okay and what we want to do in this video is give a rather technical analysis and an explanation start our three-step explanation for the reason that the demand curve slopes downwards okay now what we are talking about here is very very important to understand and as i've already just said it does get technical but i think if we break it down into step-by-step bits it'll become far more understandable and remember in economics understanding is the most important thing so the question that we're asking is why does the demand curve slope downwards and i will give a bit of a preamble here why does the law of demand exist what happens to consumers following a price change that will cause them as a result of that price change to change the amount of the good that they actually buy so when looking at this we're going to look at the definition of a demand curve which is taken by the from the glossary okay so this is word perfect and you've got to learn this all forward perfect the demand curve shows the relationship between the price of a good or service and the quantity demanded it is normally downward sloping so when we're talking about demand or any factor in economics we know that the term citrus paribus is very important and again another definition from the ib glossary that must be learned off word perfect is ceteris paribus is a latin expression meaning other things equal so all we are saying here is thus that only the price has changed and remember that the price must have changed in order to explain a downward sloping demand curve okay so we're only saying the price has changed and nothing else we're holding that um equal so this brings us on to the law of demand and the law of demand as states that as the price of a good falls the quantity demanded will normally increase and it is it's not a physics law it's a an economics law people aren't always um rational and there are other reasons that people for let's say goods of ostentation that as their price rises for conspicuous consumption people might say oh they become even more exclusive so i'm going to buy more of them to impress other people right but for the moment we're explaining and talking about goods that obey the law of demand and hence why does the demand curve slope downwards so when the price of a good or service rises the quantity demanded of that good or service falls and when the price of a good or service falls the quantity demanded of that good or service rises now i will just for the sake of completeness reiterate that the only thing that is changing is price but price must have changed okay just please please please because there's no law of demand unless there's a change in price so right now as i said price hasn't changed we're starting off with p1 we've got q1 and there's no law of demand being shown here now what we're saying is the price has been reduced to p2 we go out to the demand curve and touch it go down and we get q2 now the thing here is there has been a movement and the movement is only ever caused by a change in price and where is the movement well the movement has happened from here down the existing non-changing demand curve down to this second point here that's related to p2 so what we see is that as price falls quantity demanded increases no problem again there must have been a change in price in order for the demand the law of demand excuse me to be evident so what we've got here is a movement up the existing demand curve ceteris paribus everything else is remaining equal we know that a movement is only caused by a change in price and we're moving up the existing demand curve from this point here to this point here following a price increase um people buy less of this good or an individual consumer or a market in general by less of this good and we're asking why now so we've already talked about the demand curve and we said that the low demand tells us the quantity demanded depends on the price a change in price okay so when the price of a good changes this is known as a movement and only a change in price can cause a movement now that's from previous videos now we're getting into the nitty-gritty and we're only going to talk about one of these three things in this video and in the next two videos we're going to talk about the other two today we are only or in this video at least we're only talking about the income effect okay so let's have a look at this so the first thing is the there is an effect on your income well is there yes and no so like in in in everything in economics the answer always depends so what we're going to do is we're going to split income into two separate ideas one is called nominal income which i'll explain in a second and the other one is called real income now nominal or money income you'll you'll hear me um use those interchangeably okay so nominal income or money income refers to income in terms of currency so as i said i'm irish we use the euro so a an example is i earn 500 euro a week okay now real income is the purchasing power of money income now this is very important because and i'll come to this again later because i'd like to repeat myself over and over again nominal income only depends on how much money okay that you earn in a week it doesn't care about prices whereas real income takes both into account all right so real income means how much you can buy for a euro or 500 euro whatever it is you're earning and that's what we mean by purchasing power okay so money income is measured in currency so we've got euros we've got british pounds we've got um us dollars japanese yen and so on so forth mongolian target all that kind of stuff right so real income so let's say we're in a thousand euro that's your money income real earned income tells you how much stuff you can buy with that 1000 euro that you earn and think about this we're trying to talk about changes in price so do changes in price affect your real income absolutely they do okay now this is a long definition but must be learned off the income effect which is the first of three reasons why the demand curve slopes downwards is defined thusly when a decrease in the price of a good or service that is being consumed means that consumers experience an increase in real income usually allowing them to purchase more of the product and then the income effect can be negative now we're going to ignore that because it's not important or relevant to our course but all we're saying is that um as the price rises you may buy more of a good but we're not talking about those in general not today anyway not in this video so in a a very simple economy we assume workers earns euros and there's only one good produced and they are big macs okay so worker earns 500 euros per week and the price of big macs is five euro each the question is well there's two one calculate this consumer's nominal income and then secondly calculate this consumer's real income now the thing is the first question is not even a trick question it's just the nominal income is measured in terms of currency so they earn 500 euro a week so that's that's that's his or her real income right excuse me that's his or her nominal income now the real income is calculated by dividing the the money income the nominal income by the price so it's 500 euro divided by five euro which is 100 big max now just to kind of get into a little bit here about the the difference in economics between nominal and real real measures quantity of stuff so that's why we call this your real income because you can afford in this very simple example 100 big macs a week all right so that's why we're talking about real it's stuff so if prices doubled and the the nominal income doubled your real income would not change because real income measures how much stuff you can buy okay so please keep that in mind now what i'd ask you to do now is based on the strength of the previous example pause this video uh try and answer these questions and once you have these questions answered then press play and let's see how you do okay well i hope you've had a chance to do that so what we're trying to do now is calculate the real income for each of the following so the nominal or money income for person one in this case here they earn 200 euro and the price of pizzas is 10 euros each so to find the real income it's 20 pizzas now how do we get that 200 divided by 10 is 20. right a person earns 500 euro on the price of pizzas is 10 euro each so therefore what's their real income right well their real income is their nominal income divided by the the price and when we get to macro economics which we're not doing now we'll talk about general prices or the average price level but right now we're just talking about the price of pizzas so we're saying that this person real income is 50 pizzas a week a person earns 350 euro the price of pizzas is 15 we're saying 23 and a third pizzas i don't even know if you can buy a third of a pizza but this is just for illustrative purposes uh for question four a person earns 525 and the price of pizza is 15 it's 35 pizzas now how do we get this again just to stress we're dividing their nominal income by the price to find their real income how much stuff can their nominal income purchase which depends on the price please keep that in mind and a person earns 805 and pizzas are 17.50 a week or 1750 each and it's 46 pizzas what we have done is calculated uh their real income okay so please keep that in mind now just again to kind of finish well let's not finish it off but to finish off our initial analysis in this video money or nominal income is only affected by the amount of currency you receive per time period even if you want right if you get a raise your money income rises if you get a pay reduction your money income has fallen your nominal income has fallen money income equals nominal income they're the same thing real income depends on two things firstly yes it absolutely depends on your money income on your nominal income how much currency you are getting each month week time period whatever but secondly it also depends on the price of the good and this is how now we're leading in to the income effect and why the demand curve slopes downwards if your money income rises and prices don't change your real income has also increased if your money or nominal income falls and prices don't change or the price the good doesn't change your real income has also fallen right but now let's look at the the other side of that if your money income stays the same or your nominal income stays the same but prices increase you are now poorer in real terms you can afford to buy less please please please understand that okay your your nominal income hasn't changed but the amount that you can afford to buy following a rise in price that has made you poorer in real terms if your money income stays the same but the price of this good let's say falls whatever it is your real income has risen you can afford to buy more so the the last bit of the setup of this video is this okay so state whether a person is richer or poorer in real terms after each of the following changes so what i'd ask you to do again is to pause the video read through sections one to eight and then once you think you have your answers press play and we'll go through and see how you did okay well hopefully you've had a chance to do that so in the first one your income rises and prices stay the same well you have become richer in real terms you're getting more money income and the prices have not changed so you can afford to buy more stuff more real physical tangible stuff or more services income falls and prices stay the same well unfortunately you are poorer okay because your income has fallen and the prices haven't changed so therefore that reduced income given the same constant existing prices means that you can buy less stuff your income stays the same and prices rise you are poorer because you can afford to buy less stuff your income stays the same and price is full you're richer because you can afford to buy more stuff incomes rise and prices full you were richer that's the perfect situation is exactly what you want income falls and price rise on that's the worst situation you are definitely for now for the last two it's a bit of a cheeky one all i'm just trying to do is get you to think because your income rise and prices rise it depends on which has risen by the greater uh proportion or degree and your income falls and prices fall again it depends on which uh whether it's your income or prices have fallen by the greater proportionate degree now now what we're going to do is taking all of our knowledge of the effect of changes of prices now only on your real income we're going to extrapolate or kind of prove or show how that makes the demand curve slope downwards okay so the first thing here is the initial income is 200 euro that's your nominal income absolutely fantastic we're assuming that remains constant that isn't changing okay what we have now is the price of this good one particular good whatever it is let's make it pizzas okay is 10 euro right so the first thing is and we haven't even gone out to the demand curve but we know there's no proof of any low demand yet okay we go out to the demand curve and go down that means that we can afford 20 pizzas at the very least we can afford it okay now obviously a demand curve is how much you buy so this is the only good in the economy so that's all we care about buying is 20 uh pizzas so at a price of 10 with a nominal income of 20 we're going to buy 20 pizzas now let's say the price i'm sorry so that's just there writing that bit there now let's say the price falls to five well the first thing is what has happened to our real income our real income has risen we can now afford to buy more our nominal income has stayed the same not changed at all still 200 but now because we can afford to buy more there's this is the only good in the economy the only game in town so now we buy 40 pizzas and how do we do that i see what we're saying here is at the new lower price of five euro each i can now afford 200 divided by five which is 40 units in this case we're going to say 40 pizzas what has happened is thusly and i'm going to do it on its own separate diagram the price has fallen the law of demand is kicked in but why why why why well the first part of the thinking is the income effect is one-third of it and we're explaining that now the good has become cheaper that means that i can afford more i'm richer in real terms so i buy more now that is the income effect the good has become cheaper my income has stayed the same ceteris paribus um i can afford more i'm richer in real terms and who buys more will rich people buy more okay now just to kind of labor the point i suppose again what we're having is initial income of 200 euro the starting price is five euros so we're saying okay how much of this good is they gonna buy are we gonna save 40 units now i understand that well they don't have to i get that but just for the sake illustrative purposes we're trying to they don't have to buy 40 units i mean they could save i understand that but we're just trying to make this obvious so what we're saying is now prices have risen to 10. so how much of this good are they going to buy well at the very least they can afford to buy less now because their 200 euro is not going to buy as many pizzas at a higher price of 10 than i would have bought at the lower price of five so at the new higher price of 10 euro each i can now afford 20 units because of the change in my real income following a price increase i am now poorer in real terms and as such i buy less that is explaining the law of demand right so now just one last bit here for the the general point as the price of a good rises well what happens well one third of the reason why the demand curve is downward sloping whether it's a price rise or price full is the income effect following a price rise in this case what we see is the good has become more expensive that means i can afford less i am poorer in real terms so i buy less now that is the income effect so what is it it is the change in your real income caused by a change in price and that's the jt definition you obviously don't write that down you write down what i i put in the the glossary previously but basically what it is saying is that a change in price affects your real income the purchasing power of the money that you get in on a per time period basis and if that is affected which it is by a change in price as the price of the good falls you are richer in real terms and therefore who buys more richer or poor people will rich people buy more as the price rises you are poorer in real terms and as such you buy less because who buys less richer or poorer people while poorer people unfortunately buy less now guys i really hope that helps that's the first of three videos today on explaining why the demand curve slopes downwards and that is the income effect thank you so so much for watching guys um i really really appreciate it and i hope to see in the next video