Demand Part 1 and 2

Summary

In Demand Part 1 and 2, George Frost introduces the fundamental economic concepts of demand within the market system. The discussion begins with an explanation of how demand impacts consumer behavior, emphasizing the ceteris paribus assumption, which holds all other variables constant except price. Frost highlights the 'Law of Demand,' describing its inverse relationship between price and quantity demanded. With engaging anecdotes and humor, he illustrates the concept using relatable examples. Frost further delves into the graphical representation of demand and the mechanisms such as the real income effect, substitution effect, and diminishing marginal utility that underpin the law of demand. Concluding, he sets the stage for exploring the factors influencing demand beyond price.

Highlights

• When prices drop, people tend to buy more of the product, assuming quality and other factors remain constant. 🎉
• The 'Law of Demand' is akin to the law of gravity in economics, representing a fundamental principle. 🌍
• Graphical representation of demand involves plotting price changes against quantity demanded, traditionally with price on the vertical axis. 📊
• Real income effect explains how purchasing power influences buying behavior as prices rise or fall. 💸
• Substitution effect describes consumer tendency to switch to cheaper alternatives when prices increase. 🔄

Key Takeaways

• Understanding demand is crucial to grasp how the market system works. 📈
• The 'Law of Demand' states that the quantity demanded of a good is inversely related to its price. 🔄
• Ceteris paribus, holding other variables constant, is significant in economic analysis. ⚖️
• The real income effect and substitution effect explain why demand changes with price. 🎯
• Diminishing marginal utility plays a vital role in consumer purchasing decisions. 🔍

Overview

George Frost embarks on an enlightening journey through the intricacies of the market system by focusing on demand, a pivotal element in economic analysis. By breaking down the 'Law of Demand,' he articulates how price movements influence consumer behavior and decisions. His conversation is peppered with relatable metaphors, like widgets and shack burgers, making the theory digestible and engaging.

In a classroom-like atmosphere, Frost employs humor and anecdotal tales to demystify demand curves and the underlying mathematical conventions. He humorously addresses common student misconceptions, ensuring a comprehensive understanding of demand's role within the broader economic picture. Frost's colorful descriptions of graph plotting make even the most mathematically resistant individuals appreciate the nuances of demand.

Frost's discussion transcends mere laws and graphs, diving into the reasoning behind the law of demand. By exploring three key concepts – the real income effect, substitution effect, and diminishing marginal utility – he offers a thorough understanding of why price changes affect demand. This foundation paves the way for further exploration of what influences consumer demand beyond just price adjustments.

Chapters

• 00:00 - 00:30: Introduction to Supply and Demand This chapter introduces the fundamental economic model of supply and demand, which is crucial for understanding how the market system operates. The chapter begins with a focus on demand, before transitioning to supply, and eventually combines the two concepts to give a comprehensive understanding of market dynamics.
• 00:30 - 05:00: Understanding Demand The chapter 'Understanding Demand' discusses the basic economic principle of how demand functions in relation to changes in price. It introduces the concept of 'ceteris paribus,' which means holding all other variables constant while examining the effect of changing just one variable, such as price. The chapter challenges the assumption that a drop in price will always lead to an increase in demand by highlighting scenarios, such as a simultaneous drop in quality, where this may not hold true.
• 05:00 - 11:00: Law of Demand The chapter titled 'Law of Demand' discusses the fundamental economic principle that as the price of a product decreases, consumers are likely to purchase more of it. The discussion contrasts the use of hypothetical goods, referred to as 'widgets', in economic examples because they carry no preconceived opinions, with real goods like hot dogs which can elicit personal biases. This illustrates the variability in consumer behavior based on perceptions of value and personal preferences.
• 11:00 - 15:30: Real Income Effect The chapter 'Real Income Effect' discusses the concept of how the decrease in the price of a product leads to an increase in its purchase, assuming other factors remain constant. This idea is applied universally to all products, illustrating the lack of necessity for expert knowledge on specific items. The speaker uses a widget as a hypothetical example, suggesting that there are no strong emotional connections to it. The principle exemplifies a fundamental economic behavior across all types of goods.
• 15:30 - 19:00: Substitution Effect The chapter discusses the concept of the substitution effect, often used to explain consumer behavior when the price of goods changes. The lecturer illustrates this through a classroom example with a piece of chalk. He asks students to predict what will happen if he drops the chalk. Although some students confidently predict it will break, he challenges their certainty, illustrating the unexpected outcomes and reinforcing the idea that assumptions and predictions can sometimes lead to surprises.
• 19:00 - 21:00: Law of Diminishing Marginal Utility The chapter titled 'Law of Diminishing Marginal Utility' includes an example that highlights the predictability of scientific principles, such as the law of gravity. Although the discussion begins with an unrelated example of chalk falling from one's hand, it demonstrates how certain principles, once learned, allow us to anticipate certain outcomes with confidence, much like how the law of gravity ensures that the chalk will indeed fall to the ground. This serves as a parallel to understanding economic principles like the law of diminishing marginal utility.
• 21:00 - 21:30: Factors Affecting Demand This chapter focuses on the concept of the Law of Demand, an essential economic principle stating that the quantity of a good demanded is inversely related to its price, assuming other factors are held constant. The chapter highlights the importance of understanding this foundational economic concept and its role in analyzing demand trends.

Demand Part 1 and 2 Transcription

• 00:00 - 00:30 we're now going to begin our discussion of the market system and in order to understand how the market system works you have to understand a model economists call supply and demand in order to understand this we have to start by talking about demand first then we'll talk about supply then eventually we'll put them together so i want to talk about demand now so my question to you is this if the price of a product
• 00:30 - 01:00 falls what will people do they'll buy more right are you sure they'll buy more does it depend on the product um well it might depend on some things right if the price of a product goes down but the quality goes down at the exact same time right people aren't necessarily going to buy more so you have to remember to use that assumption that we always use in economics that's that ceteris paribus assumption or other things held constant right we're only changing one variable at a time so assuming everything else stays constant cetera is powerbase right if the price of a product goes down people will buy
• 01:00 - 01:30 more and we're sure of this it doesn't matter what the product is pizza cars widgets people buy more and some of you like what's a widget we sometimes use widget widgets and economics as a good um because it's a hypothetical good and the reason we use hypothetical goods is because no one has strong opinions about it sometimes i use a real good in a pro in a class i'll talk about hot dogs or something like that i'll say the price of hot dogs goes down if you buy more hot dogs and people say no they don't buy more hot dogs i'm like why do you why don't you think they buy more hot dogs like well my family
• 01:30 - 02:00 we've been selling hot dogs for generations we know all about this but when it's use widgets nobody has strong emotional attachments to widgets unless you've got serious problems so it's just a hypothetical good we use so when it comes to what we're saying here is we're saying when the price of a product goes down people buy more assuming everything else stays the same and it doesn't matter what the product is this applies to all products this is remarkable if you think about it it allows us not to be experts on any particular product so we can be sure
• 02:00 - 02:30 even if we don't know much about the product now the way i like to explain in my classes is let's say i have this piece of chalk right here now if i were to drop this piece of chalk from my hand what's going to happen what would you predict is going to happen it's going to what now some students say it's going to it's going to break i say you're sure it's going to break and they say yeah i'm sure i had one kid who bet his life that it was going to break and then it didn't break he was quite surprised and a little bit nervous but what i'm going to do is i'm going to ask this question are you sure if i drop
• 02:30 - 03:00 this chalk from my hand what's definitely going to happen it's going to it's going to fall right it's not going to say suspended in mid-air it is going to fall and you can be sure of this now why can you be sure of this and by the way there it did and it fell now why can you be sure of this you're not an expert in chalk you're not an expert in my particular my office how could you be sure that chalk was going to fall you were sure because in science you were taught this principle called the law of gravity and that law of gravity allowed you to predict behavior of things like that shock falling from
• 03:00 - 03:30 my hand even though you weren't an expert on shock well economists have a similar principle akin to the law of gravity and it's basically what we've been talking about it's called the law of demand here's the definition of the law of demand the quantity of a good demanded is inversely related to its price ceteris paribus or other things held constant if you will um a couple of things about the law i just want to make sure we're clear on this first
• 03:30 - 04:00 is the ceteris paribus the other things held constant part of the law important very important right because if price goes down but quality goes down at the same time we already saw that doesn't mean somebody's necessarily going to buy more if price goes down but people's income goes down people aren't necessarily going to buy more you want to hold everything constant besides the price of a good so that's important secondly price is the cause variable and quantity demanded is the effect variable or if you want to say in a different way
• 04:00 - 04:30 more mathematically precise price is the independent variable quantity demanded is the dependent variable in other words we're saying when price of a product goes up the quantity demanded goes down other things held constant we're not saying when demand goes up price goes down that's something totally different so you have to try to remember that and third i just one thing about the law and maybe a story from when i was teaching at the university of connecticut might help explain this problem i once gave a question to the
• 04:30 - 05:00 university of my university connecticut students when i was teaching there in the early 90s explain the law of demand and this was an answer i got from a student in the early 90s from uconn the law of demand demand was passed during the franklin roosevelt administration it was later expanded under lyndon johnson's administration and finally ronald reagan abolished that law in the mid 1980s this is a brief legislative history of the law of demand it's not that kind of law okay it's not it's not a law passed by government we don't have the law of demand because government got around to passing legislation it is a scientific law or a
• 05:00 - 05:30 social science law similar to the law of gravity which is a scientific law um i wrote in that student's paper you might not find it funny but i enjoyed writing i wrote zero because there's nothing about it that was correct and at the top of the page i just wrote aren't you glad that congress got around to passing that law of gravity otherwise we'd all be flying around high high high up in the sky somewhere i imagine you might be right now any event this is a brief uh explanation of law demand we're going to talk now
• 05:30 - 06:00 more about its specifics okay we're going to talk about what happens when price goes how to show it on a table and a graph this inverse relationship between price and quant demanded and that's what we will turn to next okay now we're going to do is we're going to try to show a table which illustrates uh that law of demand which we just which we just learned okay so i'm gonna put um p in my left hand column that stands for price i'm gonna put q in my right hand column that stands for quantity and
• 06:00 - 06:30 put a little d standing for demanded so we got price and we got quantity demanded okay so here are the um let's imagine the price of some particular product is ten dollars okay and the amount that people are willing to buy of that product is one now what did we just see we saw that when the price of the product drops we just said that according to law demand people are going to buy more now how much more well the truth is you don't know in a real situation you'd be collecting data from some particular market but here we're just going to make
• 06:30 - 07:00 up the numbers but we have to make them up in a way that's consistent with the law of demand right so when price goes down people buy more the amount demanded goes from one up to five and when price goes down again to six the amount demanded in this case goes up to nine and when the price goes down again to four the amount demanded goes up to 13. now again i'm getting these numbers by making them up but i'm making them up in a way that's consistent with the law of demand right when the price is going down uh the amount being produ the amount being demanded is going is going up so price
• 07:00 - 07:30 is 2 and that's 17. okay so now we're going to do is we're going to show how the graph looks now for those of you who are mathematically inclined what i'm about to do next may uh bother you as we've previously talked about price is the cause variable and quantity demanded is the effect we're saying that when price goes down quantity demanded goes up so for those of you mathematically inclined what's going to bother you is in economics we traditionally put the price
• 07:30 - 08:00 on the vertical axis we did this um about 100 years ago when they were first doing supply and demand curves they had some reasons uh for doing it back then and we've kind of done it that way just by convention now uh on the horizontal axis is quantity again it's going to bother you those who are mathematically inclined because quantity is the dependent variable and we're putting it on the x-axis or the horizontal axis which is as i said unusual now i had one kid by the way who said i won't do it i i said what do you mean
• 08:00 - 08:30 you won't do it he says i will not put price in the vertical axis this is the independent variable i said yeah i know but that's the way we do in economics he says i will not do it it violates my sense of mathematical principles i'm going to ask that you just kind of put your principles aside and try to and try to do it the way we do it in economics because it's really going to confuse you if you're constantly trying to reverse this so how do we get this table in this graph well it's very simple we just simply plot the points so here is zero for our origin right that's at a price of zero and quantity of zero and so our first point is that at ten
• 08:30 - 09:00 dollars the amount demanded is one put a little one there right and that's a ten at a price of eight dollars the amount being purchased is five so and that's five at six dollars the amount being purchased is over here at nine and you could keep on plotting these plotting these points but three will do it what do you do with uh what do you do when you have the points drawn out you can simply connect the
• 09:00 - 09:30 dots and you get a demand curve in this case it's a demand line because the slope is constant but we call it a demand we generally call it a demand curve there's no reason that should be a straight line it just happened to be that way in this particular circumstance now notice what we're saying it has what kind of slope if you look the demand curve has a negative slope now does it always have to have a negative slope yeah it always has to have a negative slope right and somebody said well why does it have to it has to right what do we call it we call it the law of demand we don't call
• 09:30 - 10:00 it the sometimes it works this way principle of demand so freaking demand always has a negative slope i have found by the way when students use the word freaking to remember the law of demand the law of freaking demand that student scores have improved so that i that you feel free to use it the only thing i ask is if you go outside of the classroom please maybe drop the freaking because some people might think it's not sophisticated enough i know somebody like freaking i can't believe you used the word freaking you know you know we're a new
• 10:00 - 10:30 generation freaking that's very old school if you want us to remember it should call it the law mother uh no i'm not going that far certainly not on audio anyway so we're going to call it the law of freaking demand all right so it always has this negative slope now what i want to show you next is what happens on the graph when the price drops how do we show that so let's say we ever appear at a price of 10 and uh and a quantity demanded of one and let's say the price starts to drop from 10 down to 8. how do i show that in the graph well
• 10:30 - 11:00 what i'll do is i will slide along i'll move along my demand curve and i will move in this direction to the right that's a little arrow there's a little off-center there's a little arrow leading to that point now notice i said we move along the curve to the right don't say down i know you're saying well the arrow is moving down here's the problem students on exams get confused by this because they look at this arrow and they say oh the arrow is going down quantum mechanic is decreasing notice quantity demanded is increasing
• 11:00 - 11:30 we're moving from one over here one over all the way over to five so quantum men is is increasing and why is quantity increasing because the price is going down we know inverse relationship right but students always look at this graph they go oh quantum demand is decreasing because they see the arrow going down that arrow's not going down don't think of it that way that arrow is moving in a rightward direction and what happens to the numbers along our horizontal axis as we move to the right they get larger right one five nine so as we move to the right
• 11:30 - 12:00 quantity demanded increases if we were if the price were to rise then we would move back the other direction on the curve and we would move to the to the left if price were to rise and the quantum demand would decrease all right so what i want you to remember here from this table is you should be able to draw the graph you should be able to show that you should know that it has a negative slope according to the law of demand and you should know that when the price drops well people buy more which means we move along our curve to the right there's an increase in quantum added and if the price rises we move
• 12:00 - 12:30 along our curve to the left there's a decrease in quantity demanded and that's basically a graphical approach to the to the demand curve what i want to do now is i want to turn um to the um i want to turn to the reasoning behind the law of demand now that you see what it looks like on a graph i want to explain to you and you know what it is i want to explain you what's the reason uh behind it because there's got to be something more if you ask somebody asked you in a science class to explain the law of gravity and you replied it's
• 12:30 - 13:00 common sense man that's really not a sophisticated answer certainly not enough for a science class so i don't want you going around when somebody asks you explain the law of demand how come there's a law demand i don't want you going around saying it's common sense man i want you to understand the reasons behind it and so that's what we're going to turn to next okay now we're going to explain the reasoning behind the law of demand so
• 13:00 - 13:30 you don't have to go around saying it's common sense man to anybody who asks you for an explanation there are actually three distinct reasons behind the law of demand and so i'd like to explain each of them to you but i'd like to use an example to help you understand it so we can kind of visualize it better so instead of talking about widgets uh let's talk about uh fast food as a matter of fact let's talk about um what's so a shake shack i want you to imagine um that you are you love the shack burger as a matter of fact you might be a shack burger addict so i would imagine you go over to shake shack you have 14 of income in your pocket and
• 13:30 - 14:00 let's say the price of a shack burger including tax i think it's obsessed with tax is seven dollars and you show up there you love the burger so much you can get fries no you get a shake no you can get yourself two shack burgers that's how much you love it matter of fact maybe you're even a shack burger addict all right so that's what you're going to do your income is 14 you got income 14 in your pocket the price is seven dollars you're going to buy two of them now i want you to imagine you go back to shake shack when you go back to shake
• 14:00 - 14:30 shack as this person who loves the shack burger who's a shack burger addict i want you imagine when you go back there with your 14 of income you look at the price of a shack burger and you see the price of a shack burger is 14. now how many shack burgers are gonna you gonna buy even if you're a shack burger addict which you're probably not probably just love it but even if you're a shack burger addict how many are you gonna buy you're gonna just buy one why
• 14:30 - 15:00 because you can only afford it right even if you wanted to buy two you can't afford it because your income has run out you only can buy one so you can see that when the price of the product goes up you have bought less even in the case we absolutely need it like in the case of shack burger so the reason behind this is known as the real income effect and that helps us understand the law of demand what does the real income effect say it says when the price of a product goes up people's purchasing power goes
• 15:00 - 15:30 down and when their purchasing power goes down they buy less quantity demanded goes down price goes up purchasing power goes down so quinn demanded goes down all right and that's known as the real income effect and notice we knew it from the law of demand when the price goes up people buy less coin demand goes down we already knew that what are we filling in we're filling in the reasoning behind it the fact is when the price goes up purchasing power's less you don't have as much money as you did before in real terms so therefore you buy
• 15:30 - 16:00 less okay so that's one of the reasons behind the law of demand now notice in my example why didn't i change income why did i assume only the price was changing well that's because the center is parabus right we have to keep income level the same price goes up and if your income level stays the same your purchasing power is going to go down so you're going to end up buying less and that's the real income effect and it's one of the law of demand it's an important one to keep in mind by the way because sometimes when i'm talking about the law of demand students will say well the law of demand doesn't apply to gasoline of course it applies to gasoline the law
• 16:00 - 16:30 demand applies to all products because as the price rises eventually your purchasing power is going to fall you're not going to buy they'll buy as much the law of demand even applies to crack addicts right in terms of their demand for crack because when the price of crack goes up people are going to have to buy less crack because eventually they're going to run out of money and that's known as the real income effect now the likelihood is you're not uh addicted to um to the shack burger the likelihood is is that you probably like it a lot um so what now i want you to
• 16:30 - 17:00 imagine you walk into today you have your your 14 worth of income i want you to imagine if the price was seven dollars you would have bought two that's how much you like the shack burger but you're not an addict you just really like it if you walked into shake shack today and you saw that the price of the of a shake shack burger was 14 how many burgers are you probably going to buy my guess is you're going to buy none now can you afford to buy one of course you can but what you're going to do in this circumstance is you're going to turn other options you're going to go to five guys you get two or three burgers or
• 17:00 - 17:30 five guys for fourteen dollars about two burgers and maybe some fries at five guys don't get the shake it's not that great um or you're gonna go to wendy's fourteen dollars at wendy's my god you could get yourself like 12 junior bacon cheeseburgers um go to taco bell you can get yourself like nine taco supremes but you're probably not going to buy any shack burgers at the price of the shack burger is 14 notice by the way it's very different here you could still afford to buy it but you're buying less now because you're turning other options this is another reason behind the law of demand it's not known as the real income effect
• 17:30 - 18:00 it's known as the substitution effect so what's the explanation of the substitution effect when the price of a product goes up right the good becomes more expensive compared to substitute items so therefore you're going to turn around and buy all those substitutes in this case you're going to buy the five guys you're going to buy wendy's you're going to buy a taco bell maybe even all-american burger when the price of the uh of the prank goes up of the shake shack goes up the shack burger goes up you turn other options and therefore you buy less of the shack
• 18:00 - 18:30 burger price goes up you buy less again that's from the law demand but why are you buying less because the good is now relatively more expensive compared to substitute goods okay so now we have two reasons behind the law of demand we have the real income effect and we have the substitution effect right price goes up purchasing power goes down people buy less that's the real income effect price goes down purchasing power goes up so people buy more real income effect or you have the substitution effect price
• 18:30 - 19:00 goes up the good's relatively more expensive compared to other options so you buy the other options so therefore you buy less quantum mana goes down the product whose price went up or when price goes down the shack burger is relatively less expensive compared to other options you turn away from the other options and you buy more shack burgers quantum demand goes up that's the substitution effect so now we got those two reasons now there's a third reason which is going to draw upon some of your knowledge from our earlier economic principles remember i told you i'll be doing this all the
• 19:00 - 19:30 time so let's think about this way if you were to increase your purchases of shack burgers if the quantity demanded of shack burgers would go up you get more shack burgers and more shack burgers and more shack burgers well we know that that's better total utility would be going up but if you remember you get a little sick of the shack burger so each additional shack burger brings you less marginal utility if you remember that's called the law of diminishing marginal utility right says the more you consume of something while
• 19:30 - 20:00 your total satisfaction may go up each additional unit brings you less additional satisfaction than the one before it so how does this apply to the law of demand well if you're increasing your quantity demanded if you're consuming more and more you're going to get a little sick of it so you're not going to want to do that so what would get you to consume more even though they weren't as satisfying if the price of the product went down so you might buy yourself an extra shack burger if the price was
• 20:00 - 20:30 lower even though those shack burgers weren't giving you as much additional satisfaction if you want a practical example of this think about when you buy a shoe right when you buy a shoe you typically might pay full price for the first shoe but a lot of the first pair of shoes but the shoe companies often will give you compare why they know that second pair isn't quite as valuable to you as the first one so that's the third reason behind when as the law of diminishing marginal utility if quantity demanded were to go
• 20:30 - 21:00 up you know that marginal satisfaction were to go down so you're not going to want to buy things at a lower marginal satisfaction unless the price goes down first and if the price does go down then you will buy more price goes down you buy more why because you're now have a better incentive even though these goods have bring you less additional satisfaction so those are the three reasons behind the law of demand they are the real income effect the substitution effect
• 21:00 - 21:30 and the law of diminishing marginal utility and now when somebody asks you explain the reasoning behind the law of demand you'll have something more than just its common sense you'll have these three reasons okay what i want to turn to next is i want to turn to all the factors other than the goods price which affect demand and that's what we're going to turn to now