IBEconomicsHLRevision Notes2. Microeconomics2.1 Demand2.1.1 Demand, Price & Quantity

Demand, Price & Quantity (HL IB Economics)

Revision Note

Introduction to Demand

  • Demand is the amount of a good/service that a consumer is willing and able to purchase at a given price in a given time period

    • If a consumer is willing to purchase a good, but cannot afford to, it is not effective demand

  • A demand curve is a graphical representation of the price and quantity demanded (QD) by consumers

    • If data were plotted, it would be an actual curve.  Economists, however, use straight lines so as to make analysis easier
       

  • The law of demand states that there is an inverse relationship between price and quantity demanded (QD), ceteris paribus

    • When the price rises the QD falls

    • When the price falls the QD rises
       

Individual and Market Demand

  • Market demand is the combination of all the individual demand for a good/service

    • It is calculated by adding up the individual demand at each price level
        

The Monthly Market Demand for Newspapers in a Small Village

Customer 1

Customer 2

Customer 3

Customer 4

Market Demand


30


15


4


4


53

 

  • Individual and market demand can also be represented graphically
     

    2-3-1-demand-price-and-quantity-1

Market demand for children's swimwear in July is the combination of boys and girls demand

 

Diagram Analysis

  • A shop sells both boys and girls swimwear

  • In July, at a price of $10, the demand for boys swimwear is 500 units and girls is 400 units

  • At a price of $10, the shops market demand during July is 900 units

Assumptions Underlying the Law of Demand

  • The law of demand is based on three key assumptions:

    • The income effect

    • The substitution effect

    • The law of diminishing marginal utility

  • These three assumptions collectively contribute to the understanding of the law of demand and how consumers' behaviour is influenced by changes in price

    • The income effect and substitution effect highlight how changes in price affect consumers' purchasing power and their choices among different goods

    • The law of diminishing marginal utility explains why consumers are less willing to pay higher prices for additional units of a good

An Explanation of the Three Assumptions


The Assumption


 Explanation

The Income Effect

  • The income effect refers to the change in a consumer's purchasing power resulting from a change in the price of a good/service

    • When the price of a good decreases, consumers' purchasing power increases as with the same income they can buy more of the good

    • When the price of a good increases, consumers' purchasing power decreases as with the same income they can afford to purchase less of the good
       

  • The income effect assumes that consumers will adjust their consumption patterns based on changes in their purchasing power caused by price fluctuations

The Substitution Effect

  • The substitution effect suggests that consumers will substitute goods/services that have become relatively more expensive with those that have become relatively less expensive

    • When the price of a particular good rises, consumers may seek alternatives that provide similar utility or satisfaction at a lower cost

    • E.g. if the price of brand A coffee increases, consumers may switch to brand B coffee, assuming it provides a similar level of satisfaction but at a lower price
       

  • The substitution effect assumes that consumers are rational decision-makers who have perfect information and respond to changes in relative prices by adjusting their consumption 

The Law of Diminishing Marginal Utility

  • The Law of Diminishing Marginal Utility states that as additional products are consumed, the utility gained from the next unit is lower than the utility gained from the previous unit

  • Marginal utility is the additional utility (satisfaction) gained from the consumption of an additional product

  • The utility gained from consuming the first unit is usually higher than the utility gained from consuming the next unit

    • For example, a hungry consumer gains high utility from eating their first hamburger. They are still hungry and purchase a second hamburger but gain less satisfaction from eating it than they did from the first hamburger
       

  • Lowering the price makes it a more attractive proposition for the consumer to keep consuming additional units - and there is a movement down the demand curve

Movements Along a Demand Curve

  • If price is the only factor that changes (ceteris paribus), there will be a change in the quantity demanded (QD)

    • This change is shown by a movement along the demand curve

L44o4OxC_1-2-2-movement-along-demand-curve_edexcel-al-economics

A demand curve showing a contraction in quantity demanded (QD) as prices increase and an extension in quantity demanded (QD) as prices decrease
 

Diagram Analysis

  • An increase in price from £10 to £15 leads to a movement up the demand curve from point A to B

    • Due to the increase in price, the QD has fallen from 10 to 7 units

    • This movement is called a contraction in QD

  • A decrease in price from £10 to £5 leads to a movement down the demand curve from point A to point C

    • Due to the decrease in price, the QD has increased from 10 to 15 units

    • This movement is called an extension in QD

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