Demand Curve Overview
A demand curve in economics is a graph that shows the relationship between the cost of a particular good (represented by the y-axis) and the quantity of that good demanded at that cost (represented by the x-axis). A market demand curve represents all of the consumers in a specific market, while an individual demand curve represents the price-quantity relationship for a single consumer.
Demand curves are typically thought to slope downward, as the adjacent image demonstrates. This is due to the law of demand, which states that when prices increase for most goods, demand decreases. Certain peculiar circumstances do not adhere to this rule. Veblen goods, Giffen goods, and speculative bubbles are a few examples of this type of phenomenon. Buyers are drawn to a commodity if its price increases.
What is the Demand Curve?
The relationship between the cost of a good or service and the quantity demanded over a specific time period is represented graphically by the demand curve. The price and quantity demanded are typically represented with the price on the left vertical axis and the horizontal axis, respectively.
Understanding the Demand Curve
The law of demand states that as the price of a given good rises, the quantity demanded decreases, all other things being equal. This is expressed by the demand curve moving downward from the left to the right.
The price is implied to be the independent variable in this formulation, and the quantity to be the dependent variable. Economics is an exception to the general rule that the independent variable appears on the horizontal or x-axis.
For instance, if the price of corn increases, consumers will be enticed to buy less corn and substitute it for other foods, resulting in a decrease in the overall amount of corn that consumers demand.
Assumptions Underlying the derivation of the Demand Curve
- The consumer's income remains constant.
- The cost of related products is unchanged.
- Constant consumer preferences, tastes, routines, and fashions.
- The number of buyers remains constant.
- The product has no status value and is a normal good.
Shift of a demand curve
When a demand curve shifts, a new demand curve emerges as a result of a change in any non-price determinant of demand. Non-price determinants of demand are those factors that will influence demand even if prices stay the same; in other words, they are those changes that could influence a consumer's decision to purchase more or less of a good even if its price remained constant.
Prices of related goods (both substitutes and complements), income, population, and expectations are some of the more crucial variables. However, since demand is determined by a consumer's willingness and ability to buy a good under the current conditions, any factor other than price that has an impact on a consumer's willingness or ability to purchase the in question good or service qualifies as a non-price determinant of demand. The weather, for instance, might affect the demand for beer at a baseball game.
The demand curve for normal goods shifts outward as more will be demanded at all prices as income rises, while the demand curve for inferior goods shifts inward as superior substitutes become more accessible. With regard to related goods, when the price of a good (such as a hamburger) increases, the demand curve for complementary goods (such as ketchup) shifts in while the demand curve for substitute goods (such as chicken) shifts out (i.e., there is less demand for complementary goods as a result of the reduction in quantity demanded of the underlying good).
Demand Curve Elasticity
Demand elasticity, also known as price elasticity of demand, is the degree to which a change in price causes a decrease in demand. The demand elasticity of corn is one if a 50% increase in corn prices results in a 50% decrease in corn demand. The demand elasticity is 0.2 if a 50% increase in corn prices only results in a 10% decrease in the quantity demanded. For products with more elastic demand, the demand curve is shallower (closer to horizontal), and for products with less elastic demand, the demand curve is steeper (closer to vertical).
A new demand curve must be drawn if a factor other than price or quantity changes. Consider the case where a region experiences a population explosion, increasing the number of mouths that need to be fed. In this case, even though the price stays the same, there will be a greater demand for corn, which causes the curve itself to move to the right (D2) in the graph below. In other words, demand will increase.
The demand curve can also be affected by other factors, like a shift in consumer preferences. The demand curve will move to the left (D3) if cultural changes cause consumers to prefer quinoa over corn. Demand will shift left (D3) if consumer income declines and their capacity to purchase corn does as well. Consumers will choose corn over the substitute if its price rises, shifting the demand curve to the right (D2). Demand will shift left (D3) if the cost of a complement, such as charcoal to grill corn, rises. Consumers will have an incentive to buy now before the price rises if the future price of corn is higher than the current price, temporarily shifting the demand to the right (D2).
Factors Affecting Individual Demand Curve
- Price changes for related goods (complements and substitutes)
- changes in disposable income, with the size of the change also influenced by the demand elasticity at different income levels.
- changes in preferences and tastes. In the short term, tastes and preferences are thought to be fixed. The assumption that preferences are fixed is a prerequisite for the combination of individual demand curves to produce market demand.
- adjustments to expectations.
Factors Affecting Market Demand Curve
Three additional factors can cause the market demand curve to shift in addition to those that can affect individual demand:
- a shift in the population of consumers,
- a shift in how consumers' tastes are distributed,
- a shift in how income is distributed among consumers with different tastes.
The following are some situations that could lead to a shift in the demand curve:
- reduction in the cost of an alternative
- price of a complement rising
- Income reduction if things are generally good
- Increase in income if the good is subpar
Movement along a Demand Curve
When a change in price results in a change in the quantity demanded, there is movement along the demand curve. It's critical to understand the difference between a demand curve's movement and its shift. Only when the price of the good changes will there be changes along a demand curve. When a non-price determinant of demand changes, the curve shifts. The demand function includes these "other variables." "Simply lumped into the intercept term of a simple linear demand function," is how one author put it. As a result, a shift in the x-intercept results from a change in a non-price determinant of demand, which causes the curve to move along the x axis.
Indifference Demand Curve
The indifference curve is a graph in economics that displays different pairings of two items, typically consumer goods, that produce the same level of satisfaction or utility for a person. It was created by British economist Francis Y. Edgeworth, who was born in Ireland, and is widely used as an analytical tool in the study of consumer behavior, especially as it relates to consumer demand. It is also used in welfare economics, a discipline that studies how various actions affect people's personal and collective well-being.
When given a choice between any two points on the classic indifference curve, the consumer would not favor one point over the other because the curve is drawn downward from left to right and convex to the origin. The consumer would not care about the combination they actually received because all of the goods combinations represented by the points are equally desirable. In order to construct an indifference curve, it is necessary to make the assumption that, other things being equal, some variables remain constant.
Price elasticity of Demand
The quantity variable Q's sensitivity to changes in the price variable P is measured by the price elasticity of demand. Its value provides an answer to the query of how much, in percentage terms, the quantity will change after a 1% change in the price. Thus, this is crucial in figuring out how revenue will change. Since the price increases while the quantity demanded decreases as a result of the law of demand, the elasticity is negative.
Demand elasticity describes how responsive demand is to a change in price. Demand is described as being inelastic if its absolute value falls between 0 and 1; unitary elastic if it equals 1; and elastic if it exceeds 1. Inelastic demand, which has a small value, indicates that changes in price have little impact on demand. High elasticity predicts that consumers will buy significantly less of the good in response to a price increase. See the section of the article titled "Selected Price Elasticities" for examples of the elasticities of specific goods.
The elasticity of demand typically varies with price. Demand is inelastic at high prices and elastic at low prices if the demand curve is linear, with unitary elasticity falling in the middle. There does exist a family of demand curves with constant elasticity for all prices.
Taxes and subsidies
If the price axis in the graph represents the price with tax, then an increase in the sales tax on the commodity has no immediate impact on the demand curve. Similar to this, if the price axis in the graph represents the price after deducting the subsidy, a subsidy on the commodity does not directly change the demand curve.
If the price axis on the graph represents the price before tax addition and/or subsidy subtraction, then the demand curve shifts inward when a tax is introduced and outward when a subsidy is introduced.
Effect of taxation on the demand curve
- All taxes are paid by the consumer when the demand curve is vertical and perfectly inelastic.
- All taxes are paid by the supplier when the demand curve is perfectly elastic (horizontal demand curve).
- The supplier is responsible for a larger portion of the cost increase or tax if the demand curve is more elastic.
Derived Demand
The markets for final and intermediate goods can be further divided based on the demand for goods. A good that is used to make another good, also known as the final good, is called an intermediate good. It is crucial to remember that in many cases, the cooperation of several inputs results in a final good, and as a result, the demand for these goods is derived from the demand of the final product; this idea is known as derived demand. Since demand for a final product drives up demand for the intermediate goods used to make it, there is a direct and positive relationship between the intermediate goods and the final good.
Specific presumptions must be made and values held constant in order to build a derived demand curve. To determine an accurate derived demand curve, the production conditions, demand curve for the final good, and supply curves for other inputs must all be kept constant.
Exceptions to the Demand Curve
The relationship between prices of goods and demand has some exceptions to the general rules. An instance of this is a Giffen good. Like bread or rice, it is regarded as a staple food for which there is no acceptable substitute. In other words, demand for a Giffen good will rise when the price does, and it will fall when the price does. These goods are in high demand, which defies the rules of supply and demand. Giffen products will therefore not experience the typical reaction (rising prices leading to a substitution effect), and the price increase will continue to drive demand.