Understanding Demand, Income, and Price Effects

• Demand is the quantity of a good or service consumers are willing and able to purchase at various prices over a period of time.

Law of Demand

• States that as the price of a good or service increases, the quantity demanded decreases, all other things being equal.
• Conversely, as the price decreases, the quantity demanded increases.

Income Effect

• Refers to the change in quantity demanded due to a change in a consumer's real income or purchasing power resulting from a price change.
• For example, a price decrease increases purchasing power, potentially leading to higher demand.

Price Effect

• The combined impact of the income and substitution effects on quantity demanded.
• Represents how a change in price influences the quantity demanded of a good or service.

Substitution Effect

• Occurs when consumers replace a relatively more expensive good with a relatively cheaper one due to a price change.
• For example, if coffee prices rise, consumers may switch to tea.

Marginal Utility

• Refers to the additional satisfaction gained from consuming one more unit of a good or service.

Normal Goods

• Goods for which demand increases as consumer income rises and decreases as income falls.
• Most goods are considered normal goods, such as luxury items, cars, electronics, and clothing.

Inferior Goods

• Goods for which demand decreases as consumer income rises and increases as income falls.
• Examples include generic brand products and used cars.

Substitutes

• Goods that can replace each other in consumption.
• If the price of one substitute increases, the demand for the other substitute increases.
• Tea and coffee are examples of substitutes.

Complements

• Goods that are typically consumed together.
• If the price of one complement rises, the demand for the other complement falls.
• Printers and ink cartridges are complements.

Elasticity of Demand

• Measures the responsiveness of the quantity demanded of a good to a change in its price.
• Elastic Demand: Quantity demanded changes significantly with a small change in price (Elasticity > 1).
• Inelastic Demand: Quantity demanded changes very little with a change in price (Elasticity < 1).
• Unitary Elastic Demand: Quantity demanded changes exactly in proportion to a change in price (Elasticity = 1).

Unitary Elastic

• Percentage change in quantity demanded is exactly equal to the percentage change in price.
• Results in no change in total revenue.

Total Revenue

• The total income a firm receives from selling its goods or services.
• Calculated as Price × Quantity.

Perfectly Inelastic and Perfectly Elastic

• Perfectly Inelastic: Quantity demanded does not change at all when the price changes (Elasticity = 0).
• Perfectly Elastic: Quantity demanded is infinitely responsive to a price change (Elasticity = ∞).

Quantity Demanded

• Refers to the specific amount of a good or service consumers are willing and able to buy at a particular price.

Demand Schedule

• A table that shows the quantity demanded at each price level.

Demand Curve

• A graphical representation of the demand schedule.
• Typically slopes downwards from left to right due to the Law of Demand.

How Price Affects Quantity Demanded

• A decrease in price leads to an increase in quantity demanded, represented as a movement along the demand curve.
• An increase in price leads to a decrease in quantity demanded, also a movement along the demand curve.

Demand

• Refers to the entire curve or schedule showing the relationship between price and quantity demanded at different price points.

Quantity Demanded

• Refers to a specific point on the demand curve corresponding to a particular price.

Non-Price Determinants of Demand

• Income: Demand for normal goods increases as income increases.
• Tastes and Preferences: Demand increases if consumer preferences favor a product.
• Prices of Related Goods: Prices of substitutes and complements affect demand.
• Expectations: Demand may increase today if consumers expect future prices to rise.
• Number of Buyers: An increase in the number of consumers in the market will increase demand.

Total Revenue Test

• If price and total revenue move in the same direction, demand is inelastic.
• If price and total revenue move in opposite directions, demand is elastic.
• If total revenue remains unchanged as price changes, demand is unit elastic.

Point-to-Point Elasticity

• Elasticity can be calculated at any point on the demand curve.
• Formula: Elasticity = % Change in Quantity / % Change in Price.

Characteristics of Elastic Products

• Have many substitutes.
• Demand is highly responsive to price changes.
• Examples: Luxury goods, non-essential items.

Characteristics of Inelastic Products

• Few or no substitutes.
• Essential goods, where consumers will buy regardless of price.
• Examples: Basic food items, medicine.

Characteristics of Unit Elastic Products

• The percentage change in price results in an equal percentage change in quantity demanded.