• Effective demand is the demand from consumers that is backed up with an ability to pay. It refers to the willingness and ability of consumers to purchase goods at different prices.
• When we think about the demand curve, we are thinking about effective demand.

1. A column that lists the price for a product in increasing or decreasing order.
2. A column that lists the quantity of the product desired at that particular price.

Let’s take Tesco’s finest shortbread as an example. There is a customer called Katy. Below we list the price for shortbread in increasing order and the individual quantity of the product desired. Here is an example of the individual demand schedule:

• At £1 per shortbread, Katy buys 10 shortbreads.
• At £2, she buys 6 shortbreads.
• At £3, she only buys 2 shortbreads.

Suppose there are only 3 buyers of shortbread in the market – Katy, Ben and Nkechi. The market schedule and market demand curve can be seen below:

Market schedule:

Market demand curve:

1. Total Utility: The complete amount of satisfaction gained from consuming a certain quantity of goods.
2. Marginal Utility: The satisfaction gained from consuming one additional unit of a good.
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Imagine you love pizza! Here's how total and marginal utility comes into play:
• Total Utility: This is the overall satisfaction you get from eating pizza. The first slice is amazing (high total utility!), and the second is pretty good too (adds to your total satisfaction), but maybe by the fifth slice, you're starting to feel full (lower total utility).
• Marginal Utility: This is the extra satisfaction you get from eating just one more slice. So, the first slice gives you a big boost in happiness (high marginal utility), but each additional slice adds a little less enjoyment (lower marginal utility).

• Second Slice: If the marginal utility of the second slice is 8, it adds to the total utility from the first slice. So, 10 (from the first slice) + 8 (from the second slice) = 18 total utility.
• Always Decreasing: Marginal utility always decreases as you consume more. Each additional slice of pizza provides less satisfaction than the previous one.

As discussed, marginal utility (MU) is the satisfaction gained from consuming one additional unit of a good. We've already plotted our total utility against our marginal utility on a graph (are we able to link this graph here?).

If we wanted to plot a demand curve using marginal utility, we could replace the price on the Y-axis with MU and keep quantity on the X-axis just like we did on the left hand side above.

Interestingly, the marginal utility curve looks exactly like a demand curve. You might be wondering, why is this the case?

• Remember, we are trying to explain the law of demand in another way using marginal utility which is all about our satisfaction!

Say you have a favourite snack. if the price of the snack remains high, you might stop buying more after a few bites because the added satisfaction just isn't worth the cost.

However, if the price drops, you're more likely to keep buying more because even though each additional bite gives you less satisfaction, the lower cost makes it worth it.

This explains why consumers like you and me buy more units of a product only when the price goes down: the lower price compensates for the lower satisfaction gained from consuming each additional unit.

• This therefore explains using marginal utility why the demand curve slopes downwards!

Now, let's talk about how changes in prices can make you feel richer or poorer, affecting your demand.

Income Effect Definition: The income effect describes how a change in the price of a good affects the purchasing power of a consumer's income, leading to a change in the quantity demanded of that good.

• Example: Imagine you have £10 to spend each day.
• If rice costs £3 per bag, and you spend £3 on rice, you have £7 left for other things.
• Price Drop: If the price of rice drops to £2 per bag, you still have your £10, but now you spend only £2 on rice and have £8 left over. It feels like you have more money, so you might buy more rice or other things.
• Price Increase: If the price of rice goes back up to £3, you spend £3 on rice again, leaving you with only £7 for other things. It feels like you have less money, so you might buy less rice or other things.

• Feeling Richer: When prices drop, you feel richer because your money goes further. This might make you want to buy more of the good whose price dropped or other goods.
• Feeling Poorer: When prices rise, you feel poorer because your money doesn’t go as far. This might make you want to buy less of the good whose price increased or other goods.
• Impact on Demand: This change in your purchasing power helps explain why demand for a product falls when its price rises. It becomes less affordable, so you buy less of it and vice versa.

The substitution effect definition: The substitution effect is the change in the quantity demanded of a good due to a change in its price, making it more or less attractive relative to other substitute goods.

• Substitute goods are products that can be used in place of each other
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Can you think of substitute goods to Rice?

Let’s say pasta and rice both costs £5:

• Price Drop: If the price of rice falls to £3, rice becomes cheaper compared to pasta. Even if the price of pasta stays the same at £5, pasta now feels more expensive. You might buy more rice instead of pasta, increasing the quantity demanded for rice.
• Price Increase: If the price of rice rises to £6, pasta feels cheaper by comparison as its price remains at £5. You might switch from rice to pasta, reducing your demand for rice.

As one good becomes cheaper, we buy more of it instead of its substitutes, and vice versa. This effect also contributes to the downward slope of the demand curve:

However, there are some interesting exceptions to this rule and it is sometimes the case that the demand curve slopes upwards instead of downwards!

Let's explore a few of them.

Definition: Giffen goods involves low-income consumers purchasing more basic food products as prices increase, because they cannot afford to purchase anything else

Imagine you're buying a basic food item like bread. Normally, if the price of bread goes up, you'd buy less bread. But what if bread is such a big part of your diet that you can't afford to buy other foods when it gets more expensive?

In this case, you might actually end up buying more bread because it's still the cheapest way to get full. This kind of strange situation is what economists call a "Giffen good."

• Example: If a staple food like bread gets more expensive and your income doesn't change, you might have to spend more on bread and less on other foods, leading you to buy more bread instead of less.

Definition: Veblen goods involve consumers purchasing more of a good because it is well-known/expensive, to “show off”.

Now let's think about luxury items like designer clothes or fancy cars. Sometimes, people buy these items not just because they need them, but because they want to show off. If the price of these items goes up, they might actually become more desirable because owning them makes you look rich and successful. These are called "Veblen goods."

• Example: If the price of a luxury car increases, some people might want it even more because it shows they can afford something expensive, making it a status symbol.

Definition: Speculation is when consumers purchase more of a good when its price rises because they expect it to rise further in the future

Speculation is all about guessing what will happen to prices in the future and making decisions based on those guesses. Sometimes, if people think the price of something will go up in the future, they might buy more of it now, even if the current price is already high. This can create an exception to the law of demand.

• Example: If people believe the price of a certain stock is going to skyrocket, they might buy a lot of it now, even if it's already expensive, hoping to sell it for a profit later.

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Did you know? Real estate speculation played a significant role in the 2008 financial crisis. Speculators took risky loans to buy lots of houses, hoping their prices would keep going up. When prices crashed, it caused big problems for banks and the economy, leading to a global recession.

Housing speculation and its economic consequences

Housing speculation became a national phenomenon in the low interest rate environment of the US during the mid-2000s. This column argues that speculation, which was largely independent of the credit expansion to subprime households, contributed significantly to US housing and economic cycles in the 2000s. It led not only to greater price appreciation, economic expansions, and housing construction during the boom in 2004–2006, but also to more severe economic downturns during the subsequent bust in 2007–2009.

cepr.org

Definition: Anticipatory purchases occur when consumers buy more of a product as they expect its price to rise in the future.

Anticipatory purchases happen when consumers believe that the price of a product, like petrol before a budget announcement, might increase soon. This behaviour can lead to increased demand even before the price actually rises.

• Example: Motorists might buy more petrol if they anticipate a price increase in an upcoming budget announcement.

Perceived quality and demand refer to situations where consumers associate high price with high quality, leading to increased demand.

When consumers perceive that a high price indicates superior quality, they may be willing to buy more of a product, even if its actual quality is not easily distinguishable.

• Example: Expensive shampoos like Aussie may see increased demand simply because consumers associate higher prices with better quality, regardless of the actual differences in product quality.

• Giffen Goods: Necessities that people buy more of when prices rise, due to budget constraints on other items.
• Veblen Goods: Luxury items that become more desirable as their prices increase, due to their status symbol appeal.
• Speculation: Buying more of something now because you think its price will rise in the future, even if it's already expensive.
• Anticipation: Purchasing more of a product in anticipation of future price increases or scarcity, to benefit from current conditions or avoid higher costs later.
• Perceived Quality and Demand: When consumers associate higher prices with higher quality, leading to increased demand for goods perceived as premium, regardless of actual differences in quality.

These exceptions show that human behaviour can sometimes be unpredictable and doesn't always follow the simple rules of supply and demand!

A shift in the demand curve means that at the exact same price, consumers wish to buy more.

A movement along the demand curve occurs following a change in price.

Expansion in demand. A fall in price from £800 to £500 leads to an expansion (increase) in demand. As price falls, there is a movement along the demand curve and more is bought from 80 to 100.

Definition: Determinants of demand are changes in conditions that cause the demand curve to shift either to the left or right.

Determinants of demand and shifting right the demand curve:

• 💰 Income: Higher incomes enable consumers to buy more goods and services, shifting demand curves to the right for normal goods.
• 👍 Tastes (Preferences): Changing preferences towards a product increase demand as more consumers desire it, shifting the demand curve to the right.
• 📢 Advertising: Effective advertising increases consumer awareness and desire, shifting the demand curve to the right.
• 🔄 Prices of Other Goods (Substitutes and Complements):
• Substitutes: Higher prices of substitutes increase demand for the original product, shifting its demand curve to the right.
• Complements: Lower prices of complements increase demand for both goods, shifting their demand curves to the right.
• 👗 Fashion: Trends and fashion shifts increase demand for trendy goods, shifting their demand curves to the right.
• 🏙️ Population: Growth in population increases overall demand for goods and services, shifting their demand curves to the right.
• 💳 Availability of Credit: Easy access to credit allows consumers to buy more, shifting demand curves to the right.
• 📈 Expectations of Price Changes: Anticipation of future price increases leads to higher current demand, shifting the demand curve to the right.

Determinants of demand and shifting left the demand curve:

• 💸 Income: Lower incomes reduce purchasing power, decreasing demand for normal goods and shifting their demand curves to the left.
• 👎 Tastes (Preferences): Changing preferences away from a product decrease demand as fewer consumers desire it, shifting the demand curve to the left.
• 🚫 Advertising: Ineffective or negative advertising can decrease consumer interest and demand, shifting the demand curve to the left.
• 🔄 Prices of Other Goods (Substitutes and Complements):
• Substitutes: Lower prices of substitutes decrease demand for the original product, shifting its demand curve to the left.
• Complements: Higher prices of complements decrease demand for both goods, shifting their demand curves to the left.
• 🕴️Fashion: Shifts away from a product in fashion decrease demand, shifting its demand curve to the left.
• 👪 Population: Declines or changes in demographics reduce overall demand for goods and services, shifting their demand curves to the left.
• 💳 Availability of Credit: Tightening credit conditions reduce consumer spending, shifting demand curves to the left.
• 📉 Expectations of Price Changes: Anticipation of future price decreases reduces current demand, shifting the demand curve to the left.

Situation: Due to adverse weather conditions in Brazil, the supply of coffee has decreased, leading to a significant increase in coffee prices worldwide.

Question: "Draw a diagram to show the effect on just the demand for tea of the increased price of coffee, assuming tea and coffee are substitutes."

• Situation: Due to increased fuel costs and regulatory changes, airlines worldwide decide to raise ticket prices for international flights by 15%.
• Question: "Draw a diagram to illustrate the effect of a 15% increase in the price of international airline tickets on the market for air travel."

• Situation: Following a global economic recession, there has been a sharp decline in consumer incomes in developed countries.
• Question: "Using a demand diagram, illustrate the impact of reduced consumer income on the demand for luxury watches."

• It helps economists and businesses understand how much quantity demanded changes when prices change.

• A smaller slope means a flatter demand curve and more elastic product.
• Example: If the price of a laptop goes down by 15% and the demand for laptops is elastic, this means that the quantity demanded for laptops will increase by more than 15%.

An inelastic demand happens when a change in price results in only a small change in the quantity demanded.

• A greater slope means a steeper demand curve and more inelastic product.
• Example: If the price of a laptop goes down by 15% and the demand for laptop is inelastic, this means that the quantity demanded for laptops will increase by less than 15%.

• PED = 1: This means the product has unit elasticity.
• If the price goes up or down by a certain percentage, the quantity demanded will go up or down by the same percentage.
• If the price of a t-shirt goes up by 10%, the quantity demanded will decrease by 10%. Similarly, if the price drops by 5%, the quantity demanded will increase by 5%. 👔
• PED > 1: This means the product is elastic.
• People are very sensitive to price changes, so if the price changes, the quantity demanded changes a lot.
• If the price of movie tickets increases by 20%, the quantity demanded might drop by 30% because people find alternative entertainment options easily. 🎫
• PED between 0 and 1: This means the product is inelastic.
• People are not very sensitive to price changes, so if the price changes, the quantity demanded changes only a little.
• If the price of gasoline rises by 15%, the quantity demanded might only decrease by 5% because people still need to drive to work and school. ⛽️

Example: Apple Iphone📱

When Apple launches a new iPhone, it usually comes with a higher price due to new features.

Impact on Demand:

💵 Price Increase: When Apple increases the price of its new iPhone model, let's say from £800 for the previous model to £1000 for the new model, consumers face a higher cost if they want to upgrade.

😐 Consumer Response:

• Elastic Demand: Many consumers may choose to delay upgrading their iPhone or stick with their current model for longer because the price increase makes the new iPhone less affordable.
• Some might wait for discounts or promotions instead of buying the new Iphone immediately.

Example: Think about soft drinks 🥤

There are many brands and flavours of soft drinks available and various store brands, providing plenty of substitutes.

Time Period Since Price Change ⏳

• Over a longer time period, consumers have more time to find alternatives and adjust their buying habits.
• Example: If the price of oil-fired heating goes up, over time people might switch to heat pumps 🔥➔❄️.

They found that a 13p levy on every £1 of property value could generate about £57 million annually. This demonstrates how governments plan to increase revenue, considering that alcohol tends to have price inelastic demand—meaning people will generally buy it even if the price increases, affecting how taxes like this are designed and their impact on government income.