AP Microeconomics

2.1 Demand
 Introduction to
Demand

• A well-defined system of property

rights creates incentives for
producers to provide goods and
services of value to consumers.

• In this Module, we examine

consumer’s demand for those
goods and services and the
influences on that demand in a
market system.
Introduction to Demand
• Lumber sellers and lumber
buyers constitute a
market.

• Market: a group of
producers and consumers
who exchange a good or
service for payment.

The market for lumber is perfectly competitive: No individual

buyer or seller can have a noticeable influence on the price of
lumber.
Introduction to Demand
Perfectly competitive market
characteristics:

1- Many buyers and sellers of the same good or service.

2- No individual’s actions have a noticeable effect on the
price at which the good or service is sold.
3- Little power to influence the price.
Introduction to Demand

• For markets with enough competition to resemble perfectly

competitive market, their behaviour is well described by the
supply and demand model.

• Because many markets are very competitive, the supply and

demand model is useful one indeed.

• The supply and demand model is a model of how a perfectly

competitive market works.
Introduction to Demand
• There are six key elements in the supply and demand model:

• The demand curve

• The set of factors that cause the demand curve to shift
• The supply curve
• The set of factors that cause the supply curve to shift
• The market equilibrium, which includes the equilibrium price and
equilibrium quantity.
• The way the market equilibrium changes when the supply curve or
demand curve shifts.
The Demand Curve
The quantity of any good or service that people want to buy depends on
the price.

The higher the price, the less of the good or service people want to
purchase, alternatively the lower the price, the more they want to purchase.

So the answer to the question ‘how many board feet of lumber do

consumers want to buy?’ depends on the price of lumber.

If you don’t know yet what the price will be, you can start by making a table
of how much of a good people would want to buy at a number of different
prices. Such a table is known as demand schedule.

This demand schedule can be used to draw a demand curve, which is one
of the key elements of the supply and demand model.

Demand Schedule is a table that shows how much of a good or service

consumers will be willing and able to buy at different prices.
The Demand
Schedule and the
Demand Curve
• Demand Schedule is a table that shows how
much of a good or service consumers will be
willing and able(want) to buy at different
prices.

• The figure below shows a hypothetical

demand schedule for lumber. It’s
hypothetical in that it doesn’t use actual
data. The demand schedule assumes that
all lumber is standardized, although in reality
there are various grades and sizes.
The Demand
Schedule and the
Demand Curve
• The law of demand: as price rises, the
quantity demanded falls. Similarly, a
decrease in price raises the quantity
demanded.

• As a result, the demand curve is

downward-sloping.
The Demand
Schedule and the
Demand Curve• According to the table, if lumber costs
$1.00 per board foot, consumers
around the world will want to purchase
100 billion board feet of lumber over
the course of a year.

• If the price is only $0.75 a board foot,

they will want to buy 115 billion board
feet.

• The higher the price, the fewer board

feet of lumber consumers will want to
purchase.

• As the price rises, the quantity

demanded of lumber – the actual
amount consumers are willing and
able to buy at a specific price- falls.
 The Demand Schedule and the Demand
Curve • The graph is a visual representation of
the demand schedule.

• The vertical axis shows the price of a

board foot or lumber.

• The horizontal axis shows the quantity

of lumber in board feet.

• Each point on the graph corresponds

to one of the entries in the table.
• The curve that connects these points
is a demand curve.
• The demand curve slopes downward.

Demand curve: is a graphical representation of the demand schedule. It shows the relationship between a
quantity demanded and price.
A higher price reduces the quantity demanded.
The Demand Schedule and the Demand
Curve
• In the real world, demand curves almost always slope downward. It
is so likely that, all other things being equal, a higher price for a
good will lead people to demand smaller quantity of it, that
economists are willing to call it a ‘law’. The law of demand.

• The principle of diminishing marginal utility helps to explain the law

of demand.
If consumers get less and less satisfaction out of additional units of a
good or service, a higher price will make fewer units worthwhile to
purchase.
Changes in Quantity demanded
• A movement along the demand curve: is a change in the
quantity demanded of a good that is the result of a change in
that good’s price.
(slopes downward)
• The movement from point A to point B is a movement along the
demand curve: the quantity demanded rises due to a fall in
price as you move down D1.

• Example: A fall in the price of lumber from $1.5 to $1 per board

foot generates a rise in the quantity demanded from 81 billion to
100 billion board feet per year.
Changes in Quantity demanded
1- The Substitution Effect

When the price of a good increases, an individual will normally buy less of that good and more
other other good. And when the price of a good decreases, an individual will buy more of that good
and less of the other good. —> law of demand and slopes downward.

Example:
Let's suppose there are only two goods between which to choose: Good 1 and Good 2.
–When the price of good 1 decreases, an individual does not have to give up many units of good 2
in order to buy one more unit of good 1. That makes it attractive to buy more of good 1 whose price
has gone down.

–When the price of good 1 increases, one must give up more units of good 2 to buy one more unit
of good 1, so consuming good 1 becomes less attractive and the buyer consumes fewer.

The substitution effect of a change in the price of a good is the change in the quantity of that good
demanded as the consumer substitute that good that has become relatively cheaper for the good
that has become relatively more expensive.
The Substitution Effect
Imagine the price of coffee increases significantly. Because of this price
increase, coffee becomes more expensive relative to tea. As a result, you
might buy less coffee and more tea because tea is now relatively cheaper

When a good absorbs

only a small share of
consumer’s income, the
substitution effect is
essentially the sole
explanation of why the
market demand curve
slopes downward
Changes in Quantity demanded
2-The Income effect
There are some goods like food and housing that account for a
substantial share of many consumer’s income. In such cases,
another effect, called the income effect comes into play.
The income effect reinforces the substitution effect.
Case Study
A family that spends half of its income on rental housing.
Suppose that the price of housing increases everywhere. This
change will have a substitution effect on the family’s demand:
other things equal, the family will have an incentive to consume
less housing by moving to a smaller apartment.

The family will also be made poorer by that higher housing

price-its income will buy less housing than before. (less
purchasing power)

When income is adjusted to reflect its true purchasing power,

it's called real income.
Changes in Quantity demanded
The Income effect

This reduction in a consumer’s real income will have an additional effect,

beyond the substitution effect. Which is the income effect.

The income effect of a change in the price of a good: is the change in the
quantity of the good demanded that results from a change in the consumer’s
purchasing power when the price of the good changes.
Changes in Quantity demanded
The Income effect

When the price rises on a good that absorbs a substantial share of income,
consumers of that good feel poorer because their purchasing power falls- this
reduction in the real income leads to a reduction in the quantity demanded
and reinforces the substitution effect.
 Inferior goods:
The demand for them decreases when income rise
and it is considered less desirable than more
expensive alternatives.

which are goods people tend to buy more of when

their income decreases.

Normal goods
The demand for them increases when income rises.

-For both normal and inferior goods, the

substitution effect of a price increase is a
decrease in the quantity demanded of the
good whose price has risen.
Income effect and substitution effect on
normal and inferior goods
When the price of a good falls, two effects come into play: the substitution effect and the income
effect.
For normal goods:
The substitution effect: we tend to buy more of the good that has become cheaper, substituting it for
the more expensive alternative.
The income effect: a lower price increases our real income, allowing us to buy more of the product.
They both result in a downward-sloping demand curve.
For inferior goods:
The substitution effect: we continue to buy more of the cheaper good.
The income effect: as our real income increases, we tend to switch to other goods we perceive as
superior. For most inferior goods, substitution effect outweighs the negative income effect, so
the demand curve still slopes downward, following the law of demand.
*However, in the special case of Giffen goods (a type of extreme inferior good), the income effect is
so strong that it outweighs the substitution effect. As a result, when the price of a Giffen good
decreases, we buy less of it. It is crucial to remember that while all Giffen goods are inferior goods,
not all inferior goods are Giffen goods.
 NOTE

The income and substitution effects move the quantity demanded in the same
direction for BOTH GOODS.
● Substitution effect: Consumers buy more of the cheaper good and less of substitutes.
● Income effect: The price decrease makes consumers feel wealthier, so they buy more
of the good.
 All the other things are not
equal
Shifts of the Demand Curve Increase/decrease in demand-
rightward/leftward shift of the
demand curve.
1) Change in Demand
There were changes between 2020 and 2021 that increased the quantity of lumber
demanded at any given price.

- Covid 19 changed consumers tastes for homes.

- The relaxation of Covid 19 restrictions improved buyers’ ability to arrange for new
construction.
- Rising incomes in countries like China allowed people to buy more homes than
before.

These changes led to an increase in the quantity of lumber demanded at any

given price (without changing the price).
Shifts of the Demand Curve
The table shows two demand schedules. The first is
a demand schedule for 2020 and the second is for
2021.

That schedule differs from the 2020 demand

schedule due to factors such as changing tastes for
new homes and higher incomes.

At each price, the 2021 schedule shows a larger

quantity demanded than 2020 schedule. For
example: the quantity of lumber consumers wanted
to buy at a price of $1 per board foot increased from
100 billion to 120 billion board feet per year.

The result is generated in a new demand schedule.

New demand curve D2 Original demand
curveD1
Shifts of the
Demand
Curve
• Change in demand: is a shift of the demand
curve, which changes the quantity demanded
at any given price.
• Represented by shift from D1 to D2.

• Example: the shift of the demand curve from

D1 to D2, holding the price constant at $1.50
per board foot, the quantity demanded rises
from 81 billion board feet at point A on D1 to
97 billion board feet at point C on D2.
Notes
1- When economists talk about a ‘change in demand’, saying ‘the demand
for X increased’ or ‘the demand for Y decreased’ they mean that the
demand curve for X or Y shifted- not that the quantity demanded rose or
fell because of a change in the price.

2- A price change causes a change in the quantity demanded, shown by a

movement along the demand curve. When a nonprice determinant of
demand changes, this changes demand and therefore shifts the demand
curve.

3- It is correct to say that an increase in the price of apples decreases the

quantity of apples demanded, and it is incorrect to say that an increase in
the price of apples decreases the demand for apples.
Notes Left is less and right is more

• Increase in demand -> rightward shift of

the demand curve.

• Decrease in demand -> leftward shift of

the demand curve.
The five principal factors that shift the
demand curve for a good or service:
• Changes in Tastes

• Changes in the prices of Related goods and services

• Changes in Income TRIBE

• Changes in the number of consumers(Buyers)

• Changes in Expectations
Changes in Tastes
• People have certain preferences, or tastes, that determine what
they choose to consume, and these tastes can change.

The impact of change in tastes on demand

When tastes change in Favor of a good, more people want to buy
it at any given price, so the demand curve shifts to the right.

When tastes change against a good, fewer people want to buy it at

any given price, so the demand curve shifts to the left.
Change in the prices of related goods and
service

Substitutes
Change in the prices of related goods and
service
• Two goods are substitutes if a rise in the price of one of the goods leads
to an increase in the demand for the other good.

• Substitutes are usually goods that in some way serve a similar function

--A rise in the price of the alternative good provides an incentive for some
consumers to purchase the original good instead of the alternative good,
shifting demand for the original good to the right.

--When the price of the alternative good falls, some consumers switch from
the original good to the alternative, shifting the demand curve to the left.
Change in the prices of related goods and
service

Complements
Change in the prices of related goods and
service
• Two goods are complements if a rise in the price of one of
the goods leads to a decrease in the demand for the other
good.
• But sometimes a fall in the price of one good makes
consumers more willing to buy another good. Example: A rise in the price of cookies
is likely to cause a leftward shift in the
demand curve for milk.
• A change in the price of one of the goods will affect the
demand for its complement.

• Complements are goods that in some sense consumed

together.

• When the price of one good rises, the demand for its
complement decreases, shifting the demand curve for the
complement to the left.
• When the price of one good falls, the demand for its
complement increases, shifting the demand curve for the
complement to the right.
Changes in Income
• Limited income is a constraint on
consumer’s purchasing decisions.

When individuals have more income, they

are normally more likely to purchase a good
or service at any given price.

For example: If a family’s income rises, it is

more likely to take that summer trip to
Disney World.

**So, a rise in consumer incomes will cause

the demand curves for most goods to shift
to the right.
Changes in Income
• So, a rise in consumer incomes will cause the demand curves for most
goods to shift to the right.

Why do we say ‘most goods’ rather than all goods?

• Most goods are normal goods.

Normal goods: the demand for them increases when consumer income
rise.
Inferior goods: the demand for them decreases when income rise and it is
considered less desirable than more expensive alternatives.

When a good is inferior, a rise in income shifts the demand curve to the left.
And, a fall in income shifts the demand curve to the right.
Changes in Income

• For example: a bus ride versus a

taxi ride.

• When they can afford to, people

stop buying inferior good and
switch their consumption to the
preferred, more expensive
alternative.
Changes in
Income
• Consider the difference between casual
dining restaurants such as Applebee’s
and fast-food chains like Wimpy.

When people income rises, they tend to

eat out more at casual dining restaurants.
People will visit wimpy less once they can
afford to move upscale.
So casual dining is a normal good, while
fast food appears to be an inferior.
Changes in the number of consumers(
buyers)
A growing world population increase the demand for most things,
including fast food, clothing, and lumber.

For example:
With more people needing housing and furniture, the overall
demand for lumber rises and the lumber demand curve shifts to
the right.

It also affects the market demand

curve
Changes in Expectations
When consumers have some choice about when to make a
purchase, current demand for a good or service is often affected
by expectations about future price.

For example: savvy shoppers often wait for seasonal sales.

-Expectations of a future drop in price lead to a decrease in
demand today.
-Expectations of a future rise in price are likely to cause an
increase in demand today.
Changes in Expectations
Changes in expectations about future income can also lead to
changes in demand.

For example:
If you learned today that you would inherit a large sum of money
sometime in the future, you might borrow some money today and
increase your demand for certain goods.

Consumption Smoothing: it shifts the demand curve for goods to the

right when your expected future income increases, and to the left
when your expected future income decreases.
Individual versus market demand curves
Individual demand curve: illustrates the relationship between
quantity demanded and price for an individual consumer.

Market demand curve: is the horizontal sum of the individual

demand curves of all consumers in that market.
 Individual versus market demand curves
Suppose that Darla is a consumer of blue jeans. Also suppose that all
blue jeans are the same, so they sell the same price.

Panel a shows how

many pairs of jeans she
will buy per year at any
given price per pair.
Ddarla is Darla’s
individual demand
curve.
 Individual versus market demand curves
Market demand curve:
- Shows the combined quantity demanded by all consumers
depends on the market price of that good.
- It is the horizontal sum of the individual demand curves of all
consumers in that market.