Microeconomic

Dr. Karim Kobeissi

Chapter 20:The
Demand for Goods

I n t r o d u c t i o n
Have you ever wonder:
1) How do consumers decide how much of any good to buy?
2) How does a change in a products price affect the

quantity they purchase or the amount of money they

spend on it ?
3) Why do consumers buy certain products but not others?

Determinants of Demand
Although, the low of demand gives us
some clues for answering the previous
questions; however, we need to look
beyond
complete

that

law

answers

to
and

fashion

more

consequently

better understand consumer behavior.

Accordingly, we have to investigate the
determinants of demand.

Determinants of Demand (con)

According

to

economists,

consumers

demand for a specific product is determined

by four factors:
1)

Tastes (desire for this and other goods)

2)

The consumers income.

3)

The consumers expectations (for income,

prices, tastes).

4)

Other goods (their availability and prices).

Ta s t e s / P r e f e r e n c e s
Economist

observed

that

the

more

pleasure a product give us, the higher

the price wed be willing to pay for it.
Economist use the tem utility to refer

to the expected pleasure or satisfaction,

obtained from goods or services.

i l

t y

Total utility (TU) refers to the aggregate level of

satisfaction

or

fulfilment

that

aconsumer

receivesthrough the consumption of a specific product.

Marginal utility (MU) refers to the extra utility a

consumer gets from one additional unit of a specific
product. In a short period of time, the marginal
utility derived from successive units of a given
product will decline. This is known as the low of
diminishing marginal utility.

TOTAL AND MARGINAL UTILITY

0
10

20
10

Marginal Utility (utils)

0
1

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10

20

10

10

Marginal Utility (utils)

0
1

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10
18

20

10
8

10

Marginal Utility (utils)

0
1
2

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10
18
24

20

10
8
6

10

Marginal Utility (utils)

0
1
2
3

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10
18
24
28

20

10
8
6
4

10

Marginal Utility (utils)

0
1
2
3
4

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10
18
24
28
30

20

10
8
6
4
2

10

Marginal Utility (utils)

0
1
2
3
4
5

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10
18
24
28
30
30

20

10
8
6
4
2
0

10

Marginal Utility (utils)

0
1
2
3
4
5
6

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10
18
24
28
30
30
28

20

10
8
6
4
2
0
-2

10

Marginal Utility (utils)

0
1
2
3
4
5
6
7

TU

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2

MU
1

Units consumed per meal

TOTAL AND MARGINAL UTILITY

0
10
18
24
28
30
30
28

20

10
8
6
4
2
0
-2

10

TU

Observe
Diminishing
Marginal
Utility

Marginal Utility (utils)

0
1
2
3
4
5
6
7

Total Utility (utils)

Tacos Total Marginal

consumedUtility, Utility, 30
per meal Utils
Utils

Units consumed per meal

10
8
6
4
2
0
-2

MU
1

Units consumed per meal

Although the theory of demand helps

explain

consumer

behavior,

it

is

insufficient. In fact, in order to have a

wider

understanding

we

have

consider also the elasticity concept.

to

E l a s t i c i t y
If a seller needs to reduce the price of a
product, how much should it be reduced?
Reduce too little, and projected increase in sales
will not meet desired goals.
Reduce too much, and the projected profit
target might not be achieved.

The economic concept here is price

elasticity of demand: how much quantity
demanded changes in response to a change
in price.

P r i c e
E l a s t i c i t y
The law of demand states that
quantity demanded will increase
when the price is lowered, and vice
versa.
The critical question to be answered
is how much quantity demanded will
change due to a price change.

P r i c e
E l a s t i c i t y
Price elasticity of demand: the percentage
change in quantity demanded divided by
the percentage change in price.
Price elasticity (E)

change in price

=
% change in quantity
demanded
%

A 10% increase in quantity demanded in

response to a 20% price decrease yields a
price elasticity of 0.5.

Computing Price Elasticity

We use the average method of
computation:
Take the quantity before and the quantity
after the price change and average them.
Divide the average quantity into the change
in quantity to get the percentage change in
quantity.

If quantity went from 2 to 4, then the

average is 3. The change is 2, so the
percentage change is 2/3 or 0.667.

Computing Price Elasticity (con)

We do the same thing to get the
percentage change in price:
Take the price before and the price after and
average them.
Divide the average price into the change in
price to get the percentage change in price.

If price went from 45 to 40, then the

average is 42.5. The change is 5, so the
percentage change is 5/42.5, or 0.118.

Computing Price Elasticity (con)

The % change in quantity is 0.667 and
the
change
is 0.118.
Price%
elasticity
(E) in
= price
% change
in quantity
demanded
%
change in price

We can now compute

elasticity of demand:

the

price

E = 0.667 / 0.118 = 5.65

A 1% change in price brings about a

5.65% change in quantity demanded.

Interpreting Elasticity
If E > 1, demand is elastic.
Consumer response is large relative to the
price change.

If E < 1, demand is inelastic.

Consumer response is small relative to the
price change.

If E = 1, demand is unitary elastic.

% change in quantity demanded is exactly
equal to % change in price.

Elasticity Estimates

Elasticity Extremes Cases

Perfectly Elastic Demand
Demand in which quantity
drops to zero at the slightest
increase in price (E= ).
Perfectly Inelastic Demand
Demand in which quantity
demanded does not respond at
all to a change in price (E=0).
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Elasticity Extremes Cases

PRICE ELASTICITY OF DEMAND

A good way to remember the difference

between the two perfect elasticities is:

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Elasticity on the
Demand Curve
At low prices,
demand is relatively
inelastic. As prices
rise,
however,
demand
becomes
less inelastic and
more elastic.
Note
that
total
revenue maxes out
when
demand
switches
from
elastic to inelastic.

The Determinants of Elasticity

AVAILABILITY OF SUBSTITUTES
Perhaps the most obvious factor affecting demand
elasticity is the availability of substitutes.

NECESSITIES Vs LUXURIES
Demand for necessities is relatively inelastic
(e.g. gasoline).
Demand for luxuries is relatively elastic (e.g.
jewelry).

THE TIME DIMENSION

The elasticity of demand in the short run may be very different from the elasticity of
demand in the long run. In the longer run, demand is likely to become more elastic, or
responsive, simply because households make adjustments over time and producers
develop substitute goods.

30 of 29

Elasticity and Total Revenu

In any market, P x Q is total revenue (TR) received

by producers:
TR = P x Q
total revenue = price x quantity

When price (P) declines, quantity demanded (QD)

increases. The two factors, P and QD, move in
opposite directions:
Effects of price changes
on quantity demanded:

P QD
and
P QD
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Elasticity and Total Revenue (con)

Because total revenue is the product of P and Q,
whether TR rises or falls in response to a price
increase depends on which is bigger, the percentage
increase in price or the percentage decrease in
quantity demanded.
Effects of price increase on
a product with inelastic demand:

P x QD TR

If the percentage decline in quantity demanded

following a price increase is larger than the percentage
increase in price, total revenue will fall.
Effects of price increase on
a product with elastic demand:

P x QD TR

32 of 29

Elasticity and Total Revenue (con)

The opposite is true for a price cut. When demand is

elastic, a cut in price increases total revenues:
Effect of price cut on a product
with elastic demand:

P x QD TR

When demand is inelastic, a cut in price reduces total

revenues:
Effect of price cut on a product
with inelastic demand:

P x QD TR

33 of 29

Effect on Total Revenu

If

Demand

Price Increase

Price Decrease

Elastic (E>1)

Decrease

Increase

Inelastic

Increase

Decrease

No Change

No Change

is

(E<1)

Unitary elastic
(E=1)

Applied Examples
You sell cigarettes. Should you put them
on sale?
No. Cigarettes are inelastic goods. Total
revenue will fall.

You sell furniture or automobiles. Should

you put them on sale?
Yes. These are elastic goods. Always have
the appearance that your product is on
sale. Total revenue will rise.

Other Important Elasticities (con)

ELASTICITY OF SUPPLY
Elasticity of Supply A measure of the
response of quantity of a good supplied
to a change in price of that good. Likely
to be positive in output markets.

% change in quantity supplied

elasticity of supply
% change in price

36 of 29

Other Important Elasticities

INCOME ELASTICITY OF DEMAND
Income Elasticity of Demand Measures
the responsiveness of demand to
changes in income.
% change in quantity demanded
income elasticity of demand
% change in income

37 of 29

Normal Vs Inferior Products

A normal product is a product that

consumers buy MORE when their
income rise (e.g. clothes).
An inferior product is a product that
consumers buy LESS when their
income rise (e.g. potato).

38 of 29

The Consumers Optimal Combination

Question:
When can we say that the consumer
maximizes

his

utility

if

he

consumes two products X and Y,

while

respecting

his

budget

Consumers Optimal Combination (con)

Answer:
According to the law of utility maximization, a
consumer who buys both products X and Y will
maximize its utility, when the marginal utility of
product X divided by the price of X is equal to the
marginal utility of Y divided by price Y.
MU X / PX = MU Y / PY
In other words, the consumer is in equilibrium when
the marginal utility per dollar spent is the same for
all the products in his basket.

The low of utility maximization explains how

consumers decide to allocate their money so
that the last dollar spent on each purchased
product yields the same amount of extra
(marginal) utility.

A consumer is in equilibrium when utility is

balanced (per dollar) at the margin. When
this is true, there is no incentive to alter the
expenditure pattern unless tastes, income,

It is marginal utility per dollar spent that is equalized;

that is, consumers compare the extra utility from
each product with its cost. As long as one
product provides more utility per dollar than
another, the consumer will buy more of the
first product; as more of the first product is
bought, its marginal utility diminishes until