IB Economics: Demand

IB Economics: Demand Demand and Supply Outline the meaning of the term Market Hi People. According to the IB syllabus, the term market is defined as where buyers and sellers meet and agree on a price. Explain the negative causal relationship between price and quantity demanded. This is a very straightforward concept. If I buy two hundred chickens from the market, it will cost X dollars. However, if the price of chickens increases dollars, the the quantity demanded will be lower. Is this not a simple concept? Why would you buy more chickens when they cost more? The main definition for demand is: The willingness and ability to consume a good or service in a given amount of time. So basically the chicken example is the law of demand in economics and this can be represented by a simple graph. This graph would also be known as the market demand for good X. Of course, price represents the money you would pay for the good/service, and the quantity represents the market demand. Hopefully it’s clear to most people that the point where the axes cross is $0 and 0 demand. As you go along the price axis and draw a line from there straight to the demand curve, you can see that the quantity demanded decreases. Note that this is true all the time ONLY if everything else remains constant. Another way to describe this is ‘ceteris paribus’. This is an extremely important word to use, as this word is basically applicable to almost every single question in economics, especially evaluation ones. HL ONLY - Well forget what I said when I said ‘all the time’. Actually there are two exceptions that the IB syllabus needs you to know. Giffen Goods – Basically goods that are SO CHEAP, that the value of these goods are viewed as extremely low. As the price of these goods fall, you will demand less of these goods, as when the price of these goods fall, you have more to spend on better things, ceteris paribus. Therefore the demand curve is upward sloping. An example to explain this better (Well believe me I did not understand this at first until I saw an example): A consumer has $5 to spend. Normally he would buy 3 bags of potatoes at $1.20 each and 1 pack of sausages at $1.40 a pack. The consumer prefers meat though. So when the price of one bag of potatoes falls to $1.08, the consumer now buys 2 packs of sausages. Spending $4.96, he bought 2 bags of potatoes, this means that the potatoes, the Giffen Good, falls in demand. Veblen Goods – These types of goods are of a nature that is totally reversed. These goods are so epic, that demand for them is also known as ostentatious consumption. When these types of goods increase in price, purchasing it appears a lot more appealing. Basically buying these goods is showing off; when the price increases, it’s even better to own such a highly valued good. An example is basically gold-plated PSPs, diamond-covered wallets, massive diamonds. The demand curve is upward sloping in this case. The non-price determinants of demand (factors that change demand or shift the demand curve) Of course, price is not the only thing that affects demand in a market. There are plenty of other factors. A list of them: ● Income ● Prices of related goods (complement and substitutes) ● Tastes of individual consumers ● Fashion and Trends (Oh look a new handbag has just came out! Got to buy it!) ● Seasons/ Weather (Ice creams and heating gas) ● Expectations (Going to get a raise at work. Going to buy my family some presents) ● Number of buyers as opposed to Quantity demanded of each individual. Before we go on, we have to explain what Complement and Substitute goods are. Complement goods are two or more goods that consumers usually buy together, for example flour and eggs (basically to make cake). Substitute goods are two different goods that people buy in place of each other, for example Coca-Cola and Pepsi. If you buy Pepsi, you do not buy Coca-Cola, they substitute one another. When anything other than price affects demand ceteris paribus, the demand curve shifts. If the price changes, there’s a contraction/expansion in demand. Hopefully you know enough English to know which one represents a rise and a fall. The demand only rises/falls at each price level if price does not affect it. (By the way this is only applicable to price-quantity graphs) Let’s go back to our demand curve. The thin arrow represents movement along the demand curve. This is because only price changes ceteris paribus. A shift in the demand curve is when curve D1 moves to D2… represented by the large arrow. Things that affect demand other than price count as a shift ceteris paribus. If it shifts right, then of course that means demand is increasing; the quantity demanded is higher at each price level. HL ONLY – Linear demand functions (equations), demand schedules and graphs Usually they come in the form Qd = a-bP. This is quite annoying to explain. I mean the maths involved is really basic, just that the logic is confusing. Let’s just start with an example. Qd= 60-5P. So basically it’s like a normal linear function in Maths. Just that when you substitute x and y like in maths, instead of y = something, you get x = 60-5y. So unlike maths, instead of 60 being the y-intercept, it is the x-intercept instead, or where the curve touches the demand axis. Don’t worry if you do not get it, read it a few more times, and get a drink. There will be a diagram below for visual learners. So why does it touch the quantity axis there? Well, remember that where the axes touch price and demand are 0. So when price is 0, and you plug it in the equation, you get Qd = 60-5(0) or Qd = 60. Simple right? That’s why it touches the quantity axis at 60, where price is as low as possible on the graph. So what is the y-intercept for these functions? Basically you reverse the demand function, or make P the subject in Qd = 60-5P. This means that you do this: Qd = 60-5P Qd -60 = -5P Qd -60 = P -5 Then you pretend that Qd is 0. So basically that’s -60 divided by -5 equals P. Work it out, you get 12. So basically the curve touches the price axis at $12. So why are we finding out intercepts? Basically, a line only needs two points. You can draw the line between both intercepts. To check, you can always find a third point. With the Qd = 60-5P, you can just choose any number between 0 and 12, since $12 is the point when the demand curve is about to disappear from the graph. Work it out and if it agrees with the graph, it should be correct. Unless you did everything wrong… hopefully not. For example choosing $5 will give you 35, which agrees with the graph I have just drawn.