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Demand
Definition of Demand:
Demand is a relation that shows the quantities that buyers are willing and able to
purchase at alternative prices during a given time period, all other things remaining the
same.
How to Graph a Demand Schedule:
See the Practical #4A Help Sheet for instructions and examples on graphing a demand
schedule.
Law of Demand:
The law of demand states that as the price of a good increases that you will buy less of
it and as the price of the good decreases that you will buy more of it, all other things
remaining the same.
Justification for the Law of Demand:
There are two reasons for the law of demand. Consider why you would buy more of a
good as the good’s price is lowered, all other things remaining the same.
1. When the price of the good is decreased, you can afford to buy more of it. For
instance, if the price of shrimp falls by 50% you will probably eat more shrimp since
you can afford to buy more shrimp. This effect is known as the income effect.
2. When the price of a good is decreased, you will probably buy more of it since it is a
better bargain relative to other goods. For instance, if the price of shrimp falls by 50%
you will probably eat more shrimp since shrimp is a better bargain relative to fish and
oysters. This effect is known as the substitution effect.
Two Kinds of Changes Involving Demand:
1. Change in the Quantity Demanded. Movement along a demand curve is
called a change in the quantity demanded. A change in the quantity demanded of a
good is due to a change in the price of the good.
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Change in Quantity Demanded
25
A
Price
20
15
B
10
5
0
0
2
4
6
Quantity
8
10
12
Let the price of the good fall from $20 to $10. This will cause the quantity demanded
to increase from 4 units to 8 units or movement from point A to point B.
2. Change In Demand. Movement from one demand curve to another is called a
change in demand:
Change in Demand
30
New Demand
25
Price
20
15
10
5
Initial Demand
0
0
2
4
6
8
Quantity
10
12
14
3
An increase in demand is a shift of the demand curve to the right (e.g. from the initial
demand curve to the new demand curve). It means that consumers are willing to
purchase a greater quantity of goods at every price level. For instance, consumers
were willing to purchase 8 units of goods at a price of $10 before the shift but are
willing to purchase 12 units of goods at $10 after the shift.
A decrease in demand is a shift of the demand curve to the left (e.g. from the new
demand curve to the initial demand curve). It means that consumers are willing to
purchase a smaller quantity of goods at every price level. For instance, consumers
were willing to purchase 10 units of goods at a price of $15 before the shift but are
willing to purchase 6 units of goods at $15 after the shift.
Factors that Cause a Change in Demand:
1. Income. A change in income will cause a change in demand. The direction in
which a demand curve shifts in response to a change in income depends on the type of
good represented by the demand curve. There are two types of goods:
i) Normal Good. A normal good is one in which the quantity demanded at any price
increases with income. This means that an increase in income will shift the demand
curve for a normal good to the right.
ii) Inferior Good. An inferior good is one in which the quantity demanded at any
price decreases with income. This means that an increase in income will shift the
demand curve for an inferior good to the left.
2. Tastes and Preferences. An increase in the preference or taste for a good will
shift the demand curve for the good to the right. A decrease in the preference or taste
for a good will shift the demand curve for the good to the left.
3. Prices of Substitutes and Complements.
i) Substitutes are goods that can replace each other in consumption. They are related
such that an increase in the price of one good will cause an increase in the demand for
the other good. Examples of substitutes include butter and margarine and coffee and
tea.
ii) Complements are goods that are jointly consumed. They are related such that an
increase in the price of one good will cause an decrease in the demand for the other
good. Examples of complements include lamps and light bulbs and milk and cereal.
4. Expectations About the Future. Expectations about future income and prices
can shift the demand curve. For example, someone who expects higher income or
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prices in the future will probably buy more goods today. In this case, the demand
curve will shift to the right.
5. Population. An increase in the population causes a greater quantity of goods to
be demanded at every price level. This causes the demand curve to shift to the right.
Equilibrium Price and Quantity, Surpluses, and Shortages :
Shortages and Surpluses
30
Supply
25
Surplus
Price
20
Equilibrium
15
10
Shortage
5
Demand
0
0
2
4
6
Quantity
8
10
12
The equilibrium price and quantity are determined by the intersection of the demand
and supply curves. The equilibrium price is the level at which the quantity demanded
equals the quantity supplied. In other words, consumers are willing to buy the
quantity of goods supplied by producers at the equilibrium price. In the graph, the
equilibrium price is $15.00 and the equilibrium quantity is 6 units.
A surplus is a condition in which the quantity of goods offered by producers exceeds
the quantity of goods demanded by consumers at the existing price. It is obtained
when the price of a good is greater than the equilibrium price. A price floor, which is
a price set and maintained by the government to artificially raise prices, will cause a
surplus. In the graph, a surplus of 4 units (8 - 4 = 4) is obtained when the price is $20.
A surplus is eliminated if the price drops to the equilibrium price level.
A shortage is a condition in which the quantity of goods offered by producers is less
than the quantity of goods demanded by consumers at the existing price. It is obtained
when the price of a good is less than the equilibrium price. A price ceiling, which is a
price set and maintained by the government to artificially lower prices, will cause a
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shortage. In the graph, a shortage of 4 units (8 - 4 = 4) is obtained when the price is
$10. A shortage is eliminated if the price increases to the equilibrium price level.