## Demand, Supply and Equilibrium by Frieda Mendelsohn Demand

INTRODUCTION

As we learn about the mechanics of DEMAND, we'll be following the buying habits of Fred.

Fred likes to eat. He'll eat anything, chicken, beef, pork, he's not very choosy. He was asked how much chicken he wants to buy at different prices (each week).

The graph (right) represents the relationship between the price of the chicken and the amount Fred is willing to buy.   As you can see, he'll buy about 5 pounds of chicken a week at \$1.00 per pound. As the price goes higher, he's wiling to buy less chicken; as the price goes lower; he's willing to buy more.   However, even when the price gets very low, 5 pounds of chicken is all he wants (any more than that and he starts growing feathers and pecking for corn).

INTRODUCTION – EXERCISE #1

How much is Fred willing to spend at \$2.00 per pound?   At \$2.00 per pound, Fred is willing to buy 4 pounds of chicken per week.

INTRODUCTION – EXERCISE #2

How much is Fred willing to spend at \$5.00 per pound? At \$5.00 per pound, Fred is still willing to buy a pound of chicken a week. He obviously likes chicken more than I do!

DEFINITION

DEMAND: the relationship between the price of a good and the quantity of the good that one is willing to buy in a given time period.

Notice that the higher the price (if nothing else changes), the less Fred will want to spend. This is referred to as the LAW OF DEMAND.

QUANTITY OR QUANTITY DEMANDED

Demand is the whole table of numbers - the entire set of points on the graph - the underlying relationship between price and quantity - in fact, the white diagonal line on the graph!

Suppose the price of chicken increases from \$1.00 per pound to \$2.00 per pound. Fred will now buy less chicken; however, if he were offered chicken at \$1.00 per pound, he'd still be willing to buy 5 pounds.   There's no change in his willingness to buy chicken at each price - his demand for chicken has not changed.

A change in the price of the good (in this case, chicken) cannot change the demand for chicken because each price is included in the table.   A change in price will result in a change in the quantity people are willing to buy.

QUANTITY DEMANDED – EXERCISE #1

Suppose the price changes from \$3.00 per pound to \$4.00 per pound. Is this a change in demand, or a change in the quantity demanded? There is no change in the demand. When the price changes people buy less, but that's what the demand curve already says!

SUBSTITUTES

By now you're wondering what can cause a change in Demand.

A Change in Demand can be caused by anything that causes the basic relationship between price and quantity to change.

To get back to Fred, suppose the price of beef decreases.

Fred likes chicken, but now he can eat more steak because it’s cheaper. So, Fred substitutes one steak dinner for one chicken dinner. The price of chicken hasn't changed, but Fred's attitude - his willingness to buy chicken at that price - has changed. So, Fred's Demand for chicken has decreased because the price of a substitute decreased.

A change in price of a substitute good can cause the demand of the first good to change.

Look at the new demand curve and at the table.   At each price, Fred is now willing to buy less chicken and at anything over \$3.00 per pound, he would rather buy steak! This is a change in demand.

So, one factor which will cause the demand to change is the price of a related good.

SUBSTITUTES – EXERCISE #1

Suppose the price of fish goes up. What will happen to Fred's demand for chicken? Demand increases.   Notice that the old table of quantities is now changed.   Fred is willing to buy more chicken at each price. This is what a change in demand means!

SUBSTITUTES – EXERCISE #2

Suppose the price of chicken goes down. What will happen to Fred's demand for chicken? (Careful, this is a trick question).   There is no change in demand.   The quantity that Fred will buy has increased, but he'd still but the same amount at the old price.   At \$3.00, Fred is willing to buy 3 pounds of chicken a week. When the price falls to \$2.00, he'll buy 4 pounds.   Since economists use the word demand to refer to the whole relationship between prices and quantities, this is not a change in demand - it is just a change in the amount Fred will buy.    We could also call this a movement along the curve rather than a movement of the demand curve.

COMPLEMENTS

Related goods can also be COMPLEMENTS - that is, things that are used together in some way. When the price of one changes, the demand for the other good is likely to move in the opposite direction.

Suppose the price of biscuits goes up. Fred will buy less biscuits because the price went up. Fred always has biscuits with chicken (they complement each other). So, Fred's demand for chicken is likely to fall because he'll eat a little less chicken and biscuits (together). This is a change in demand for chicken because Fred is willing to buy less chicken at each price of chicken.

Look at the table and the graph.   Again, at each price, the amount that Fred is willing to buy has changed. This is a decrease in demand.

COMPLEMENTS – EXERCISE

Suppose the price of corn goes down. (Fred loves corn on the cob with chicken). What will happen to Fred's demand for chicken?   There is an increase in demand. Fred will buy more corn (moving along his demand curve for corn) when the price of corn falls. This will increase his willingness to buy chicken to go with the corn, even though the price of chicken hasn't changed.

INCOME

There are other factors, which will change Fred's demand for chicken.

If he gets laid off, he's probably going to eat a lot more macaroni and cheese instead of chicken - or at least chicken casserole instead of roast chicken. So, his demand for chicken will fall (since there's been no change in the price of chicken - only his willingness to buy chicken).

So, changes in income can affect the demand for a good.

Again, at each price, Fred is willing to buy a smaller amount of chicken. There is a new quantity (Q') column in the table and the demand curve has shifted. This is a change in demand.

INCOME – EXERCISE

Now, Fred gets a new job that pays even better than the old one. Fred isn't rich; he just got a small raise. What will happen to Fred's demand for chicken? There is an increase in demand. Fred's income increased, so he's willing to buy more chicken at each price.

TASTES

What else could happen to poor Fred?

One possibility is that the Surgeon General could declare that a chicken a day keeps the doctor away. (Chicken prevents heart attacks, for example).

Fred will now buy more chicken each week (at the same old prices) because his tastes have changed. This is a change in demand because his behavior changed even though the price of chicken didn't change.

A change in tastes (or attitudes) can cause a change in demand.

By the way, taste doesn't just apply to food - it's a catchall term that economists use to describe changes in attitude, which can be about anything from the latest clothing fad to solid waste disposal and environmental awareness!

Again, Fred is willing to buy more chicken at each price of chicken. His demand for chicken has increased.

TASTES– EXERCISE #1

Suppose Fred tries a new chicken recipe, which he absolutely can't get enough of.   What happens to his demand for chicken? There is an increase in demand. Since Fred can't get enough chicken made with his new recipe, he must be buying more chicken at each price.

TASTES – EXERCISE #2

Suppose Fred's wife gets him a new Barbeque. Fred only grills steak on the BBQ - chicken is beyond is skills. What happens to his demand for chicken?   Demand for chicken decreased. Since Fred is buying more steak to BBQ, he's buying less chicken at the same old prices. Fred's behavior has changed even though the prices remain the same.

TASTES – EXERCISE #3

Fred has just decided that he can't stand the sight of fish, but he still likes chicken.   What happens to his demand for chicken? Here is an increase in demand. Since Fred no longer eats fish, he's got to eat something, so he'll eat more chicken (along with other food). His behavior has changed, so the line representing that behavior (the demand curve) has changed.

TASTES – EXERCISE #4

Fred has finally learned to BBQ chicken.   Mmmmmm, he loves it!   What happens to his demand for chicken? There is an increase in demand. Fred will buy more chicken for the barbeque simply because he likes it! The price of chicken hasn't changed - just his behavior.

EXPECTATIONS

Finally, there's one more disaster to befall poor old Fred - he's heard that the price of chicken will be going up next week (it hasn't gone up yet, though). Fred has a big freezer, so I think he'll probably stock it up. His demand for chicken will increase (this week).

A change in expectations (can cause a change in demand.

This can get a little tricky because, while a change in the price of chicken never causes the demand for chicken to increase, a change in the expected price of chicken can cause the demand to increase! What's the difference? The difference is that the price has not changed - only people's beliefs (or attitudes) about the future have changed. They are willing to buy a different amount of chicken at each current price.

Yet, again, Fred is willing to buy more chicken at each price of chicken. Demand has increased.

EXPECTATIONS – EXERCISE

Suppose Fred expects the price of chicken to fall next week. What happens to his demand for chicken this week? Remember the price of chicken hasn't changed yet. Demand for chicken decreased.   Since Fred expects prices to go down next week, why should he buy it now? He'd be better off eating hamburger this week and stocking up on chicken next week.

SUMMARY

1. A change in the price of the good never changes the demand for the good - it changes the quantity demanded.

2. The following factors will change demand (i.e. shift the demand curve):

• the price of a related good (substitute or complement)
• income
• tastes (attitudes)
• expectations (generally about future prices)

3. Generally, the higher the price of a good, the less people are willing to buy; the lower the price, the more people are willing to buy. This is referred to as the Law of Demand.

Fred was very considerate to answer our questions about how much chicken he’d be willing to buy at each of the prices.   Usually, we don’t have this type of information.   Still, even if we don’t know exactly how much he will buy, we know something about his demand curve for chicken. That is, we know that if the price of beef increases, he’ll eat more chicken. And, we know if he decides that chicken is “bad for him,” then he’ll be willing to buy less chicken at each price.

So, we really won’t need numbers on our graphs – they represent more factual knowledge than we’re likely to have. Instead, we’ll simply say that demand increases or decreases (or doesn’t change), but not by how much.

Let’s look at the neighborhood’s babysitting services.   The higher the price per hour, the fewer hours of babysitting people will buy (they’ll stay home, take the kids along, leave them with a relative, swap with a neighbor, or leave them home alone). The lower the price of babysitting services, the more hours they’d be willing to buy.

EXERCISE #1

A new hit movie is opening at the theater that everybody wants to see (rated R).   What happens to the demand for babysitters?

Since everybody wants to see the movie, they’ll need babysitters to stay with the little darlings while they go out (the movie is rated R after all). No prices have changed, but people are willing to hire more sitters at each price. This is an increase in demand.

EXERCISE #2

Restaurants in the neighborhood just came up with new “ kiddie” menus, which have dinners that only cost \$2.50.   Now Mom and Dad can take the kids along!   What happens to the demand for babysitters?

Taking the kids out to eat is a substitute for going out without them (and hiring a sitter). I know, for some people, it’s not a substitute at all. However, not everyone has to feel that it’s a substitute for there to be a significant change in the total behavior of all the parents in the neighborhood. The demand for sitters will decrease, as some people will take their little darlings with them.

EXERCISE #3

Many people in the neighborhood work at “The Plant,” which just gave everybody a raise (they had a good year).   What happens to the demand for babysitters?

When incomes go up, people are willing to spend more – especially on leisure activities. So, at each price, people are willing to hire more sitters. This is an increase in demand.

EXERCISE #4

The video store in the neighborhood lowers its rental price for movies.   What happens to the demand for babysitters?

This time, the price of a substitute good decreased. People are going to move along their demand for videos and rent a larger quantity. This is a substitute for going out, so they won’t hire a babysitter as often.   This is a decrease in demand. If you looked at the babysitter’s behavior (e.g. more willing to sit at a house that has a DVD player) you’re looking at supply. Please be patient, we’ll get there. Remind me to discuss this later.

EXERCISE #5

Empire State College has just opened a unit in the neighborhood and many parents are enrolling as students. They find that they need a babysitter to allow them to see their instructors.   What happens to the demand for babysitters?

People now have an additional reason to hire a sitter.   Again, not everyone will go to college and not everyone who goes to college will need a sitter. However, there will be some additional use of sitters as adults try to carve out the time for school.

EXERCISE #6

Babysitters got together and decided to give a discount to families who have premium movie channels (e.g. HBO).   What happens to the demand for babysitters? (Careful, this is tricky)

Only the price has changed. There is no change in demand. The sitters are offering a discount to those families with premium movie channels – this is a decrease in the price (at least to some parents). So, while there will be a movement from one point on the demand curve to another, the demand curve will not change at all. Some people will hire more sitters at the lower price; however if the price goes back up, they’ll go back to the same use of babysitters they had before.

Tired of chicken and babysitters? Good … now you can practice with a variety of problems.

EXERCISE #7

Fees at the local golf course just went up. What do you think will happen to the demand for golf balls?

If the fees at the golf course increase, some golfers may play less golf (remember, not everyone needs to make the same decisions for there to be a significant change in behavior). Since people will be playing less golf, they’ll be buying fewer golf balls. So, the demand for golf balls has decreased, because the price of a complement good increased.

EXERCISE #8

Last year, the football team went to the Super Bowl. What do you think will happen to the demand for football tickets this year?

When a football team does well, people are more willing to pay to see it. It’s exciting! So, at every price of tickets, fans are more willing to go to the game. This is a change in tastes – peoples desire to see the game has increased.

EXERCISE #9

The local donut shop just distributed a lot of coupons for “two for the price of one” donuts. What do you think will happen to the demand for coffee?

Coffee and donuts are complement goods – that is many people consume them together.   If the price of donuts decreases (that’s the effect of the coupon, after all), some additional people will stop for donuts and coffee.   This is an increase in the demand for coffee.

EXERCISE #10

OPEC has failed to reach an agreement on the price of oil and prices have fallen. What will happen to the demand for gasoline?

Only the price of gasoline has fallen – nothing else has changed. When the price of a good changes, people buy more by moving along their demand curve. This is not a change in demand. Of course, there’s always the possibility that expectations for further price declines could have an effect, but I won’t get very far without gasoline – I think I’ll go ahead and fill ‘ er up now!

EXERCISE #11

People are afraid of another big increase in the price of gasoline. What do you think will happen to the demand for houses in the outer suburbs?

Here we have a combination of concepts – expectations and the price of a related good.   In this case, people expect an increase in the price of a complement. How are they complements? Generally, the farther out in the suburbs one lives, the more gasoline it takes to get to work (I know that’s not true for everybody, but it’s true for many). So, the higher the price of gasoline, the more it costs to commute. This makes moving to the suburbs more expensive – people are less willing to buy a house at each price of houses.

EXERCISE #12

When interest rates rise (the price of loans), what happens to the demand for houses?

First, let’s look at the connection between interest rates and buying a house (let’s leave the contractor out of it for now). When buying a house, the limiting factors are the down payment and the monthly mortgage costs. The higher the interest rates, the higher the monthly payment will be for a loan of the same size. So, buyers will be less willing to buy a house at each price of houses.   The price of a complement good, mortgage loans, has increased – the demand for houses will decrease.

EXERCISE #13

As landfills become more crowded, “tipping fees” (the fee to dump a load of garbage) are going up. What do you think will happen to the town’s willingness to recycle?

Towns have to pay to dump garbage into landfills.   If the fee increases, the legislators will start to look for substitutes (they’ll move along their demand curve for garbage disposal). This increases the demand for substitutes, and one such substitute is recycling. So, an increase in the tipping fees at landfills will increase demand for viable substitutes to disposing of solid waste.