We begin our study of markets by examining the behaviour of buyers. To focus our thinking, let’s keep in mind a particular good—ice cream.
The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. As we will see, many things determine the quantity demanded of any good, but in our analysis of how markets work, one determinant plays a central role—the price of the good. If the price of ice cream rose to $20 per scoop, you would buy less ice cream. You might buy frozen yogurt instead. If the price of ice cream fell to $0.20 per scoop, you would buy more. This relationship between price and quantity demanded is true for most goods in the economy and, in fact, is so pervasive that economists call it the law of demand: Other things equal, when the price of a good rises, the quantity demanded of the good falls, and when the price falls, the quantity demanded rises.
The amount of a good that buyers are willing and able to purchase
Law of demand
The claim that, other things equal, the quantity demanded of a good falls when the price of the good rises
A table that shows the relationship between the price of a good and the quantity demanded
A graph of the relationship between the price of a good and the quantity demanded
Market Demand versus Individual Demand
The demand curve in Figure 1 shows an individual’s demand for a product. To analyse how markets work, we need to determine the market demand, the sum of all the individual demands for a particular good or service.
The table in Figure 2 shows the demand schedules for ice cream of the two individuals in this market—Catherine and Nicholas. At any price, Catherine’s demand schedule tells us how much ice cream she buys, and Nicholas’s demand schedule tells us how much ice cream he buys. The market demand at each price is the sum of the two individual demands.
Notice that we sum the individual demand curves horizontally to obtain the market demand curve. That is, to find the total quantity demanded at any price, we add the individual quantities, which are found on the horizontal axis of the individual demand curves. Because we are interested in analysing how markets function, we work most often with the market demand curve. The market demand curve shows how the total quantity demanded of a good varies as the price of the good varies, while all the other factors that affect how much consumers want to buy are held constant.
Shifts in the Demand Curve
Because the market demand curve holds other things constant, it need not be stable over time. If something happens to alter the quantity demanded at any given price, the demand curve shifts. For example, suppose the American Medical
Association discovered that people who regularly eat ice cream live longer, healthier lives. The discovery would raise the demand for ice cream. At any given price, buyers would now want to purchase a larger quantity of ice cream, and the demand curve for ice cream.
Any change that increases the quantity demanded at every price, such as our imaginary discovery by the American Medical Association, shifts the demand curve to the right and is called an increase in demand. Any change that reduces the quantity demanded at every price shifts the demand curve to the left and is called a decrease in demand.
There are many variables that can shift the demand curve. Here are the most important.
IncomeWhat would happen to your demand for ice cream if you lost your job one summer? Most likely, it would fall. A lower income means that you have less to spend in total, so you would have to spend less on some—and probably most—goods. If the demand for a good falls when income falls, the good is called a normal good.
Not all goods are normal goods. If the demand for a good rises when income falls, the good is called an inferior good. An example of an inferior good might be bus rides. As your income falls, you are less likely to buy a car or take a cab and more likely to ride a bus.
Prices of Related GoodsSuppose that the price of frozen yogurt falls. The law of demand says that you will buy more frozen yogurt. At the same time, you will probably buy less ice cream. Because ice cream and frozen yogurt are both cold, sweet, creamy desserts, they satisfy similar desires. When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes.
Substitutes are often pairs of goods that are used in place of each other, such as hot dogs and hamburgers, sweaters and sweatshirts, and movie tickets and DVD rentals.
Now suppose that the price of hot fudge falls. According to the law of demand, you will buy more hot fudge. Yet in this case, you will buy more ice cream as well because ice cream and hot fudge are often used together. When a fall in the price of one good raises the demand for another good, the two goods are called complements. Complements are often pairs of goods that are used together, such as gasoline and automobiles, computers and software, and peanut butter and jelly.
TastesThe most obvious determinant of your demand is your tastes. If you like ice cream, you buy more of it. Economists normally do not try to explain people’s tastes because tastes are based on historical and psychological forces that are beyond the realm of economics. Economists do, however, examine what happens when tastes change.
A good for which, other things equal, an increase in income leads to an increase in demand
A good for which, other things equal, an increase in income leads to a decrease in demand
Two goods for which an increase in the price of one leads to an increase in the demand for the other
Two goods for which an increase in the price of one leads to a decrease in the demand for the other
ExpectationsYour expectations about the future may affect your demand for a good or service today. If you expect to earn a higher income next month, you may choose to save less now and spend more of your current income buying ice cream. If you expect the price of ice cream to fall tomorrow, you may be less willing to buy an ice-cream cone at today’s price.
Number of BuyersIn addition to the preceding factors, which influence the behaviour of individual buyers, market demand depends on the number of these buyers. If Peter were to join Catherine and Nicholas as another consumer of ice cream, the quantity demanded in the market would be higher at every price, and market demand would increase.
The demand curve shows what happens to the quantity demanded of a good when its price varies, holding constant all the other variables that influence buyers. When one of these other variables changes, the demand curve shifts. Table 1 lists the variables that influence how much consumers choose to buy of a good.
A curve shifts when there is a change in a relevant variable that is not measured on either axis. Because the price is on the vertical axis, a change in price represents a movement along the demand curve. By contrast, income, the prices of related goods, tastes, expectations, and the number of buyers are not measured on either axis, so a change in one of these variables shifts the demand curve.
Two Ways to Reduce the Quantity of Smoking Demanded
Public policymakers often want to reduce the amount that people smoke because of smoking’s adverse health effects. There are two ways that policy can attempt to achieve this goal.
One way to reduce smoking is to shift the demand curve for cigarettes and other tobacco products. Public service announcements, mandatory health warnings on cigarette packages, and the prohibition of cigarette advertising on television are all policies aimed at reducing the quantity of cigarettes demanded at any given price. If successful, these policies shift the demand curve for cigarettes to the left.
Alternatively, policymakers can try to raise the price of cigarettes. If the government taxes the manufacture of cigarettes, for example, cigarette companies pass much of this tax on to consumers in the form of higher prices. A higher price encourages smokers to reduce the numbers of cigarettes they smoke. In this case, the reduced amount of smoking does not represent a shift in the demand curve.
Instead, it represents a movement along the same demand curve to a point with a higher price and lower quantity.
How much does the amount of smoking respond to changes in the price of cigarettes? Economists have attempted to answer this question by studying what happens when the tax on cigarettes changes. They have found that a 10 per cent increase in the price causes a 4 per cent reduction in the quantity demanded.
Teenagers are found to be especially sensitive to the price of cigarettes: A 10 per cent increase in the price causes a 12 per cent drop in teenage smoking.
A related question is how the price of cigarettes affects the demand for illicit drugs, such as marijuana. Opponents of cigarette taxes often argue that tobacco and marijuana are substitutes so that high cigarette prices encourage marijuana use. By contrast, many experts on substance abuse view tobacco as a “gateway drug” leading the young to experiment with other harmful substances. Most studies of the data are consistent with this latter view: They find that lower cigarette prices are associated with greater use of marijuana. In other words, tobacco and marijuana appear to be complements rather than substitutes.
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