Demand

The Demand Curve

The demand curve (or demand line, for simplification reasons, in this lesson) shows the relationship between price and quantity demanded:

• The definition of quantity demanded is the amount of a good that buyers are willing and able to purchase.
• One important determinant of quantity demanded is the price of the product.
  • Quantity demanded is negatively related to price. This implies that the demand curve is downward sloping. It should be noted that this negative link assumes that we hold all other variables constant, such as income, prices of related goods, and so on.
  • The definition of the law of demand: the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises.
• The definition of a demand schedule: a table that shows the relationship between the price of a good and the quantity demanded.

Example of Demand Schedule

Assume that you run a bakery shop and sell pastries. In Table 1.1, you can find the demand schedule for your pastries. It shows how many pastries people are willing to purchase at different price levels.

Table 1.1. Demand Schedule

Price of pastry	Quantity of pastries demanded
$0.00	24
$1.00	20
$2.00	16
$3.00	12
$4.00	8
$5.00	4
$6.00	0

The definition of demand curve: a graph of the relationship between the price of a good and the quantity demanded.

• Price is traditionally drawn on the vertical axis.
• Quantity demanded is represented on the horizontal axis.

Example of Demand Curve

The demand curve is drawn by plotting each of the points from the demand schedule like an (x, y) coordinate system (see Figure 1.1).

Market Demand Versus Individual Demand

• The market demand is the sum of all of the individual demands for a particular good or service.
• The demand curves are summed horizontally—meaning that the quantities demanded are added up for each level of price.
• The market demand curve shows how the total quantity demanded of a good varies with the price of the good, holding constant all other factors that affect how much consumers want to buy.

Shifts in the Demand Curve

First, please note the difference between a change in price (which causes a movement along the demand curve) and a change in another determinant (which shifts the demand curve). If the price of the product is the only changing determinant, this will lead to change in quantity demanded. In Figure 1.2, this is represented by a movement along the demand curve. If other determinants change, such as income, prices of related goods, and so on, this will lead to change in demand. In the figure, it is represented by shifts in the demand curve.

In Figure 1.2, assume that a market has been represented. S is the supply curve in the market and D1 (blue line) is the original demand curve. D2 (red line) represents a higher demand (D1 shifts to the right and becomes D2). D3 (black line) represents a lower demand (D1 shifts to the left and becomes D3).

• Because the market demand curve holds other things constant, it need not be stable over time. If any of the following factors, such as income, prices of related goods, and so on, change, the demand curve will shift.
  • An increase in demand is represented by a shift of the demand curve to the right.
  • A decrease in demand is represented by a shift of the demand curve to the left.
• Income
  • The relationship between income and quantity demanded depends on what type of good the product is. Higher income leads to higher demand for normal goods but lower demand for inferior goods. Oppositely, lower income leads to a lower demand for normal goods but a higher demand for inferior goods.
  • Definition of a normal good: a good for which, other things equal, an increase in income leads to an increase in demand. For example, clothes are a normal good. As income levels rise, people spend more money on clothes.
  • Definition of an inferior good: a good for which, other things equal, an increase in income leads to a decrease in demand. For example, noodles can be considered an inferior good. Because noodles are a cheap product, the demand for noodles gets higher when income gets lower.
• Prices of related goods
  • Definition of substitutes: two goods for which an increase in the price of one good leads to an increase in the demand for the other. For example, apples and oranges can be considered substitute products because one fruit can be consumed instead of the other fruit.
  • Definition of complements: two goods for which an increase in the price of one good leads to a decrease in the demand for the other. For example, coffee and milk can be considered complementary products because they are mostly consumed together.
• Consumer preference: If any product is preferred more, it will increase the demand for that product.
• Expectations:
  • Future income: Higher future income tends to increase the current demand for normal goods and services.
  • Future prices: Higher future prices tend to increase the current demand for goods and services because consumers prefer purchasing goods and services when they are cheap now.
• Number of buyers: Increasing population raises the demand for goods and services.

The Demand Function

The demand function for Good X is a mathematical representation describing how many units will be purchased at different prices for X, the price of a related Good Y, income, and other factors that affect the demand for Good X.

One simple but useful representation of a demand function is the linear demand function:

$Q{x}^d={\alpha }_O+{\alpha }_X{P}_X+{\alpha }_Y{P}_Y+{\alpha }_{M}M+{\alpha }_{H}H$

where

• Q_X^d is the number of units of Good X demanded;
• P_X is the price of Good X;
• P_Y is the price of a related Good Y;
• M is the income; and
• H is the value of any other affecting demand.

The signs and magnitude of the $\alpha$ coefficients determine the impact of each variable on the number of units of X demanded:

$Q{x}^d={\alpha }_O+{\alpha }_X{P}_X+{\alpha }_Y{P}_Y+{\alpha }_{M}M$

For example:

• ${\alpha }_X<0$ by the law of demand; ${\alpha }_X=\frac{\text{Change in }}{Q_X^d}$
• ${\alpha }_Y>0$ if Good Y is a substitute for Good X
• ${\alpha }_Y<0$ if Good Y is a complement for Good X
• ${\alpha }_M<0$ if Good X is an inferior good
• ${\alpha }_M>0$ if Good X is a normal good