Microeconomics Study Guide – Law of Demand Explained

microeconomics study guideMicroeconomics is part common sense or logic and part pure learning. The rules of microeconomics form part of our everyday lives. Think about how we react to price changes at the local grocery store. The more the price goes up, the less we want to buy as consumers.  As prices increase we buy less and less of a given product. But in terms of the company selling the product, the higher the price goes, the more the company wants to sell to cash in on the profits. This concept is part of supply and demand in microeconomics and the concept forms the basis of some of the most important microeconomic fundamentals. For an introduction to demand and supply analysis in Microeconomics for CFA purposes, enroll in the CFA Level 1 Economics course. This course will introduce you to the analysis of demand and supply. It will teach you how to understand consumer demand and it will teach you about demand and supply from the organization’s point of view.

The Law of Demand – Terms You Should Know

Let’s start by looking at the concepts and terms used in defining the laws of demand. Terms used to define demand include: ·         Demand – Demand represents the relationship between what goods and services cost and the amount that consumers are willing to purchase at a given price. For example, if a stick of butter costs fifty cents, a consumer would buy ten but if it cost a dollar each consumers would only buy five. ·         Aggregate Demand – the combined demand of all households or buyers in the market. ·         Buyer – A person who purchases goods or services from a seller. ·         Competition – The number of buyers or sellers who are trying to buy or sell a service. Competition can only affect prices where there are large amounts of buyers or sellers and where no one individual has the ability to affect market prices. ·         Complementary product – A product whose demand is linked to another product in some way. A change in the demand of one product will affect the demand for the other product. Like Bread and butter to a certain extent. When more bread is sold, more butter is sold too. ·         Demand Curve – The demand curve is a graphical depiction of the relationship between the price of an item and the buyer’s willingness to purchase the item. The demand curve slopes downwards showing less willingness to purchase as prices increase. ·         Diminishing return – The concept that explains that the marginal utility of successive purchases decreases as quantities purchased increases. Think of it in terms of butter. You may really need five sticks of butter. Ten becomes less useful and one hundred even less useful. In fact one hundred sticks of butter may cause some storage headaches! ·         Equilibrium Price – The price point at which the supply of a product or service meets the demand for that product or service. Also called the market clearing price. ·         Equilibrium Quantity – The amount of goods or services sold at the equilibrium price. ·         Normal Goods – Goods that react to market forces normally. When income rises, prices rise and when income falls, prices fall. ·         Inferior Goods – When income rises, prices fall and when income falls prices rise – think of when people looks for bargains because their income has decreased. ·         Veblen Goods – also known as snob goods – as prices increase, demand for product increases due to their perceived social value. Think of items like designer clothing. ·         Household – A unit of buyers. ·         Income Effect – This is a mechanism used to describe the effect of changes in price on changes in consumption. The income effect essentially says that a buyer feels poorer as prices increase or richer as prices decrease. Income hasn’t really changed but buyers feel like it has. ·         Marginal Utility – The utility derived from each successive purchase of a particular good or service. Think of the ten sticks of butter versus one hundred. ·         Market – The group of buyers and sellers buying and selling the same goods or services. It generally refers to a large group of buyers and sellers. ·         Optimization – The process of maximizing the use of resources. ·         Resource – The supply of capital, materials, assets, etc. within an economy. Resources may be consumed and become scarce with insufficient to go around. ·         Scarcity – The concept that goods and services are scarce. There is not enough for everyone. ·         Seller – A unit or person that sells goods to the buyer. ·         Utility –  a measure of the “happiness” value of an item.

The Demand Curve

The following graph represents a normal demand curve. It represents the relationship between the demand for a product related to the price of the particular product. Each individual buyer may have their own demand curves representing their demand in terms of the price of a product. Demand1 Think of the demand curve in terms of your own buying habits. If a burger costs a dollar, then you may be inclined to buy more burgers. If a burger costs two dollars, you may be inclined to purchase less and at four dollars a burger you may decide that you don’t want to purchase any burgers at all. This is generally why demand curve slope downwards from left to right. As the price of a product or service increases, the demand for the product decreases. To read the demand curve, you begin by selecting a price and then seeing where the quantity intersects that price level or vice versa. See the pink link in the graph above. At a price of two dollars this buyer would buy six items. At a price of three dollars per item, the buyer would only buy four items. The above demand curve is based on the assumption that certain variables such as income remains constant. Should income change, then the demand curve will shift. Think about when you receive a raise at work or find a job that pays more. You may feel four dollars for a burger is too much if you are earning minimum wage but if you are earning twenty thousand dollars a month, then you demand for a four dollar burger would be higher. An increase in income therefore generally causes the demand curve to shift to the right and a decrease in income causes the demand curve to shift towards the left. On the graph below, the green line indicates an increase in income and thus an increase in demand and a shift in the demand curve whilst the red line indicates a decrease in income with the opposite effect: Demand2 If you are interested in the subject of microeconomics or would like to learn more about economics, enroll in the Micro & Macro Economics CFA certified course now. This course offers over a hundred lectures designed to help you understand economics. It contains sections on microeconomics and demand and supply analysis. It includes lectures on consumer demand and the analysis of the elasticity of demand and supply.

Microeconomics is Fascinating

The study of consumer behavior, demand and supply and the other concepts that make up the subject of microeconomics is fascinating. The key to excelling in the field of microeconomics, in my opinion, is to ensure you have a good understanding of the definitions and terms used in the subject and that you then creatively apply your own knowledge and logic to the topic so that you really understand how these concepts work. Economics is as much a practical as a theoretical field of study and being able to apply the concepts taught in Economics makes the world a more interesting place to live. Ready to pursue economics on a global scale? If you want to know how the global economy works – and your place in it, this is the course for you.