Demand curve

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An example of a demand curve shifting. D1 and D2 are alternative positions of the demand curve, S is the supply curve, and P and Q are price and quantity respectively. The shift from D1 to D2 means an increase in demand with consequences for the other variables Supply-and-demand.svg
An example of a demand curve shifting. D1 and D2 are alternative positions of the demand curve, S is the supply curve, and P and Q are price and quantity respectively. The shift from D1 to D2 means an increase in demand with consequences for the other variables

A demand curve is a graph depicting the inverse demand function, [1] a relationship between the price of a certain commodity (the y-axis) and the quantity of that commodity that is demanded at that price (the x-axis). Demand curves can be used either for the price-quantity relationship for an individual consumer (an individual demand curve), or for all consumers in a particular market (a market demand curve).

Contents

It is generally assumed that demand curves slope down, as shown in the adjacent image. This is because of the law of demand: for most goods, the quantity demanded falls if the price rises. [2] Certain unusual situations do not follow this law. These include Veblen goods, Giffen goods, and speculative bubbles where buyers are attracted to a commodity if its price rises.

Demand curves are used to estimate behaviour in competitive markets and are often combined with supply curves to find the equilibrium price (the price at which sellers together are willing to sell the same amount as buyers together are willing to buy, also known as market clearing price) and the equilibrium quantity (the amount of that good or service that will be produced and bought without surplus/excess supply or shortage/excess demand) of that market. [2] :57

Movement "along the demand curve" refers to how the quantity demanded changes when the price changes.

Shift of the demand curve as a whole occurs when a factor other than price causes the price curve itself to translate along the x-axis; this may be associated with an advertising campaign or perceived change in the quality of the good. [3]

Demand curves are estimated by a variety of techniques. [4] The usual method is to collect data on past prices, quantities, and variables such as consumer income and product quality that affect demand and apply statistical methods, variants on multiple regression. Consumer surveys and experiments are alternative sources of data. For the shapes of a variety of goods' demand curves, see the article price elasticity of demand.

Shape of the demand curve

In most circumstances the demand curve has a negative slope, and therefore slopes downwards. This is due to the law of demand which conditions that there is an inverse relationship between price and the demand of commodity (good or a service). As price goes up quantity demanded reduces and as price reduces quantity demanded increases.

Demand curves are often graphed as straight lines, where a and b are parameters:

.

The constant a embodies the effects of all factors other than price that affect demand. If income were to change, for example, the effect of the change would be represented by a change in the value of "a" and be reflected graphically as a shift of the demand curve. The constant b is the slope of the demand curve and shows how the price of the good affects the quantity demanded. [5]

The graph of the demand curve uses the inverse demand function in which price is expressed as a function of quantity. The standard form of the demand equation can be converted to the inverse equation by solving for P:

. [5]

Curvature

Convex demand curve Monopoly Demand Curve.png
Convex demand curve

The demand is called convex (with respect to the origin [6] ) if the (generally down-sloping) curve bends upwards, concave otherwise. [7]

The demand curvature is fundamentally hard to estimate from the empirical data, with some researchers suggesting that demand with high convexity is practically improbable. [8]

Assumptions underlying the derivation of the demand curve

  1. Income of the consumer remains constant.
  2. Price of other related goods remain constant.
  3. Preference, tastes, habits and fashions of consumer remains constant.
  4. Number of buyers remain constant.
  5. The commodity is a normal good and has no status value.

Three categories of demand curves

The slope of the market industry demand curve is greater than the slope of the individual demand curve; the slope of the enterprise demand curve is less than the slope of the industry demand curve.

The slope of a firm's demand curve is less than the slope of the industry's demand curve.

Shift of a demand curve

The shift of a demand curve takes place when there is a change in any non-price determinant of demand, resulting in a new demand curve. [9] Non-price determinants of demand are those things that will cause demand to change even if prices remain the samein other words, the things whose changes might cause a consumer to buy more or less of a good even if the good's own price remained unchanged. [10]

Some of the more important factors are the prices of related goods (both substitutes and complements), income, population, and expectations. However, demand is the willingness and ability of a consumer to purchase a good under the prevailing circumstances; so, any circumstance that affects the consumer's willingness or ability to buy the good or service in question can be a non-price determinant of demand. As an example, weather could be a factor in the demand for beer at a baseball game.

When income increases, the demand curve for normal goods shifts outward as more will be demanded at all prices, while the demand curve for inferior goods shifts inward due to the increased attainability of superior substitutes. With respect to related goods, when the price of a good (e.g. a hamburger) rises, the demand curve for substitute goods (e.g. chicken) shifts out, while the demand curve for complementary goods (e.g. ketchup) shifts in (i.e. there is more demand for substitute goods as they become more attractive in terms of value for money, while demand for complementary goods contracts in response to the contraction of quantity demanded of the underlying good). [9] With factors of individual demand and market demand, both complementary goods and substitutes affect the demand curve.

Factors affecting individual demand

Factors affecting market demand

In addition to the factors which can affect individual demand there are three factors that can cause the market demand curve to shift:

Some circumstances which can cause the demand curve to shift in include:

Movement along a demand curve

There is movement along a demand curve when a change in price causes the quantity demanded to change. [9] It is important to distinguish between movement along a demand curve, and a shift in a demand curve. Movements along a demand curve happen only when the price of the good changes. [12] When a non-price determinant of demand changes, the curve shifts. These "other variables" are part of the demand function. They are "merely lumped into intercept term of a simple linear demand function." [12] Thus a change in a non-price determinant of demand is reflected in a change in the x-intercept causing the curve to shift along the x axis. [13]

Price elasticity of demand

The price elasticity of demand is a measure of the sensitivity of the quantity variable, Q, to changes in the price variable, P. Its value answers the question of how much the quantity will change in percentage terms after a 1% change in the price. This is thus important in determining how revenue will change. The elasticity is negative because the price rises, and the quantity demanded falls, a consequence of the law of demand.

The elasticity of demand indicates how sensitive the demand for a good is to a price change. If the elasticity's absolute value is between zero and 1, demand is said to be inelastic; if it equals 1, demand is "unitary elastic"; if it is greater than 1, demand is elastic. A small value--- inelastic demand--- implies that changes in price have little influence on demand. High elasticity indicates that consumers will respond to a price rise by buying much less of the good. For examples of elasticities of particular goods, see the article section, "Selected price elasticities".

The elasticity of demand usually will vary depending on the price. If the demand curve is linear, demand is inelastic at high prices and elastic at low prices, with unitary elasticity somewhere in between. There does exist a family of demand curves with constant elasticity for all prices. They have the demand equation , where c is the elasticity of demand and a is a parameter for the size of the market. These demand curves are smoothly curving with steep slopes for high values of price and gentle slopes for low values.

Taxes and subsidies

A sales tax on the commodity does not directly change the demand curve, if the price axis in the graph represents the price including tax. Similarly, a subsidy on the commodity does not directly change the demand curve, if the price axis in the graph represents the price after deduction of the subsidy.

If the price axis in the graph represents the price before addition of tax and/or subtraction of subsidy then the demand curve moves inward when a tax is introduced, and outward when a subsidy is introduced.

Effect of taxation on the demand curve

Derived demand

Derived demand Supply and demand-stacked4.png
Derived demand

The demand for goods can be further divorced into the demand markets for final and intermediate goods. An intermediate good is a good utilized in the process of creating another good, effectively named the final good. [15] It is important to note that the cooperation of several inputs in many circumstances yields a final good and thus the demand for these goods is derived from the demand of the final product; this concept is known as derived demand. [16] The relationship between the intermediate goods and the final good is direct and positive as demand for a final product increases demand for the intermediate goods used to make it.

In order to construct a derived demand curve, specific assumptions must be made and values held constant. The supply curves for other inputs, demand curve for the final good, and production conditions must all be held constant to ascertain an effective derived demand curve. [16]

See also

Related Research Articles

A monopoly, as described by Irving Fisher, is a market with the "absence of competition", creating a situation where a specific person or enterprise is the only supplier of a particular thing. This contrasts with a monopsony which relates to a single entity's control of a market to purchase a good or service, and with oligopoly and duopoly which consists of a few sellers dominating a market. Monopolies are thus characterised by a lack of economic competition to produce the good or service, a lack of viable substitute goods, and the possibility of a high monopoly price well above the seller's marginal cost that leads to a high monopoly profit. The verb monopolise or monopolize refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power to charge overly high prices, which is associated with unfair price raises. Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry.

<span class="mw-page-title-main">Supply and demand</span> Economic model of price determination in a market

In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, in a competitive market, the unit price for a particular good or other traded item such as labor or liquid financial assets, will vary until it settles at a point where the quantity demanded will equal the quantity supplied, resulting in an economic equilibrium for price and quantity transacted. The concept of supply and demand forms the theoretical basis of modern economics.

<span class="mw-page-title-main">Indifference curve</span> Concept in economics

In economics, an indifference curve connects points on a graph representing different quantities of two goods, points between which a consumer is indifferent. That is, any combinations of two products indicated by the curve will provide the consumer with equal levels of utility, and the consumer has no preference for one combination or bundle of goods over a different combination on the same curve. One can also refer to each point on the indifference curve as rendering the same level of utility (satisfaction) for the consumer. In other words, an indifference curve is the locus of various points showing different combinations of two goods providing equal utility to the consumer. Utility is then a device to represent preferences rather than something from which preferences come. The main use of indifference curves is in the representation of potentially observable demand patterns for individual consumers over commodity bundles.

Taxes and subsidies change the price of goods and, as a result, the quantity consumed. There is a difference between an ad valorem tax and a specific tax or subsidy in the way it is applied to the price of the good. In the end levying a tax moves the market to a new equilibrium where the price of a good paid by buyers increases and the proportion of the price received by sellers decreases. The incidence of a tax does not depend on whether the buyers or sellers are taxed since taxes levied on sellers are likely to be met by raising the price charged to buyers. Most of the burden of a tax falls on the less elastic side of the market because of a lower ability to respond to the tax by changing the quantity sold or bought. Introduction of a subsidy, on the other hand, may either lowers the price of production which encourages firms to produce more, or lowers the price paid by buyers, encouraging higher sales volume. Such a policy is beneficial both to sellers and buyers.

<span class="mw-page-title-main">Deadweight loss</span> Measure of lost economic efficiency

In economics, deadweight loss is the loss of societal economic welfare due to production/consumption of a good at a quantity where marginal benefit does not equal marginal cost – in other words, there are either goods being produced despite the cost of doing so being larger than the benefit, or additional goods are not being produced despite the fact that the benefits of their production would be larger than the costs. The deadweight loss is the net benefit that is missed out on. While losses to one entity often lead to gains for another, deadweight loss represents the loss that is not regained by anyone else. This loss is therefore attributed to both producers and consumers.

<span class="mw-page-title-main">Economic surplus</span> Concept in economics

In mainstream economics, economic surplus, also known as total welfare or total social welfare or Marshallian surplus, is either of two related quantities:

In economics, elasticity measures the responsiveness of one economic variable to a change in another. If the price elasticity of the demand of something is -2, a 10% increase in price causes the quantity demanded to fall by 20%. Elasticity in economics provides an understanding of changes in the behavior of the buyers and sellers with price changes. There are two types of elasticity for demand and supply, one is inelastic demand and supply and the other one is elastic demand and supply.

A good's price elasticity of demand is a measure of how sensitive the quantity demanded is to its price. When the price rises, quantity demanded falls for almost any good, but it falls more for some than for others. The price elasticity gives the percentage change in quantity demanded when there is a one percent increase in price, holding everything else constant. If the elasticity is −2, that means a one percent price rise leads to a two percent decline in quantity demanded. Other elasticities measure how the quantity demanded changes with other variables.

In economics, the crosselasticity of demand measures the effect of changes in the price of one good on the quantity demanded of another good. This reflects the fact that the quantity demanded of good is dependent on not only its own price but also the price of other "related" good.

The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption, by maximizing utility subject to a consumer budget constraint. Factors influencing consumers' evaluation of the utility of goods include: income level, cultural factors, product information and physio-psychological factors.

<span class="mw-page-title-main">Substitute good</span> Economics concept of goods considered interchangeable

In microeconomics, substitute goods are two goods that can be used for the same purpose by consumers. That is, a consumer perceives both goods as similar or comparable, so that having more of one good causes the consumer to desire less of the other good. Contrary to complementary goods and independent goods, substitute goods may replace each other in use due to changing economic conditions. An example of substitute goods is Coca-Cola and Pepsi; the interchangeable aspect of these goods is due to the similarity of the purpose they serve, i.e. fulfilling customers' desire for a soft drink. These types of substitutes can be referred to as close substitutes.

In economics and particularly in consumer choice theory, the substitution effect is one component of the effect of a change in the price of a good upon the amount of that good demanded by a consumer, the other being the income effect.

<span class="mw-page-title-main">Price elasticity of supply</span> Measure in economics

The price elasticity of supply is a measure used in economics to show the responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its price. Price elasticity of supply, in application, is the percentage change of the quantity supplied resulting from a 1% change in price. Alternatively, PES is the percentage change in the quantity supplied divided by the percentage change in price.

<span class="mw-page-title-main">Law of demand</span> Fundamental principle in microeconomics

In microeconomics, the law of demand is a fundamental principle which states that there is an inverse relationship between price and quantity demanded. In other words, "conditional on all else being equal, as the price of a good increases (↑), quantity demanded will decrease (↓); conversely, as the price of a good decreases (↓), quantity demanded will increase (↑)". Alfred Marshall worded this as: "When we say that a person's demand for anything increases, we mean that he will buy more of it than he would before at the same price, and that he will buy as much of it as before at a higher price". The law of demand, however, only makes a qualitative statement in the sense that it describes the direction of change in the amount of quantity demanded but not the magnitude of change.

<span class="mw-page-title-main">Marginal revenue</span> Additional total revenue generated by increasing product sales by 1 unit

Marginal revenue is a central concept in microeconomics that describes the additional total revenue generated by increasing product sales by 1 unit. Marginal revenue is the increase in revenue from the sale of one additional unit of product, i.e., the revenue from the sale of the last unit of product. It can be positive or negative. Marginal revenue is an important concept in vendor analysis. To derive the value of marginal revenue, it is required to examine the difference between the aggregate benefits a firm received from the quantity of a good and service produced last period and the current period with one extra unit increase in the rate of production. Marginal revenue is a fundamental tool for economic decision making within a firm's setting, together with marginal cost to be considered.

In economics, tax incidence or tax burden is the effect of a particular tax on the distribution of economic welfare. Economists distinguish between the entities who ultimately bear the tax burden and those on whom the tax is initially imposed. The tax burden measures the true economic effect of the tax, measured by the difference between real incomes or utilities before and after imposing the tax, and taking into account how the tax causes prices to change. For example, if a 10% tax is imposed on sellers of butter, but the market price rises 8% as a result, most of the tax burden is on buyers, not sellers. The concept of tax incidence was initially brought to economists' attention by the French Physiocrats, in particular François Quesnay, who argued that the incidence of all taxation falls ultimately on landowners and is at the expense of land rent. Tax incidence is said to "fall" upon the group that ultimately bears the burden of, or ultimately suffers a loss from, the tax. The key concept of tax incidence is that the tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply. As a general policy matter, the tax incidence should not violate the principles of a desirable tax system, especially fairness and transparency. The concept of tax incidence is used in political science and sociology to analyze the level of resources extracted from each income social stratum in order to describe how the tax burden is distributed among social classes. That allows one to derive some inferences about the progressive nature of the tax system, according to principles of vertical equity.

In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item is a function of an item's perceived necessity, price, perceived quality, convenience, available alternatives, purchasers' disposable income and tastes, and many other options.

<span class="mw-page-title-main">Supply (economics)</span> Amount of a good that sellers are willing to provide in the market

In economics, supply is the amount of a resource that firms, producers, labourers, providers of financial assets, or other economic agents are willing and able to provide to the marketplace or to an individual. Supply can be in produced goods, labour time, raw materials, or any other scarce or valuable object. Supply is often plotted graphically as a supply curve, with the price per unit on the vertical axis and quantity supplied as a function of price on the horizontal axis. This reversal of the usual position of the dependent variable and the independent variable is an unfortunate but standard convention.

Total revenue is the total receipts a seller can obtain from selling goods or services to buyers. It can be written as P × Q, which is the price of the goods multiplied by the quantity of the sold goods.

<span class="mw-page-title-main">Factor market</span> In economics, a market where resources used in the production process are bought and sold

In economics, a factor market is a market where factors of production are bought and sold. Factor markets allocate factors of production, including land, labour and capital, and distribute income to the owners of productive resources, such as wages, rents, etc.

References

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  2. 1 2 3 Krugman, Paul; Wells, Robin; Graddy, Kathryn (2007). Economics: European Edition. Palgrave Macmillan. ISBN   978-0-7167-9956-6.
  3. "Demand Curve Shifts". 17 January 2021.
  4. Samia Rekhi (16 May 2016). "Empirical Estimation of Demand: Top 10 Techniques". economicsdiscussion.net. Retrieved 11 December 2020.
  5. 1 2 Besanko; Braeutigam (2005). Microeconomics . Hoboken: Wiley. p.  91. ISBN   0-471-45769-8.
  6. RBB Economics 2014, p. 16.
  7. Malueg 1994, p. 237.
  8. RBB Economics 2014, p. 36.
  9. 1 2 3 Case, K. E.; Fair, R. C. (1994). "Demand, Supply, and Market Equilibrium". Principles of Economics (3rd ed.). Englewood Cliffs, New Jersey: Prentice Hall. ISBN   0-13-039950-7.
  10. "Demand and Supply". www.harpercollege.edu.
  11. Binger, B.; Hoffman, E. (1998). Microeconomics with Calculus (2nd ed.). Addison-Wesley. ISBN   0-321-01225-9. A change in relative price changes the distribution of income which in turn changes the demand curve
  12. 1 2 Underwood, Instructor's Manual, Microeconomics 5th ed. (Prentice-Hall 2001) at 5.
  13. The x intercept is affected because the standard diagram uses the inverse demand function
  14. Hutchinson, Emma (16 November 2017). "4.7 Taxes and Subsidies". Pressbooks.bccampus.ca. Retrieved 1 May 2022.
  15. Kenton, Will. "Understanding Intermediate Goods". Investopedia. Retrieved 2020-12-01.
  16. 1 2 Whitaker, John K. (2008), Palgrave Macmillan (ed.), "Derived Demand" , The New Palgrave Dictionary of Economics, London: Palgrave Macmillan UK, pp. 1–3, doi:10.1057/978-1-349-95121-5_97-2, ISBN   978-1-349-95121-5 , retrieved 2020-12-01

Sources