APMacro: Demand


A market is an institution or mechanism that brings together buyers and sellers of particular goods, services, or resources. All situations that link potential buyers with potential sellers are markets. Some markets are local, while others are national or international. Some are highly personal, involving face-to-face contact between buyers and sellers. Others are impersonal, with buyers and sellers never seeing or knowing each other. We will focus on markets consisting of large numbers of independently acting buyers and sellers of standardized products. These are highly competitive markets in which price is discovered through the interacting decisions of buyers and sellers. They are not the markets in which one or a handful of producers set prices.

Demand is a schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time. Demand shows the quantities of a product that will be purchased at various possible price, other things equal. To be meaningful, the quantities demanded at each price must relate to a specific period: a day, a week, a month. Unless a specific time period is stated, we do not know whether the demand for a product is large or small.

A fundamental characteristic of demand is this: All else equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. In short, there is a negative or inverse relationship between price and quantity demanded. Economists call this inverse relationship the law of demand. Why the inverse relationship between price and quantity demanded? There are three explanations:

The law of demand is consistent with common sense. People ordinarily do buy more of a product at a low price rather than a higher price. Price is an obstacle that deters consumers from buying. The higher that obstacle, the less of a product they will buy; the lower the price obstacle, the more they will buy. The fact that businesses have sales is evidence of their belief in the law of demand.

In any specific period, each buyer of a produce will derive less satisfaction or utility from each successive unit of the product consumed.That is, consumption is subject to diminishing marginal utility. And because successive units of a particular product yield less and less marginal utility, consumers will buy additional units only if the price of those units is progressively reduced.

We can also explain the law of demand in terms of income and substitution effects. The income effect indicates that a lower price increases the purchasing power of a buyer’s money income, enabling the buyer to purchase more of the product than they could buy before. A higher price has the opposite effect. The substitution effect suggests that at a lower price buyers have the incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive.The product whose price has fallen is now a better deal relative to the other products.  The income and substitution effects combine to make consumers able and willing to buy more of a product at a low price than at a high price.

demand-graph-l3fig9

The inverse relationship between price and quantity demanded for any product can be represented on a simple graph. We measure quantity demanded on the horizontal axis and price on the vertical axis. The demand curve is a curve with a downward slope which reflects the law of demand – people buy more of a product, service, or resource as its price falls. The relationship between price and quantity demanded is inverse.

Economists assume that price is the most important influence on the amount of any product purchased. But economists know that other factors can and do affect purchases. These factors, called determinants of demand are assumed to be constant. They are the other things equal in the relationship between price and quantity demanded. When any of these determinants changes, the demand curve will shift to the right or left. For this reason, determinants of demand are sometimes referred to as demand shifters. The basic determinants of demand are 1) consumers’ tastes or preferences, 2) the number of consumers in the market, 3) consumers’ incomes, 4)  the prices of related goods (substitutes and complements), and 5) consumer expectations about future prices and income.

demand_vs_Qdemanded

A change in demand must not be confused with a change in quantity demanded. A change in demand is a shift of the demand curve to the right or to the left. It occurs because the consumer’s state of mind about purchasing the product has been altered in response to a change in one or more of the determinants of demand. Recall that demand is a schedule or curve, therefore a change in demand means a change in the schedule and a shift of the curve.

In contrast, a change in quantity demanded is a movement from one point to another point (from one price-quantity combination to another) on a fixed demand schedule or demand curve.The cause of such a change is an increase or decrease in the price of the product under consideration.


Homework:
1) Read Chapter 3 Demand pp.39-45

Arrows-02-june

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