Notes on Demand

The best way to learn economics is to apply the concepts to examples that you can understand. In the tutorial, I used chicken. Here is another look at these concepts using coffee. mmm… coffee!

Here is some background information on coffee so that we all start with the same foundation:

Beller, Debra. “How Coffee Works.” 18 June 2001. HowStuffWorks.com. <http://recipes.howstuffworks.com/coffee.htm> 04 August 2008.
Specialty Coffee Association of America http://www.scaa.org/

First, read the textbook chapter(s) on Demand. Then work through the 1) Demand section of the Demand, Supply, and Equilibrium Tutorial by Frieda Mendelsohn.

As you work through this material, think about your demand for coffee. Do you drink a lot of coffee? Does your coffee drinking depend on the price? Are you more likely to be influenced by coffee commercials or by price specials in the paper? Do you drink “specialty” coffees?

Think about how this analysis relates to your coffee drinking and share your thoughts in the coffee discussion in Angel.

Substitutes

  • What might you drink instead of coffee? What determines when you switch?
  • Does the relative price between coffee and tea, for example, matter to your choice?
  • Is decaffeinated coffee really “coffee” for you? If you found one that tasted as good as coffee, how would that affect your coffee drinking? Would this be classified as a “substitute” if the relative prices remained the same?

These are questions which can be summarized by the phrase: what could/would you do instead? This phrase is essential in economic understanding; it reminds us that there is always a choice.

Think about what substitutes you have for coffee.

Complements

Let’s think about what you eat or do along with your coffee.

  • Do you like doughnuts with your coffee?
  • If the price of doughnuts at Tim Horton’s goes down, will you stop more often to buy more coffee?
  • What if the price of gasoline goes up? How might that affect your demand for coffee?

All of these relationships are “complements.” That is, they go together. Think about what complementary goods you have for coffee.

Tastes

Tastes are pretty obvious when it comes to coffee; however, the word has a much larger meaning in this context. Economists use “tastes” to include everything from the taste of the coffee, itself, to one’s attitudes toward health risks (or benefits) to one’s religious beliefs if the religion bans caffeine or to one’s political beliefs (e.g., support for “fair trade” growing practices).

  • For example, if the Surgeon General announced that coffee drinking cures Athlete’s Foot, somebody might now be more willing to drink coffee than she was before. Notice that this doesn’t require that everybody make a change, it only means that this might be enough to affect the tastes of somebody.

Expectations

Expectations are key to understanding many of the concepts throughout this course.

All decisions are about things that haven’t happened yet; after all, if they already happened, they happened. That means that we’re constantly making decisions now about costs and benefits we expect in the future. These expectations may, of course, be informed by our experiences from the past; nevertheless, we’re not able to change the past, we can only go forward.

Let’s think about what this means in the context of coffee demand.

  • Suppose you believe that the price of coffee is going to go down next week. Will you stock up at the grocery store this week or will you buy just enough to get you through to next week? Does the fact that you expect prices to change somehow influence your buying behavior? If so, then you’ve experienced the expectations effect on demand.

What other expectations might be relevant?

Elasticity of Demand

“Elasticity” is a way of describing the responsiveness of one variable to another. What does that mean?

Let’s go back to our earlier discussion: just what is “coffee” to you? Is “coffee” anything that comes out of a package labeled “coffee” or do you define coffee more narrowly?

  • Option 1: Coffee is defined broadly. Then, if the price of Folger’s coffee goes up, you’ll easily switch to a cheaper brand — you just don’t care. In this case, demand for Folger’s coffee is said to be relatively elastic: a small change in price leads to a large change in quantity demanded.
  • If the price of all supermarket coffees goes up, will you buy less coffee? Or, if the price of tea goes up, will you drink more coffee? In this case, you’re probably less likely to change your coffee drinking as much — you’re demand for coffee is less elastic than your demand for Folger’s coffee.
  • Option 2: Coffee is defined very narrowly: If the only coffee I will drink in the afternoon is Green Mountain Vermont Country Blend Decaf (hey – it really does taste like coffee! and no, I don’t get a kickback), and if the price of it goes up a 15 cents a bag, how likely is it that I will switch to Folger’s decaf? Not very likely (I’d rather drink Poland Spring bottled water than Folger’s decaf). My demand for Green Mountain Vermont Country Blend Decaf is relatively inelastic; if the price goes up a bit, I’m not very likely to change my purchasing behavior. The result of this is that Green Mountain will get more total revenue from me.

So

  1. The more choices the consumer perceives and is willing to make, the greater the elasticity of demand; the fewer choices, the less the elasticity of demand.
  2. An elasticity greater than 1 (relatively elastic) means that the total revenues from an increase in price will fall; an elasticity less than 1 (relatively inelastic) means that the total revenues from an increase in price will rise. If you are a seller, this means that you will want to know whether elasticity of demand for your product at its current price is greater or less than 1 — if it is, you might increase your total revenue by changing the price!

Product differentiation

Before Starbuck’s came to town, most people were probably quite happy with an automatic drip coffee pot and a can of whatever was on sale that week. Some shoppers bought the supermarket generic while others switched between the popular brands. So how did Starbuck’s get people to pay (much) more for coffee? They differentiated their product by

  • Advertising
  • Offering discounts
  • Selling the brand
  • Selling specialty drinks that take special equipment and aren’t easy to make at home

For some people, they were successful — coffee was no longer a “commodity” (coffee is coffee); instead, Starbuck’s coffee was perceived as different and, therefore, worth the higher price.
Note: commoditization is the reverse: a product becomes “commoditized” when consumers no longer think it’s sufficiently different from other coffees to warrant the higher price.