Chapter 4: Consumer Demand

Determinants of Demand What determines what we buy? The Sociopsychiatric Explanation. The Economic Explanation.

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Chapter 4Consumer DemandWhat determines what we buy?The Sociopsychiatric Explanation.The Economic Explanation.Determinants of Demand4-*Sociopsychiatric ExplanationThe desire for goods and services arises from our needs for social acceptance (or envy), security, and ego gratification. “Keeping up with the Joneses.”Self-preservation.Expressions of affluence.4-*The Economic ExplanationPrices and income are just as relevant to consumption decisions as more basic desires and preferences.The willingness and ability to pay are critical.4-*Determinants of DemandMarket demand for a specific product is determined by:Tastes.Income.Expectations.Other goods.The number of consumers in the market.4-*Total UtilityUtility is the pleasure or satisfaction obtained from a good or service.Total utility is the amount of satisfaction obtained from entire consumption of a product. 4-*Marginal UtilityMarginal utility is the change in total utility obtained by consuming one additional (marginal) unit of a good or service. 4-*Figure 4.34-*Law of Diminishing Marginal UtilityThe marginal utility of a good declines as more of it is consumed in a given time period.Suppose a student who enjoys popcorn can eat all he/she wants for free.The first box consumed is very rewarding.The third box is decent, etc.After eating the sixth box, she gets sick.4-*As long as the marginal utility is positive, the consumer receives additional satisfaction and total utility increases.Additional quantities of a good yield increasingly smaller increments of satisfaction.Law of Diminishing Marginal Utility4-*Law of Demand The concepts of marginal utility and ceteris paribus explain the downward slope of the demand curve.With given income, tastes, expectations, and prices of other goods and services, people are willing to buy additional quantities of a good only if its price falls.4-*The higher the marginal utility, the more you are willing to pay.Diminishing marginal utility explains why price must decrease in order for you to continue to buy a good or service.Law of Demand 4-*According to the law of demand, the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus, and vice versa.Law of Demand 4-*Figure 4.44-*The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. Price Elasticity 4-*The price of popcorn goes up 20% and the quantity demanded goes down 10%.The price elasticity of demand is:(E)=percentage change inquantity demandedpercentage change in price=–10%20%– 0.5 =Price Elasticity 4-*Elastic DemandDemand is elastic if the absolute value of E is greater than 1.Consumer response is large relative to the change in price.A 20% price rise generates a 30% decrease in quantity demanded. 4-*Inelastic DemandDemand is inelastic if the absolute value of E is less than 1.Consumers are not very responsive to price changes.A 20% price rise generates only a 10% decrease in quantity demanded. 4-*Unitary Elastic DemandDemand is unitary elastic if the absolute value of E equals 1.The percentage change in quantity demanded is equal to the percentage change in price.A 20% price rise generates a 20% decrease in quantity demanded.4-*Table 4.14-*Price Elasticity and Total RevenuePrice elasticity explains why producers cannot charge the highest possible price.Although one would think otherwise, higher prices may actually reduce total sales revenue.4-*Elasticity and Total RevenueA price cut decreases total revenue if demand is price inelastic (E 1).A price cut does not change total revenue if demand is unitary elastic (E = 1).4-*Figure 4.54-*Determinants of Price Elasticity Differences in price elasticity are explained by several factors:Whether the Good Is a Necessity or LuxuryThe Availability of SubstitutesThe Price Relative to Income4-*Necessities versus LuxuriesSome goods are so critical to our everyday life that we regard them as necessities.We must buy even if the price goes up.Demand for necessities is relatively inelastic.4-*A luxury good is something we’d like to have but aren’t likely to buy unless our income jumps or the price declines sharply.We will simply wait for a sale.Demand for luxury goods is relatively elastic.Necessities versus Luxuries4-*Availability of SubstitutesIf substitute goods are readily available, we can switch to the substitute. Demand for goods easily substituted for will be relatively elastic.If substitute goods are not readily available, we must stay with this good. Demand for goods with few substitutes will be relatively inelastic.4-*Price Relative to IncomeIf the price of a product is very high relative to the consumer’s income, the demand will tend to be elastic.We will put off the purchase until there is a sale.4-*Price Relative to IncomeIf the price of a product is very low relative to the consumer’s income, the demand will tend to be inelastic.We do not pay much attention to any price change.4-*Substitute and Complementary Goods Substitute Goods: The demand for a good increases when the price of a substitute for the good goes up.We will switch from Starbucks to Dunkin’ Donuts.4-*Substitute and Complementary Goods Complementary Goods: The demand for a good decreases when the price of a complement to the good goes up.As gas prices rise, people trade in SUVs for hybrids.4-*Changes in IncomeIncome is a determinant of demand.If our income rises, we can, and do, want to buy more products at any price.We illustrate income changes with shifts of the demand curve.4-*
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