Understanding Demand

Welcome to Module 2 (Supply & Demand)!  Here's the good news: much of what you will learn in this module is information that you've already been using in your daily life.   This unit explains how people and businesses respond to changes in price.  For example, would you rather pay $1.50 or $3.50 for a slice of your favorite pizza?  Unless you are very strange, you chose the lower amount.  Consumers usually want to purchase quality goods and services for as little as possible, which explains why Mr. Stimson sometimes settles for Little Caesar's instead of going to an expensive gormet pizzaria.  Demand describes the ability and desire to buy a good or service. The law of demand says that the quantity demanded of a good will fall as the good's price increases. A consumer is much more likely to buy a video game for $30 than $60. 

Every consumer reacts to price.  There are two possible responses to a change in price: the substitution effect —where people buy an alternative product that is cheaper; and the income effect—meaning that when an individual's income increases, that person will demand more goods and services; thus increasing their consumption.

The degree to which a person or economy will spend more of their income on consumption is called the marginal propensity to consume (MPC). The MPC depends on the individual's or economy's saving characteristics.  Some people would be likely to spend much more of their paycheck if they got an increase in pay, while others might continue to limit their spending, and save the extra income.

 

• Respond to the following questions and prompts:
1. Describe demand.
2. What is the law of demand?
3. What is one example of the substitution effect in your daily life?
4. Give an example of how you might respond to the income effect.