GED Social Studies Practice Test: I Want! I Want! I Want! An Introduction to Demand

Demand is the quantity of a good or service that a consumer is (a) willing; and (b) able to buy at various prices over a specific period of time. Of course, if you have no money, your demand will fall of deaf ears; producers are there to make money, not hand out free stuff. On the other hand, you may be willing to pay more for something depending on a variety of factors: how much do you want something; do you need it or simply want it, and the biggie: how much money do you have. Your purchasing power is usually determined by your income. The more money a person has, usually, the more she or he demands. This is called the income effect.

But, very often, the prime determinant of demand is price — how much money is the producer charging for the good or service. For the lucky few who are super-rich, price may not mean anything. For the rest of us, living on a budget, we’re sensitive to price. We may not have enough money to purchase all that we want. Or, we may decide the price of a good is too high, and we won’t buy it. Let’s look at a graphic that may help explain demand:

econ pic 3

The ABC Pizzeria prides itself on making the highest-quality pizza. But that doesn’t come cheap. So the pizzeria charges $5 per slice. Even though it’s located in a prime location with lots of hungry people (say, a shopping mall), no one is willing to buy a slice at that price. If the ABC Pizzeria drops the price to $4, then it will sell 10 slices. As you can see from the downward slope of the graph, the lower the price, the higher the demand.

What happens when a hungry customer goes to the ABC Pizzeria, sees the sign that says “$5 a slice” and then walks away in disgust? The customer’s demand for pizza may still exist (and who doesn’t want a slice of pizza?). Maybe there’s another pizzeria in the mall  with lower prices, say, $2.50 per slice. That means that for the same $5, the consumer can get twice as much pizza at the less expensive place than the ABC Pizzeria.

This is known as the substitution effect. Very often, people will substitute a lower-price product that is similar in nature to a higher-priced product. When the price of a brand-name breakfast cereal goes up, people may opt to buy the generic version, or a cheaper cereal.

So our hungry customer goes to the less expensive pizzeria and orders two slices at $2.50 each. The first slice is delicious — she’s hungry after all. The second slice is also yummy — in fact, she would have paid $3 for each slice. But now our consumer is beginning to feel full. Is a third slice worth $2.50? No. Suppose the guy behind the counter offers our consumer a third slice for only $2? Okay, maybe she’ll buy that. By the time the fourth slice is offered — even at the bargain-basement price of 50 cents — it’s of no use to her. She can’t eat another bite. This is called diminishing marginal utility and explains why demand for a good or service may not be limitless.

As a general rule, there are some factors that determine demand. Let’s take a look.

What are the Current Tastes and Fashions? Even at the rock-bottom price of $1 a pair, no one wants to buy the trousers put out by the Not-So-Cool-Fashion-Company. Why? because no one likes the cut, color, and fit of their goods. No matter how much they advertise, the company can’t sell its goods. It may think it has a good product, but it’s wrong. Consumer tastes and preferences are among the strongest determinants of demand. Think of a hot new electronics item. Everyone wants one, so the company producing them should make more and more of them (and the company can charge a pretty penny for them, too).

How Many People Want the Good or Service? If more people want something, the more likely it is that the producer will produce large numbers of the good or service. Conversely, if fewer people want something, it makes good business sense to produce fewer of that particular good or service. Why do pharmaceutical makers produce so many drugs to treat depression, cholesterol, and back pain?  It’s because the market for them is huge. Should a drug company produce only a tiny amount of a medication used to treat a disease that affects only a few hundred people a year? Well, it would be a fine and charitable thing to do, but we are talking about business — and not charity — here. The company would be foolish to use its valuable natural, human, and capital resources producing something that only a few people will purchase.

How Much Money Do People Have? No surprises here. When people have more money, they tend to buy more goods and services. When they have less, they buy less, and producers often have to scale back the number of goods and services they offer. During the Great Recession that began in 2007-2008, people’s incomes began to shrink. Producers of all stripes — from the stores on Main Street to the major automobile companies — felt the pinch and scaled back production (and this led to greater unemployment as they let workers go).

What do People Expect to Happen in the Future? You get a new job. Hooray! Even before you start the new gig, you go out and splurge. You’ve bought goods and services in anticipation of an increase in income. You have increased demand without an increase in income.

When times are good and people feel optimistic, they may spend more money than their incomes allow (we’ll discuss credit later), or spend money they had put away for another purpose. When the economy suffers and people are apprehensive, people often put off purchases. Perhaps you’re worried about your job. Even though you might have the money now, you decide that the new washer or refrigerator will wait. You’ll make do with the one you have.

 

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