2.4: Demand
What you’ll learn to do: explain the law of demand
Imagine that the price of Ben & Jerry’s ice cream decreases by 25 percent during the next summer. What do you think will happen to the amount of Ben & Jerry’s ice cream that people will want to buy? Clearly, the demand for ice cream will increase. By the same token, if the price of the ice cream were to rise by 25 percent, then the demand for the ice cream would fall. In this section, you will examine the law of demand and see why this simple concept is essential to understanding economics.
Learning Objectives
- Explain a demand curve
- Explain the factors that can change demand
The Law of Demand
Demand describes the amount of goods or services that consumers want to (and are able to) pay to purchase that good or service. Before learning more about the details of demand, watch this video to get a basic understanding about what it is and its importance to understanding economic behavior.
The law of demand states that, other things being equal,
- More of a good will be bought the lower its price
- Less of a good will be bought the higher its price
Ceteris paribus means “other things being equal.”
Demand for Goods and Services
Economists use the term demand to refer to the amount of some good or service consumers are willing and able to purchase at each price. Demand is based on needs and wants—a consumer may be able to differentiate between a need and a want, but from an economist’s perspective, they are the same thing. Demand is also based on ability to pay. If you can’t pay for it, you have no effective demand.
What a buyer pays for a unit of the specific good or service is called the price . The total number of units purchased at that price is called the quantity demanded . A rise in the price of a good or service almost always decreases the quantity of that good or service demanded. Conversely, a fall in price will increase the quantity demanded. When the price of a gallon of gasoline goes up, for example, people look for ways to reduce their consumption by combining several errands, commuting by carpool or mass transit, or taking weekend or vacation trips closer to home. Economists call this inverse relationship between price and quantity demanded the law of demand. The law of demand assumes that all other variables that affect demand are held constant.
An example from the market for gasoline can be shown in the form of a table or a graph. (Refer back to “Reading: Creating and Interpreting Graphs” in module 0 if you need a refresher on graphs.) A table that shows the quantity demanded at each price, such as Table 1, is called a demand schedule . Price in this case is measured in dollars per gallon of gasoline. The quantity demanded is measured in millions of gallons over some time period (for example, per day or per year) and over some geographic area (like a state or a country).
| Table \(\PageIndex{1}\). Price and Quantity Demanded of Gasoline | |
|---|---|
| Price (per gallon) | Quantity Demanded (millions of gallons) |
| $1.00 | 800 |
| $1.20 | 700 |
| $1.40 | 600 |
| $1.60 | 550 |
| $1.80 | 500 |
| $2.00 | 460 |
| $2.20 | 420 |
A demand curve shows the relationship between price and quantity demanded on a graph like Figure 1, below, with quantity on the horizontal axis and the price per gallon on the vertical axis. Note that this is an exception to the normal rule in mathematics that the independent variable (x) goes on the horizontal axis and the dependent variable (y) goes on the vertical. Economics is different from math! Note also that each point on the demand curve comes from one row in Table \(\PageIndex{1}\). For example, the upper most point on the demand curve corresponds to the last row in Table \(\PageIndex{1}\), while the lower most point corresponds to the first row.
Figure \(PageIndex{1}\). A Demand Curve for Gasoline (derived from the data in Table \(\PageIndex{1}\).
The demand schedule (Table \(\PageIndex{1}\) shows that as price rises, quantity demanded decreases, and vice versa. These points can then be graphed, and the line connecting them is the demand curve (shown by line D in the graph, above). The downward slope of the demand curve again illustrates the law of demand—the inverse relationship between prices and quantity demanded.
The demand schedule shown by Table \(\PageIndex{1}\) and the demand curve shown by the graph in Figure \(|PageIndex{1}\) are two ways of describing the same relationship between price and quantity demanded.
Demand curves will look somewhat different for each product. They may appear relatively steep or flat, or they may be straight or curved. Nearly all demand curves share the fundamental similarity that they slope down from left to right. In this way, demand curves embody the law of demand: As the price increases, the quantity demanded decreases, and conversely, as the price decreases, the quantity demanded increases.
practice question \(\PageIndex{1}\)
Which of the following demand curve for tomatoes violates the law of demand?
Answer
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b is the answer because as the price drops from $4 to $3 the quantity demanded is shown to fall, which is not consistent with the law of demand.
practice question \(\PageIndex{2}\)
You are given the following demand schedule for used cars. Which of the following demand curves accurately represents this demand schedule and has proper formatting?
The demand schedule for used cars:
| Price ($) | Quantity Demanded |
| 1000 | 7600 |
| 2000 | 6500 |
| 3000 | 5400 |
| 4000 | 4300 |
| 5000 | 3200 |
| 6000 | 2100 |
| 7000 | 1000 |
| 8000 | 300 |
Answer
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b is correct - Price is displayed on the vertical axis, quantity on the horizontal, and all points are faithfully plotted according to the demand schedule.
demand vs. quantity demand
I n economic terminology, demand is not the same as quantity demanded . When economists talk about demand, they mean the relationship between a range of prices and the quantities demanded at those prices, as illustrated by a demand curve or a demand schedule. When economists talk about quantity demanded, they mean only a certain point on the demand curve, or one quantity on the demand schedule. In short, demand refers to the curve and quantity demanded refers to the (specific) point on the curve.
Change in Demand vs. Change in Quantity Demanded
It’s hard to overstate the importance of understanding the difference between shifts in curves and movements along curves. Remember, when we talk about changes in demand or supply, we do not mean the same thing as changes in quantity demanded or quantity supplied .
A change in demand refers to a shift in the entire demand curve, which is caused by a variety of factors (preferences, income, prices of substitutes and complements, expectations, population, etc.). In this case, the entire demand curve moves left or right.
A change in quantity demanded refers to a movement along the demand curve, which is caused only by a chance in price. In this case, the demand curve doesn’t move; rather, we move along the existing demand curve.
Factors Affecting Demand
We defined demand as the amount of some product that a consumer is willing and able to purchase at each price . This suggests at least two factors, in addition to price, that affect demand. “Willingness to purchase” suggests a desire to buy, and it depends on what economists call tastes and preferences. If you neither need nor want something, you won’t be willing to buy it. “Ability to purchase” suggests that income is important. Professors are usually able to afford better housing and transportation than students, because they have more income. The prices of related goods can also affect demand. If you need a new car, for example, the price of a Honda may affect your demand for a Ford. Finally, the size or composition of the population can affect demand. The more children a family has, the greater their demand for clothing. The more driving-age children a family has, the greater their demand for car insurance and the less for diapers and baby formula.
These factors matter both for demand by an individual and demand by the market as a whole. Exactly how do these various factors affect demand, and how do we show the effects graphically? To answer those questions, we need the ceteris paribus assumption.
The Ceteris Paribus Assumption
A demand curve or a supply curve (which we’ll cover later in this module) is a relationship between two, and only two, variables: quantity on the horizontal axis and price on the vertical axis. The assumption behind a demand curve or a supply curve is that no relevant economic factors, other than the product’s price, are changing. Economists call this assumption ceteris paribus , a Latin phrase meaning “other things being equal.” Any given demand or supply curve is based on the ceteris paribus assumption that all else is held equal. (You’ll recall that economists use the ceteris paribus assumption to simplify the focus of analysis.) Therefore, a demand curve or a supply curve is a relationship between two, and only two, variables when all other variables are held equal . If all else is not held equal, then the laws of supply and demand will not necessarily hold.
Ceteris paribus is typically applied when we look at how changes in price affect demand or supply, but ceteris paribus can also be applied more generally. In the real world, demand and supply depend on more factors than just price. For example, a consumer’s demand depends on income, and a producer’s supply depends on the cost of producing the product. How can we analyze the effect on demand or supply if multiple factors are changing at the same time—say price rises and income falls? The answer is that we examine the changes one at a time, and assume that the other factors are held constant.
For example, we can say that an increase in the price reduces the amount consumers will buy (assuming income, and anything else that affects demand, is unchanged). Additionally, a decrease in income reduces the amount consumers can afford to buy (assuming price, and anything else that affects demand, is unchanged). This is what the ceteris paribus assumption really means. In this particular case, after we analyze each factor separately, we can combine the results. The amount consumers buy falls for two reasons: first because of the higher price and second because of the lower income.
practice question \(\PageIndex{3}\)
Below is the demand curve for oranges in a Florida supermarket. Select the demand schedule that best corresponds to this demand curve.
-
Demand Schedule for Oranges Quantity (thousands) Price (per pound) 8 $10 7 $9 6 $8 5 $7 4 $6 3 $5 2 $4 1 $3 -
Demand Schedule for Oranges Quantity (thousands) Price (per pound) 1 $20 2 $18 3 $16 4 $14 5 $12 6 $10 7 $8 8 $6 -
Demand Schedule for Oranges Quantity (thousands) Price (per pound) 1 $10 2 $9 3 $8 4 $7 5 $6 6 $5 7 $4 8 $3
- Answer
-
C.
practice question \(\PageIndex{4}\)
You are the chief data analyst of the U.S. Fish and Wildlife Service for the Northeast region. Recently the agency has become concerned about overfishing in the North Atlantic fisheries, and you are charged with estimating the demand curve for tuna as part of the agency’s mitigation efforts.
From public surveys you know that when the price of a freshly caught tuna is $400, the public will demand a quantity of 1 million fish. If the price is $275 then the public will demand 4 million fish. Finally, if the price was $185 consumers will demand a quantity of 8 million fish.
Which curve below could be the correct demand curve for North Atlantic tuna given these three data points?
- the blue curve
- the silver curve
- the orange curve
Answer
-
A is correct - only the blue curve passes through all three data points given
The Effect of Income on Demand
Let’s use income as an example of how factors other than price affect demand. Figure 4 shows the initial demand for automobiles as D0. At point Q, for example, if the price is $20,000 per car, the quantity of cars demanded is 18 million. D0 also shows how the quantity of cars demanded would change as a result of a higher or lower price. For example, if the price of a car rose to $22,000, the quantity demanded would decrease to 17 million, at point R.
The original demand curve D0, like every demand curve, is based on the ceteris paribus assumption that no other economically relevant factors change. Now imagine that the economy expands in a way that raises the incomes of many people, making cars more affordable. How will this affect demand? How can we show this graphically?
Return to Figure \(\PageIndex{1}\). The price of cars is still $20,000, but with higher incomes, the quantity demanded has now increased to 20 million cars, shown at point S. As a result of the higher income levels, the demand curve shifts to the right to the new demand curve D1, indicating an increase in demand. Table \(\PageIndex{1}\), below, shows clearly that this increased demand would occur at every price, not just the original one.
| Price | Decrease to D 2 | Original Quantity Demanded D 0 | Increase to D 1 |
|---|---|---|---|
| $16,000 | 17.6 million | 22.0 million | 24.0 million |
| $18,000 | 16.0 million | 20.0 million | 22.0 million |
| $20,000 | 14.4 million | 18.0 million | 20.0 million |
| $22,000 | 13.6 million | 17.0 million | 19.0 million |
| $24,000 | 13.2 million | 16.5 million | 18.5 million |
| $26,000 | 12.8 million | 16.0 million | 18.0 million |
Now, imagine that the economy slows down so that many people lose their jobs or work fewer hours, reducing their incomes. In this case, the decrease in income would lead to a lower quantity of cars demanded at every given price, and the original demand curve D 0 would shift left to D 2 . The shift from D 0 to D 2 represents such a decrease in demand: At any given price level, the quantity demanded is now lower. In this example, a price of $20,000 means 18 million cars sold along the original demand curve, but only 14.4 million sold after demand fell.
When a demand curve shifts, it does not mean that the quantity demanded by every individual buyer changes by the same amount. In this example, not everyone would have higher or lower income and not everyone would buy or not buy an additional car. Instead, a shift in a demand curve captures a pattern for the market as a whole: Increased demand means that at every given price, the quantity demanded is higher, so that the demand curve shifts to the right from D 0 to D 1 . And, decreased demand means that at every given price, the quantity demanded is lower, so that the demand curve shifts to the left from D 0 to D 2 .
We just argued that higher income causes greater demand at every price. This is true for most goods and services. For some—luxury cars, vacations in Europe, and fine jewelry—the effect of a rise in income can be especially pronounced. A product whose demand rises when income rises, and vice versa, is called a normal good . A few exceptions to this pattern do exist, however. As incomes rise, many people will buy fewer generic-brand groceries and more name-brand groceries. They are less likely to buy used cars and more likely to buy new cars. They will be less likely to rent an apartment and more likely to own a home, and so on. A product whose demand falls when income rises, and vice versa, is called an inferior good . In other words, when income increases, the demand curve shifts to the left.
practice question \(\PageIndex{5}\)
Alexis owns a small business selling power tools. This past month she has noticed that the quantity demanded for high-end electric drills has decreased by 25%. Which of the following demand curve shifting events is a possible explanation for this change?
- The price of electric drills has increased.
- Customers' incomes have decreased.
- Customers' incomes have increased.
- Answer
-
b is correct - Falling incomes would lead to a leftward shift of the demand curve causing less quantity demanded at any given price.
a is incorrect - While this would explain the decrease in quantity demanded, it will not have occurred because of a shift in the demand curve, rather movement along the existing curve.
c is incorrect - This would cause an increase in quantity demanded at any given price level rather than a decrease.
practice question \(\PageIndex{6}\)
Over the past century the quantity of potatoes purchased by Irish consumers has fallen significantly, while incomes have grown exponentially. Meanwhile potatoes are still the cheapest source of calories available to the consumer. From this information it would be correct to assume that potatoes are a(n) ________ good.
- essential
- normal
- inferior
- Answer
-
c is correct - An inverse relationship between demand and incomes in the hallmark of an inferior good.
a is incorrect - Whether a good is 'essential' or not has no bearing on the evidence presented.
b is incorrect - We would expect to see demand increases as incomes rose if potatoes are a normal good.
Other Factors That Shift Demand Curves
Income is not the only factor that causes a shift in demand. Other things that change demand include tastes and preferences, the composition or size of the population, the prices of related goods, and even expectations. A change in any one of the underlying factors that determine what quantity people are willing to buy at a given price will cause a shift in demand. Graphically, the new demand curve lies either to the right (an increase) or to the left (a decrease) of the original demand curve. Let’s look at these factors.
Changing Tastes or Preferences
Changes in the Composition of the Population
The proportion of elderly citizens in the United States population is rising. It rose from 9.8 percent in 1970 to 12.6 percent in 2000 and will be a projected (by the U.S. Census Bureau) 20 percent of the population by 2030. A society with relatively more children, like the United States in the 1960s, will have greater demand for goods and services like tricycles and day care facilities. A society with relatively more elderly persons, as the United States is projected to have by 2030, has a higher demand for nursing homes and hearing aids. Similarly, changes in the size of the population can affect the demand for housing and many other goods. Each of these changes in demand will be shown as a shift in the demand curve.
Changes in the Prices of Related Goods
The demand for a product can also be affected by changes in the prices of related goods such as substitutes or complements. A substitute is a good or service that can be used in place of another good or service. As electronic books, like this one, become more available, you would expect to see a decrease in demand for traditional printed books. A lower price for a substitute decreases demand for the other product. For example, in recent years as the price of tablet computers has fallen, the quantity demanded has increased (because of the law of demand). Since people are purchasing tablets, there has been a decrease in demand for laptops, which can be shown graphically as a leftward shift in the demand curve for laptops. A higher price for a substitute good has the reverse effect.
Other goods are complements for each other, meaning that the goods are often used together, because consumption of one good tends to enhance consumption of the other. Examples include breakfast cereal and milk; notebooks and pens or pencils, golf balls and golf clubs; gasoline and sport utility vehicles; and the five-way combination of bacon, lettuce, tomato, mayonnaise, and bread. If the price of golf clubs rises, since the quantity of golf clubs demanded falls (because of the law of demand), demand for a complement good like golf balls decreases, too. Similarly, a higher price for skis would shift the demand curve for a complement good like ski resort trips to the left, while a lower price for a complement has the reverse effect.
Changes in Expectations About Future Prices or Other Factors That Affect Demand
While it is clear that the price of a good affects the quantity demanded, it is also true that expectations about the future price (or expectations about tastes and preferences, income, and so on) can affect demand. For example, if people hear that a hurricane is coming, they may rush to the store to buy flashlight batteries and bottled water. If people learn that the price of a good like coffee is likely to rise in the future, they may head for the store to stock up on coffee now. These changes in demand are shown as shifts in the curve. Therefore, a shift in demand happens when a change in some economic factor (other than the current price) causes a different quantity to be demanded at every price.
practice question \(\PageIndex{7}\)
Natalie runs a fast food stand selling hot dogs and soft drinks. A decrease in the price of which good below is likely to negatively impact her bottom line?
- hamburgers
- t-shirts
- mustard
- Answer
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a is correct - Hamburgers and hot dogs are likely to be substitutes, so if the price of hamburgers falls this will likely shift the demand curve for hot dogs to the left, decreasing her sales of hot dogs.
practice question \(\PageIndex{8}\)
Over the past 10 years consumer incomes have grown by 15%, while the price of automobiles has increased by over 20%. Tires and automobiles are complement goods. What would be a reasonable expectation regarding the demand for tires today compared to 10 years ago?
- The demand for tires will shift to the left because the price of the complement good-automobiles-has increased
- The demand for tires will shift to the right because of the income effect.
- It is impossible to know with the given information
- Answer
-
c is correct - The income effect will increase demand for tires, while the increase in the price of automobiles will decrease demand. It is impossible to know at the present time which effect is strong.
a is incorrect - While increasing the price of a complement good would decrease demand for tires, the impact of income on tires and automobiles must also be considered.
b is incorrect - While the income effect is likely to increase demand for automobiles and therefore tires, the effect of a price increase for the complement good automobiles must also be considered.
Summary
Six factors that can shift demand curves are summarized in Figure \(\PageIndex{5}\), below. The direction of the arrows indicates whether the demand curve shifts represent an increase in demand or a decrease in demand. Notice that a change in the price of the good or service itself is not listed among the factors that can shift a demand curve. A change in the price of a good or service causes a movement along a specific demand curve, and it typically leads to some change in the quantity demanded, but it does not shift the demand curve.
practice question \(\PageIndex{9}\)
You are a consultant analyzing the American car market for the new Toyota Prius. Your chief competitor Tesla has recently dropped the list price of their vehicles by 20%. When illustrating shifts of the demand curve it is customary to draw arrows to show the direction of change. Which directions should the arrows be drawn in the graph below? Which curve represents old demand and which curve the new demand?
- The arrows should be drawn pointing leftwards. The curve on the right represents the new demand and the curve on the left old demand.
- The arrows should be drawn pointing rightwards. The curve on the right represents new demand and the curve on the left old demand.
- The arrows should be drawn pointing leftwards. The curve on the right represents the old demand and the curve on the left new demand.
- Answer
-
C
practice question \(\PageIndex{10}\)
You are in charge of data analytics for Home Depot’s South Florida division. Recently you have observed a change in the market for power generators illustrated below. Which explanation best corresponds with the observed data?
- The price of a competitor's generators has fallen.
- The price of Home Depot generators has dropped 20%.
- A hurricane is expected to arrive next week.
Answer
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c is correct - Expectations of an impending storm are likely to increase short-run demand, which is consistent with what we observe in the demand curves here.
a is incorrect - A drop in the price of substituted goods will cause a leftward shift of the demand curve.
b is incorrect - A price change would cause a movement along the demand curve, not a shift in demand. Step 2. Suppose income increases. As a result of the change, are consumers going to buy more or less pizza? The answer is more. Draw a dotted horizontal line from the chosen price, through the original quantity demanded, to the new point with the new Q1. Draw a dotted vertical line down to the horizontal axis and label the new Q1. An example is provided in Figure 6.
Shift in demand due to income increase
A shift in demand means that at any price (and at every price), the quantity demanded will be different than it was before. Following is a graphic illustration of a shift in demand due to an income increase.
Step 1. Draw the graph of a demand curve for a normal good like pizza. Pick a price (like P 0 ). Identify the corresponding Q 0 . An example is shown in Figure \(\PageIndex{6}\).
Step 2. Suppose income increases. As a result of the change, are consumers going to buy more or less pizza? The answer is more. Draw a dotted horizontal line from the chosen price, through the original quantity demanded, to the new point with the new Q 1 . Draw a dotted vertical line down to the horizontal axis and label the new Q 1 . An example is provided in Figure \(\PageIndex{7}\).
Step 3 . Now, shift the curve through the new point. You will see that an increase in income causes an upward (or rightward) shift in the demand curve, so that at any price, the quantities demanded will be higher, as shown in Figure \(\PageIndex{8}\).
Simulation: Demand for Food Trucks
Play the simulation below multiple times to see how different choices lead to different outcomes. All simulations allow unlimited attempts so that you can gain experience applying the concepts.