Economics Chapter 4 Study Guide

Demand
The desire to own something and the ability to pay for it

law of demand
When a goods price is lower, consumers will buy more of it. When the price is higher consumers will buy less of it.

The law of demand is the result of two behavior patterns
substitution effect, income effect

substitution effect
When consumers react to an increase in a good’s price by consuming less of that good and more of other goods.

income effect
the change in consumption resulting from a change in real income

demand schedule
A table that lists the quantity of a good that a person will purchase at each price in the market

market demand schedule
shows the quantities demanded at each price by all consumers in the market.

demand curve
a graph representation of a demand curve

ceteris paribus
the latin phrase ” all other things are held constant”

normal goods
a good that consumers demand more of when their income increases

inferior goods
a good that consumers demand less of when their income increases

complements
two goods that are bought and used together

substitutes
goods used in the place of another.

law of demand
as prices go down, quantity goes up
as prices go up, quantity demanded goes down

economists measure consumption
in the amount of goods that are being bought

An increase in price will make the quantity demanded fall
this movement along the demand curve is referred to as decrease in the quantity demanded.

A decrease in price would lead to an increase..
in the quantity demanded

if you expect the price to rise, your current demand will rise,
which means you will buy the good sooner

if you expect the price to drop, your current demand will fall, and you will
wait for a lower price.

what causes a shift?
income, consumer expectations,population, consumer taste/advertising.

elasticity of demand
dictates how drastically buyers will cut back or increase their demand for a good when the price rises or falls, respectively.

elasticity of demand measures
how consumers react to a change in price.

inelastic
relatively unresponsive to price changes

elastic
demand that is very sensitive to a change in price

unitary elastic
describes demand whose elasticity is exactly equal to 1.

factors affecting elasticity
1) availability of substitues
2)relative importance
3) necessities versus luxury?
4) price change over time

What does the elasticity of demand determine?
how a change in prices will affect a firms total revenue or income.

total revenue
defined as the amount of money the company receives by selling its goods.

if a firm knows that the demand for its product is inelastic as its current price
it knows that an increase in price will increase total revenue.

income effect?
People consume more when their income increases and less when their income decreases.

A demand curve is an accurate tool for predicting the decisions of consumers as long as
there are no changes other than price that could affect consumers.
EXPLANATION: If an entrepreneur is selling 20 tee shirts a day for $10.00 and decides to drop the price to $8.00, he or she might expect to sell more t-shirts. However, if there is a cold front the same day the sale starts, the entrepreneur will learn that the demand curve only is accurate when all the other factors affecting consumer decisions remain unchanged.

After a producer determines that the demand for one of its products is inelastic, why would this firm probably raise the price of this product?
CORRECT: The firm’s total revenues would probably increase.
EXPLANATION: Inelasticity of demand means that a relatively large increase in price, such as 15 percent, will cause a relatively small decrease in quantity demanded, such as 5 percent. A higher price and a small reduction in quantity demanded would result in higher total revenue.

entrepreneurs can estimate the elasticity of demand for some goods
use this number to make pricing decisions

A drop in price will
CORRECT: increase the quantity demanded of goods.