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Module 5 - Demand

Study Guide in BAC 102 – Basic Mircoeco nomics

MODULE 5

DEMAND MODULE OVERVIEW The prices for most goods and services are established in markets by forces of supply and demand. The demand side of the market encompasses the buying behavior of people driven by their self-interest to purchase the best products at the lowest possible price. Demand is a fundamental economic concept as it is manifested every time people buy a good or service. This module will cover what demand is all about. It explains the consumer's willingness to pay for a specific good or service as influenced by price. The module will make use of different models like demand schedule, demand curve, and demand equation to represent the law of demand. The module will also analyze how the other factors such as income, tastes and preferences, prices of related goods, market size, and expectations affect demand in general.

LEARNING OBJECTIVES After studying and completing this module, you should be able to 1. Define demand. 2. State the law of demand and explain the inverse relationship between price and quantity demanded. 3. Create a hypothetical demand schedule and describe the relationship between individual demand and market demand. 4. Draw a demand curve. 5. Derive a demand equation from a set of data and/or diagram. 6. Distinguish between a change in quantity demanded and a change in demand 7. Draw diagrams to show the difference between movements along the demand curve and shifts of the demand curve. 8. Analyze how different factors, including consumer income (in the case of normal and inferior goods), prices of related goods (substitutes and complements), the number of buyers, and expectations may increase or decrease demand. LEARNING CONTENTS

Definition of Demand People have varied needs or wants. To fulfill these wants and needs, they buy goods or avail services. The buying decisions of consumers can be explained by the concept of demand. Demand represents the goods or services that people buy. For most economists, demand refers to the quantity of goods or services that consumers are both willing and able to purchase at certain conditions. Since demand is a variable, it can be quantified. As a condition, for demand to become effective, consumers should have the willingness and the ability to buy a good or service. Law of Demand Demand can be a relationship between the price of the good and the quantity of that good. The Law of Demand, considered the most popular principle in economics, explains this relationship, and describes how people react to changes in price. The law of demand indicates the inverse relationship between price and quantity demanded. Price is the amount of money a consumer pays for a good while quantity demanded is the amount of good that a

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Study Guide in BAC 102 – Basic Mircoeco nomics

Module 5 - Demand

consumer is willing and able to buy at a specific price. It states that as the price goes up, the quantity demanded goes down, and as price goes down, the quantity demanded goes up, ceteris paribus. In other words, more people will buy more of a good if the price is lower while fewer people will buy less of a good if the price is higher. For example, if the price of airline tickets drop, people are encouraged to travel more. However, if the price of movie tickets rises, fewer people want to watch a movie. Demand Schedule A demand schedule represents the relationship of price to quantity demanded in the form of a table. In short, it lists the prices and the corresponding quantities demanded of a particular good or service. Demand schedule can be an individual schedule or a market demand schedule. Individual demand is the schedule of a person or household that shows the quantities demanded at each price. Market demand schedule is the sum of all individual demands. It is derived by adding up the quantities that every person or household is willing and able to purchase at each price for a particular good. Consider the demand for onions. Presented in table 5.1 is the hypothetical individual demand schedule of a carinderia owner for onions in a week. At each price, the carinderia owner will buy a certain quantity of onions. For instance, at Ᵽ10, the owner will buy 10 kilos of onions per week. As the price goes up, less onions are purchased. At a price of Ᵽ50, the quantity of onions demanded is only 2 kilos. Table 5.1 – Individual Demand Schedule

Choice A B C D E

Price (in pesos) 10 20 30 40 50

Quantity of Onions Demanded (in kg) 10 8 6 4 2

The quantity of onions demanded in Pangasinan at each listed price is presented in Table 5.2 showing the market demand for onions. Comparing the schedule to the previous one, this suggests a higher quantity of onions demanded at each price, other things held constant. This is because the schedule sums up all the demands of onion consumers in Pangasinan, including that of the carideria owner. Again, the law of demand applies here as consumers will demand more for onions at lower price, and vice versa. Table 5.2 – Market Demand Schedule

Choice A B C D E

Price (in pesos) 10 20 30 40 50

Quantity of Onions Demanded (in kg) 1,000 900 800 700 600

Demand Curve The law of demand can be graphed using the demand curve, which serves as the graphical representation of the demand schedule. The demand curve is illustrated by plotting the listed prices and quantities from the given schedule. The price is placed on the vertical axis, and the quantity demanded is measured on the horizontal axis. Each combination (price and quantity demanded) represents a point on the graph. When the points are connected with a line, the demand curve is derived. The demand curve for onions of the carinderia owner is shown in Figure 5.1

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Module 5 - Demand

Study Guide in BAC 102 – Basic Mircoeco nomics

Price of Onions (Kg)

60 E

50

D

40

C

30

B

20

A

10 0 0

2

4 6 8 Quantity of Onions Demanded

10

12

Figure 5.1 – Individual Demand Curve

In the figure, Point A corresponds to choice A in the accompanying demand schedule— a price of Ᵽ10 and 10 kilos of onions per week demanded. Similarly, points B, C, D, and E denote the corresponding choices in the schedule. Note that the demand curve slopes downward from left to right, which means that quantity and price are inversely related.

Demand Equation The inverse relationship between price and quantity demanded can also be represented with the help of a demand equation. Mathematically, quantity demanded is the function of price, 𝑄𝑑 = 𝑓(𝑃). The demand equation could be in the form: 𝑄𝑑 = 𝑎 − 𝑏𝑃 where 𝑄𝑑 is the quantity demanded, 𝑃 denotes the price, b is the slope, and 𝑎 is a constant term. For example, if the actual equation is 𝑄𝑑 = 1,400 − 8𝑃, we can predict that quantity demanded is 920 units when the 𝑃 = 60. A demand equation from an accompanying demand schedule or curve can be obtained applying the twopoint form formula: 𝑃 − 𝑃1 =

𝑃2 − 𝑃1 (𝑄 − 𝑄𝑑1 ) 𝑄𝑑2 − 𝑄𝑑1 𝑑

Using two points (Points A and B) from the demand schedule, the resulting demand equation for onions of 1 the carinderia owner is 𝑄𝑑 = − 𝑃 + 12. The derivation of the equation is given as follows: 5

Suppose, 𝑃1 = 10, 𝑃2 = 20, 𝑄𝑑1 = 10, 𝑄𝑑2 = 8 𝑃 − 10 =

20 − 10 (𝑄 − 10) 8 − 10 𝑑

𝑃 − 10 =

10 (𝑄 − 10) −2 𝑑

𝑃 − 10 = −5𝑄𝑑 + 50 𝑃 = −5𝑄𝑑 + 60 1 𝑄𝑑 = − 𝑃 + 12 5 Change in Quantity Demanded versus Change in Demand Quantity demanded is a point on the demand curve that shows how much is demanded at a specific price. A change in quantity demanded happens whenever there is a change in price, ceteris paribus. When the price of a good increases or decreases, this causes the quantity demanded to change. The change is represented by a movement along a demand curve.The movement to a different point (Point A to B or B to A) within the same demand curve is shown in Figure 5.2. PANGASINAN STATE UNIVERSITY

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Study Guide in BAC 102 – Basic Mircoeco nomics

Module 5 - Demand

Figure 5.2 – Change in Quantity Demanded (Movement Along the Demand Curve)

On the other hand, a change in demand occurs whenever there is a change in non-price determinants of demand—income, number of buyers, preferences, prices of related goods, expectations, ceteris paribus. For instance, when the income of a consumer rises, this causes the quantity demanded to change. The change in demand is represented by the shift of the demand curve. The shift of the demand curve from D1 to D2 or D2 to D1 is shown in Figure 5.3.

Figure 5.3 – Change in Demand (Shift of the Demand Curve)

Non-Price Determinants of Demand Apart from price, there are other factors that can affect demand. These factors that can increase or decrease the level of demand are referred to as non-price determinants of demand. The determinants include the income of consumers, prices of related goods, number of buyers, tastes or preferences, and expectations. 1. Income. The income of consumers is a key determinant of demand. As people’s income changes, they may buy more or less of a particular good. When considering the influence of a change in income on demand, there are two goods involved —normal goods and inferior goods. A normal good is a product in which demand varies directly with income. A rise in income causes an increase in demand, and a fall in income leads to a decrease in demand. Most of the products are normal goods, including restaurant meals, branded t-shirts, and electronic devices.

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Study Guide in BAC 102 – Basic Mircoeco nomics

Module 5 - Demand

An inferior good is a product in which demand varies inversely with income. The demand for inferior goods rises as income decreases, and demand falls when income increases. Common examples of inferior goods include canteen meals, generic drugs, and surplus goods. 2. Price of related goods. The demand for a good is also affected by the price and availability of related products. The two categories of related goods are called substitutes and complements. A substitute good is a product that can be used in replacement of another product. Laptop and tablet, lemonade and iced tea, and Spotify and Apple Music are pairs of substitute goods. When two goods are substitutes, an increase in the price of an alternative good will increase the demand for the other good. Conversely, a decrease in the price of one good will decrease the demand for the other. For instance, when the price of a laptop increases, consumers will purchase less of it, and increase their demand for a tablet. When the subscription price of Spotify falls, the demand for say, Apple Music rises. A complementary good is a product that is always used together with another product. Toothpaste Personal computer and software, toothpaste and toothbrush, and Netflix and Globe mobile data are some pairs of complementary goods. When two goods are complements, an increase in the price of good will decrease the demand for the other good. Conversely, a decrease in the price of one good will increase the demand for the other. For example, when the price of a PC rises, the demand for software applications will increase. When the subscription price of Netflix falls, consumers will increase their demand for Globe mobile internet. 3. Tastes and preferences. The demand for any good depends on tastes and preferences which define what people like and wish to choose. Several factors that may influence how consumers like and prefer goods include trends, seasonality, health hazards, advertisement, culture, and religion. A favorable consumer taste for a good may increase demand while unfavorable one may decrease demand. For example, a trending movie best illustrates a higher demand for movie tickets. However, when the trend dies out, fewer moviegoers will demand for tickets. The demand for hotels during Valentine’s Day is high, and the demand for air conditioners every winter season is low. Muslims do not normally buy alcohol and pork because their religion prohibits the consumption of these goods; thus, the demand for these goods is relatively lower. 4. Number of buyers. Population and market size determines the number of consumers buying a good or service. The population clearly affects the demand for any good. A higher population or greater market size results in higher demand, while a lower population or market size takes the reverse situation. The Philippines’ 108 million people will buy fewer bananas and smartphones than China’s 1.4 billion individuals. An increase in the market size for Korean barbecue in the Philippines leads to higher demand among Filipinos for samgyupsal. 5. Expectations. Expectations refer to the anticipation of consumers concerning future events, which can affect the demand for a good at present. These expectations comprise price and buyer’s income. Consumers who expect the price of a good to increase in the future may prompt them to buy today, thus increasing the current demand for the good. Conversely, those who expect the price of a good to fall in the future may cause them to buy the good later, thus decreasing the current demand for the good. Motorists who anticipate the gasoline price to be higher in the near future will likely have a full tank now, thus increasing gasoline demand today. Likewise, an expectation about future income may cause consumers to adjust their level of present spending. If consumers expect a lower future income, they tend to reduce their demand for some goods; thus, current demand decreases.

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Module 5 - Demand

Study Guide in BAC 102 – Basic Mircoeco nomics

Non-Price Determinant of Demand Income (Normal Good)

Table 5.3 – Non-Price Determinants of Demand Change in a NonChange in Graphical Illustration Price Demand Determinant Increase in income Increase in demand Decrease in income

Decrease in demand

Increase in income

Decrease in demand

Decrease in income

Increase in demand

Increase in price of a substitute good

Increase in demand

Decrease in price of a substitute good

Decrease in demand

Price of a Complementary Good

Increase in price of a complementary good

Decrease in demand

Increase in demand

Tastes and Preferences

Decrease in price of a complementary good Favorable taste/preference Unfavorable taste/preference

Decrease in demand

Increase in population, market size, etc Decrease in population, market size, etc

Increase in demand

Expectation on price to increase in the future Expectation on price to decrease in the future

Increase in demand

Expectation on income to increase in the future Expectation on income to decrease in the future

Increase in demand

Income (Inferior Good)

Price of a Substiture Good

Number of Buyers

Future Price Expectation

Future Income Expectation

PANGASINAN STATE UNIVERSITY

Increase in demand

Decrease in demand

Decrease in demand

Decrease in demand

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Study Guide in BAC 102 – Basic Mircoeco nomics

Module 5 - Demand

SUMMARY       

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Demand represents the goods or services that people buy. It refers to the quantity of goods or services that consumers are both willing and able to purchase at certain conditions. The law of demand states that as the price goes up, quantity demanded goes down, and as the price goes down, quantity demanded goes up, ceteris paribus. More people will buy more of a good if the price is higher while less people will buy less of good if the price is lower. A demand schedule represents the relationship of price to quantity demanded thru a table. In short, it lists the prices and the corresponding quantities demanded for a particular good or service. An individual demand is the demand of a person or household that shows the quantities demanded at each price while market demand schedule is the sum of all individual demands. Demand schedule is the graph of a demand curve. Demand equation is a mathematical model that explains the inverse relationship between price and quantity demanded in the form 𝑄𝑑 = 𝑎 − 𝑏𝑃. A change in quantity demanded happens whenever there is a change in price, ceteris paribus. The change is represented by a movement along a demand curve. On the other hand, a change in demand occurs whenever there is a change in non-price determinants of demand—income, number of buyers, preferences, prices of related goods, expectations, ceteris paribus. The change in demand is represented by the shift of the demand curve. Apart from price, there are other factors that can affect demand. These factors that can increase or decrease the level of demand are referred to as non-price determinants of demand. The determinants include the income of consumers, prices of related goods, number of buyers, tastes or preferences, and expectations. A normal good is a product in which demand varies directly with income while an inferior good is a product in which demand varies inversely with income. When two goods are substitutes (products that can be used in replacement of another product), an increase in the price of an alternative good will increase the demand for the other good. When two goods are complements (products that are always used together), an increase in the price of good will decrease the demand for the other good. The demand for any good depends on tastes and preferences which define what people like and wish to choose. Trends, seasonality, health hazards, advertisement, culture and religion are several factors that may influence how consumers like and prefer goods. A favorable consumer taste for a good may increase demand while unfavorable one may decrease demand. Population and market size determine the number of consumers buying a good or service. Higher population or greater market size results in higher demand while lower population takes the reverse situation. Expectations refer to the anticipation of consumers concerning future events, which can affect the demand for a good at present.

LEARNING ACTIVITIES

ACTIVITY A Modified True or False. Write true if the statement is correct. If false, underline the word or phrase to make the statement right and write the correct answer in the blank space provided. 1. Demand is the quantity of goods or services that buyers are willing and able to sell. ______________ 2. Demand is effective if a consumer is willing but unable to buy a good or service. ______________ 3. The lower the price of a good, the fewer the quantity people will buy. ______________ 4. The slope of a demand curve is positive. ______________ 5. Taste is the most influential factor affecting demand. ______________ 6. Price varies when any of the non-price determinants of demand changes. ______________ 7. Demand for inferior goods tend to rise sharply with higher levels of income. ______________ PANGASINAN STATE UNIVERSITY

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Study Guide in BAC 102 – Basic Mircoeco nomics

Module 5 - Demand

8. Trends and culture are factors associated with the price of related goods. ______________ 9. The demand curve shifts to the left if the price of a substitute good falls. ______________ 10. More people will demand for a good if the...