Notes
The law of demand
- Demand is willingness and ability to buy. The law of demand: as price rises, quantity demanded falls, ceteris paribus.
- Reasons: the substitution effect, the income effect and diminishing marginal utility.
- A demand schedule is a table; a demand curve slopes downward. Market demand adds all buyers' quantities at each price.
Movements and shifts
- A change in the good's own price causes a change in quantity demanded, a movement along the curve.
- Other factors cause a change in demand, shifting the whole curve: right for an increase, left for a decrease.
- Determinants of demand: income (normal vs. inferior goods), prices of substitutes and complements, tastes, expectations and the number of buyers.
Elasticity
- $\displaystyle E_d = \frac{\% \text{ change in } Q_d}{\% \text{ change in } P}$ in absolute value. Greater than 1 is elastic, less than 1 is inelastic, equal to 1 is unit elastic.
- Demand is more elastic with many substitutes, for luxuries, for big-budget items and over longer time periods.
- Total revenue $= P \times Q$. If demand is elastic, a price rise lowers revenue; if inelastic, a price rise raises revenue.
Topics in this unit
Each topic has its own short notes and practice.
Practice
Some coffee drinkers switch to the now-cheaper tea, so coffee demand falls at every price.
Price rises $\displaystyle \frac{0.50}{2.00} = 25\%$; quantity falls $\displaystyle \frac{40}{400} = 10\%$; $\displaystyle \frac{10\%}{25\%} = 0.4$.
$2.00 \times 400 = 800$ and $2.50 \times 360 = 900$, as expected with inelastic demand.
Expectations and tastes shift demand; the coat's own price only moves buyers along the curve.
Many close substitutes exist, so buyers switch easily when its price rises.
Demand for an inferior good falls as income rises; demand for a normal good rises.
Free response
Write your answer first, then open the scoring guide.
Free-response question
A pizza shop lowers the price of a slice from $4 to $3. Its daily sales rise from 200 slices to 300 slices.
(a) Calculate the price elasticity of demand and state whether demand is elastic, inelastic or unit elastic.
Show the answer and scoring guide
Price falls by $\displaystyle \frac{1}{4} = 25\%$. Quantity rises by $\displaystyle \frac{100}{200} = 50\%$. $\displaystyle E_d = \frac{50\%}{25\%} = 2$, so demand is elastic.
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(b) Calculate total revenue before and after the price change, and explain why the result fits your answer to part (a).
Show the answer and scoring guide
Before: $4 \times 200 = 800$, or $800. After: $3 \times 300 = 900$, or $900. Revenue rose because demand is elastic: the percentage gain in slices sold (50%) is larger than the percentage drop in price (25%).
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(c) A new taco restaurant opens next door. Explain how this affects the demand for the shop's pizza and describe the change on a demand graph.
Show the answer and scoring guide
Tacos are a substitute for pizza, and the new restaurant may also add to competition for the same customers. Some customers will choose tacos, so at every price fewer slices are demanded. This is a decrease in demand: the entire demand curve shifts to the left. It is not a movement along the curve, because the price of pizza did not change.
Check off the points you earned: