# Key Topics demand law of demand change in quantity demanded change in demand determinants of demand

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5 58 Introductory Economics prices on the schedule. You can read the demand curve in Figure 5-1 to find that the quantity demanded at the price of \$5 each is 4 bottles. The Law of Demand Look again at the demand curve plotted in Figure 5-1. The curve is composed of all the alternative prices of the good and the particular quantity that would be purchased at each price. A certain relationship is established between the price and the quantity demanded. This relationship is known as the law of demand. The law of demand shows an inverse relationship between the price of a good and the quantity demanded of that good. When price goes in one direction, the quantity demanded goes in the opposite direction. Figures 5-2 and 5-3 illustrate this law clearly. As the price decreases from \$6 to \$4, the quantity demanded increases from 3 to 5 (Figure 5-2). Part of the law of demand states that as price falls, more is purchased. This is indicated by the quantity demanded increasing. The other part of the law of demand states that as price rises, less is purchased. This is indicated by the quantity demanded decreasing. As the price increases from \$4 to \$6, the quantity demanded decreases from 5 to 3 (Figure 5-3). Observe in Figures 5-2 and 5-3 that the downward-sloping demand curve, from left to right, is a perfect reflection of the law of demand. Price D Bottles Figure 5-2 An Increase in the Quantity Demanded Here we see that if the price decreases, the quantity demanded increases. In this case, we are moving along the demand curve, and demand does not change, but the quantity demanded does.

6 Chapter 5. Demand 59 Price D Bottles Figure 5-3 A Decrease in the Quantity Demanded Here we see that if the price rises, the quantity demanded falls. Again realize that we are moving along the demand curve, so demand does not change, only the quantity demanded. A movement downward along the demand curve represents a fall in price and a corresponding increase in the quantity demanded. A movement upward along the demand curve represents an increase in price and a corresponding decrease in the quantity demanded. There is clear evidence of the law of demand at work all around us. Postage rates increase and fewer Christmas cards are mailed. The quantity demanded has fallen as the price has risen. Retail stores advertise sales. Sales serve to increase the quantity demanded by lowering the price. Buyer response to higher fuel and energy prices will lead to smaller and more fuel-efficient cars, and, in homes, cooler temperatures and sweaters. There is a lower quantity demanded of energy at the higher price. Buyers do respond to changing prices. We are sensitive to sacrifice and changing opportunity cost. What is the reason for the law of demand and the downward-sloping demand curve? Why would we expect a consumer to buy more of a good if its price fell? Part of the explanation lies in the substitution effect of a change in price. As the price of hair oil goes down, hair oil becomes an attractive substitute for other goods. Thus the consumer buys more hair oil to replace those goods. For example, as the price of hair oil goes down, the consumer will buy hair oil to use as lubricant in the lawn mower. If price goes down far enough, the consumer will even buy it to burn as fuel. So one reason why the consumer buys more of a good as the price falls is that the good becomes an

9 62 Introductory Economics show your demand, and we must start the what if questions and find your demand all over again. Only now your demand will be different. Recall that the determinants of demand include a change in taste for a good, a change in income, an expectation of a change in the price of a good, and a change in the price of a related good. Each of these will be discussed in turn. Watch a few reruns of old Elvis Presley movies and see what happens to your demand for hair oil. Suppose that you want hair oil more than before. This reflects an increase in taste or preference. Figure 5-4 shows your old (D 1 ) and new (D 2 ) demand for the good. At the price of \$4 a bottle, you would now purchase 8, whereas before you would have purchased 5. You can see that at each and every price you will purchase more hair oil than before. Note that there was not an increase in the quantity demanded. That can only be brought about by a fall in price. The old quantity demanded associated with each price no longer exists, only the new. If someone were to ask you how much hair oil you would buy at \$4, you would not reply either 5 or 8 bottles. There is only one quantity that you would now buy at that price, 8 bottles as shown by the new demand curve. Recognize that the price of hair oil did not change. So there is no change at all in the quantity demanded. But of course there is a change, a change in demand. More would be bought than before at each and every price. The demand curve will shift or move to the right. Price D 2 D Bottles Figure 5-4 An Increase in Demand This figure shows the demand for hair oil increasing. Here the whole demand curve shifts to the right from D 1 to D 2. More will be bought at each and every price. Now at \$4 each, 8 bottles would be bought rather than 5.

11 64 Introductory Economics Price D 2 D Bottles Figure 5-5 An Increase in Demand In this figure we see that another way to think about an increase in demand is that the buyer would pay a higher price at each quantity. Here \$4 rather than \$2 would be paid for each of 8 bottles if necessary. Price D 1 2 D Bottles Figure 5-6 A Decrease in Demand This figure shows a decrease in demand. The demand curve is shifting left. Less will be bought at each and every price; a lower price would be paid for the same quantity.

12 Chapter 5. Demand 65 Table 5-2 What Happens to Demand When Income Changes Income Demand for the Normal Good Demand for the Inferior Good rises rises falls falls falls rises This table shows the relationship between a change in income and the change in demand that results. If income rises and the good is normal, then demand rises. If the good is inferior, an increase in income causes demand to fall. more hair oil now before it does become more expensive. Take note that the price has not changed, only that you expect it to. The result is an increase in demand since more is bought than before at each and every price of the good. If the expectation, however, is for a fall in price, then you may reduce your buying while waiting for the price to fall. The result is a decrease in demand. A change in the price of some related good may in turn affect the demand for the good in question. Two goods can be related either as complements or substitutes. Goods that are not related are independent. For goods that are complements, if you purchase more (less) of one, you purchase more (less) of the other. There are many common examples of complements that will come to mind, such as beer and pretzels, peanut butter and jam, bread and butter, cameras and film, cars and gasoline, and tennis rackets and tennis balls. With substitute goods, on the other hand, if you buy more (less) of one, you buy less (more) of the other. Examples of substitutes are sugar and saccharin, butter and margarine, coffee and tea, and attendance at any other school and Harvard. Note that whether goods are substitutes or complements is an individual matter. While tea may substitute for coffee in one household, hot chocolate may substitute in another. Suppose that there are two goods, the first good and a related good. What happens if the price of the first good falls? The law of demand predicts an increase in the quantity demanded of the first good. More would be bought at the lower price than at the higher price. But what about the related good? If the two goods are complements, the demand (not the quantity demanded) for the related good will increase. As more is bought of the first good as its price falls, then more is bought of its complement. More of the complement is purchased at the same price. As the price of turkey falls, more turkey and more of its complement, cranberries, are bought. The quantity of turkey demanded increases, as does the demand for cranberries. But if two goods are substitutes, less will be bought of the related good as the price of the first good falls. As

13 66 Introductory Economics Table 5-3 What Happens to Demand for a Related Good When the Price of the First Good Changes First Good Demand for the Related Good Price Quantity Demanded Complement Substitute rises falls falls rises falls rises rises falls This table shows the relationship between the price of a good and the quantity demanded of that good as well as the demand for a complement or substitute. So if the price of a good rises, the quantity demanded of the good falls, the demand for a complement falls, and the demand for a substitute rises. the price of turkey falls, more turkey and less of its substitute, chicken, is bought. Demand for chicken falls. And what happens if the price of the first good increases? As the price of peanut butter goes up, less of the complement good, jam, will be bought. Demand for the complement falls. And as the price of peanut butter goes up, more tuna will be substituted. Demand for the substitute increases. So with a knowledge of demand and the relation between goods, it is possible to predict how a change in price of one good can affect the amount of another you might buy. The demand curve for one good may be shifted by the price change of another good. Thus we are able to classify goods based on how the demand curve shifts when the price of the related good changes. If demand for a good increases as the price of another good goes up, the two goods are substitutes. If the demand for a good decreases as the price of another good goes up, then the goods are complements. Review this relation between goods in Table 5-3. Demand and Quantity Demanded The economist carefully distinguishes between demand, which is the entire curve, and the quantity demanded, a point on the demand curve. When the economist uses the phrase change in demand, the entire demand curve has shifted. Contrast this to the phrase change in the quantity demanded. What is the difference in meaning? A change in the quantity demanded means a movement along a demand curve in response to a price change. Accordingly, a change in price of a good is the only occurrence that can cause a change in the quantity demanded for that good. This is the focus of the law of demand, the response of the buyer to a change in price. A change in demand means

14 Chapter 5. Demand 67 that something else besides the price of the good has changed and affected the willingness and ability of the buyer. This change in a determinant of demand shifts the entire demand curve. You should be able to see the difference between these two concepts in Figure 5-7. In Figure 5-7A, as the price of pizza goes up, you buy less pizza, a change in the quantity demanded. The demand for pizza remains unchanged. The quantity demanded decreased just as your demand curve indicated. You had already revealed that you would buy less pizza at a higher price. However, Price D Price A Pizza D 1 D 2 B Spaghetti Figure 5-7 A Change in Price of a Related Good In graph A the price of pizza rises and the quantity demanded falls. In graph B, the demand for spaghetti increases due to the rise in the price of pizza. More spaghetti is bought at the same price of spaghetti. The entire demand curve moves.

15 68 Introductory Economics there is a change in demand for spaghetti. Demand for spaghetti increased as the price of its substitute, pizza, went up. So at each and every price of spaghetti, you buy more spaghetti than before the price of pizza increased. This is shown in Figure 5-7B as the demand for spaghetti increases from D 1 to D 2. Now for a moment, consider only your new, higher demand for spaghetti. What if the price of spaghetti fell? There would be an increase in the quantity demanded of spaghetti as you move down the existing D 2 demand curve. And now you should be able to predict a fall in demand for pizza. The demand for pizza would shift to the left, indicating that less would be bought than before at each and every price. After all, you are eating more spaghetti and less pizza. You will see the impact of both a change in price and a change in a determinant again in the next chapter. Summary This chapter introduced the concept of demand. Demand has been summarized as the willingness and ability of the buyer to buy goods at each possible price. The law of demand highlights the inverse relationship between price and quantity demanded. The demand curve slopes downward to the right, reflecting the law of demand, explained by both the substitution and income effect of a change in price. Movements along the demand curve are called changes in the quantity demanded; shifts of the entire demand curve are called a change in demand. A change in the price of the good causes a change in the quantity demanded. A determinant of demand must change before demand changes. The determinants of demand include a change in taste, change in income, an expectation of a change in the price of a good, and a change in the price of a related good. Demand is half the story of price determination. In the next chapter, we will introduce the other equally important participant in price determination, supply. Key Concepts demand quantity demanded law of demand substitution effect income effect determinants of demand normal good inferior good complements substitutes change in quantity demanded change in demand