Demand - The Economic Lowdown Podcast Series

Today I'm talking about the economic concept of demand.

Economists define demand as the quantity of a good or service that buyers are willing and able to buy at all possible prices during a certain time period. Notice that there are two components to demand: willingness to purchase and ability to pay. I might be willing to buy a new Corvette, but if I do not have the ability to pay for it, it can't really be called demand. Likewise, if I had the ability to pay for a Corvette, but not the willingness to buy it, it can't be called demand. I'm simply not in the market for Corvettes.

Understanding demand provides some insight into the behavior of buyers. For example, if the price of chocolate bars was 50 cents each, I would buy two chocolate bars. If the price of chocolate bars was 25 cents each, I would likely buy more than two-perhaps three bars. If the price of chocolate bars was 1 dollar per bar, I would likely buy fewer bars-perhaps only one. The behavior I just described is called the law of demand by economists.

Simply stated, the law of demand says that as the price of a good increases, the quantity of that good or service demanded decreases. Likewise, as the price of a good or service decreases, the quantity of that good or service demanded increases. Notice that we include only two variables-price and quantity. That's all that the law of demand does: It states how a change in the price of a good or service affects the quantity demanded.

Picture This...

In fact, if we put the quantity of chocolate bars on the x or horizontal axis of a graph and the price of chocolate bars on the y or vertical axis and plot the information we just discussed, we would start to see a picture of demand or a visual relationship between the two variables: The line that is created when we connect the points on the graph slopes downward. This downward slope means that there is an inverse (or opposite) relationship between price and quantity demanded. When price increases, quantity demanded decreases, and when price decreases, quantity demanded increases. In fact, we could recreate this same scenario with almost any good or service and get the same result-a downward-sloping line. This downward-sloping line is called a demand curve.

The demand curve is a helpful tool, but it is not static (or unchanging). It shifts back and forth as conditions in the market change. For example, if you heard of an impending chocolate shortage, you might expect chocolate prices to rise in the future. As a result, you might run to your favorite candy store and buy extra chocolate bars before chocolate prices increase. In this case, the original demand curve no longer tells the whole story; it must shift to the right to accurately reflect the change in chocolate bar demand. Or put another way, your chocolate bar demand curve shifted to the right because the quantity of chocolate bars you-and your fellow chocolate lovers-demand would be greater at each of the given prices.

What Things Change the Curve?

There are several reasons a demand curve might shift to the left or the right. In each of the following examples, imagine that the price of chocolate bars remains constant but something else in the market changes.

1. A change in consumer expectations. Your fear of a chocolate bar shortage and rising prices is a good example of a change in consumer expectations. If many other chocolate lovers had similar fears, the demand curve for chocolate bars would shift to the right as more people bought chocolate bars.
2. A change in consumer tastes or preferences. Imagine that scientists discovered some new health benefits from eating chocolate. You can bet that more people would buy chocolate bars, causing the demand curve to shift to the right.
3. A change in the number of consumers in the market. A huge convention of candy lovers has come to town-and they want chocolate bars now! The demand curve shifts to the right.
4. A change in income. During recessions, the demand curve for chocolate bars usually shifts to the left because many chocolate lovers have smaller incomes due to the bad economy and can't buy as much chocolate. This means that the demand curve for chocolate bars-and nearly everything else-would shift to the left as people buy less chocolate.
5. A change in the price of a substitute good. Imagine that the price of licorice has fallen by half while chocolate bar prices have remained the same. You can bet that more than a few chocolate lovers would start eating licorice. As a result, the chocolate bar demand curve would shift to the left as people substitute licorice for chocolate because licorice is cheaper. So a change in the price of a substitute-licorice-changes the demand for chocolate bars.
6. A change in the price of a complementary good. In this case, when I say complementary I do not mean free; instead, I mean a good that is used with another good. Imagine that the prices of peanut butter and ice cream-your two favorite chocolate bar complements-have doubled. You and lots of others would buy fewer jars of peanut butter and fewer containers of ice cream-and even though the price of chocolate bars hasn't changed you and other chocolate bar lovers would likely cut back on your chocolate bar purchases, shifting the chocolate bar demand curve to the left. So a change in the price of complements—peanut butter and ice cream—changes the demand for chocolate bars.

Notice that two types of changes are occurring. The first is called a change in the quantity demanded, which is the result of a change in price. A change in quantity demanded is illustrated by moving from point to point on a given demand curve. The second type is called a change in demand. The demand for a good or service changes not when the price of the good changes, but when something else in the market changes-for example, changes in prices of related goods, consumer expectations, consumer preferences, consumer income, and number of consumers in the market. These changes make the original demand curve irrelevant. A change in demand is illustrated by shifting the demand curve left or right. An easy what to remember which way the demand curve shifts is this: When demand is LESS, the demand curve shifts to the LEFT - both start with an L and have 4 letters.

Wrap-Up

To summarize, the law of demand describes the behavior of buyers. Generally speaking, people buy more of a good when prices are low than when prices are high. When this relationship is graphed, the result is a demand curve. A change in price results in movement one point to another along a given demand curve and is called a change in the quantity demanded. When other factors in the market change, the demand curve shifts to the left or the right. We call this a change in demand.

Of course, demand is only one of the two forces that make up a market. Supply tells the rest of the story and is the topic of our next podcast.