will tend to be elastic. o If the price of a product is very low relative to the consumer’s income, the demand will tend to be inelastic. 4-40 LO-4 Substitute Goods and Complementary Goods o Substitute Goods: o The demand for a substitute good increases when the price of the product goes up. o Complementary Goods: o The demand for a complementary good decreases when the price of the product goes up. 4-41 LO-4 Changes in Income o Income is a determinant of demand. o We illustrate income changes with shifts of the demand curve. 4-42 LO-4 Caveat Emptor: The Role of Advertising o Advertising campaigns are often designed to exploit our senses and lack of knowledge. o Caveat emptor means “let the buyer beware.” 4-43 LO-5 Are Wants Created? o Advertising is not the only reason consumption has increased. o Personality and social interaction dynamics have changed how much we consume. o A successful advertising campaign is one that shifts the demand curve to the right. 4-44 LO-5 Consumer Demand End of Chapter 4 4-45
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