Demand curve

Demand curve

In economics, the demand curve can be defined as the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. The demand curve for all consumers together follows from the demand curve of every individual consumer: the individual demands at each price are added together.

Demand curves are used to estimate behaviors in competitive markets, and are often combined with supply curves to estimate the equilibrium price (the price at which all sellers are able to find a willing buyer, 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.

Characteristics

The demand curve usually slopes downwards from left to right; that is, it has a negative association (for two theoretic exceptions, see Veblen good and Giffen good). The negative slope is often referred to as the "law of demand," which means that when all things but price are held equal, if the price of the good/service increases, the less of that good/service will be purchased by consumers; see also price elasticity of demand. The demand curve is related to the marginal utility curve, since the price one is willing to pay depends on the utility. However, the demand directly depends on the income of an individual while the utility does not. Thus it may change indirectly due to change in demand of other commodities. These individual factors come together to determine the budget constraint and indifference curve of consumers. The demand curve is then generated by connecting the points where those lines are tangent to one another.

If the price a consumer is willing to pay for an additional unit of a good increases initially as function of amount (see examples) then the maximum price pmax he is willing to pay is more than the price he would be willing to pay for the first unit. At this price pmax there is a non-zero amount A for which the consumer surplus is zero; at this price and amount the negative consumer surplus for the first units is compensated by the more attractive later units, for each of which the consumer would be willing to pay more than pmax. At this amount the price he is willing to pay for an additional unit has decreased back to pmax. If the price is lower than pmax the consumer will buy more. Thus he buys either nothing or at least A. In this case the individual demand curve has a discontinuity, where, after decreasing with price as usual, the demand jumps to zero. At this price he is indifferent between buying this minimum amount and buying nothing (spending the money on something else). Geometrically pmax is the slope of the steepest line through the origin and another point of the graph of the total price the consumer is willing to pay as function of amount. In the case of a smooth function this line is tangent to the graph.

If the price a consumer is willing to pay for an additional unit of a good goes up and down more often, then the demand curve has more discontinuities, each associated with a line through two points of the graph of the total price the consumer is willing to pay as function of amount, with no part of the graph above the line.

Demand schedule

Demand schedules are tables that contain experimentally obtained information of buying habits at varied prices. From these data a demand curve is then estimated and graphed, usually with the amount of a good or service demanded graphed to the x axis (often named in equations as "Q") and the price at which the good or service would be purchased on the y axis (often named in equations as "P").

Parameters

Points on the demand curve show how the quantity demanded depends on the price of the good or service. The curves themselves depend on determinants of demand such as income, customer preference, prices of complementary and substitute goods/services. "Change in demand" often refers to change of the curve, due to a change in one of these factors other than the price of the commodity itself. It is e.g. a shift, or a change of slope.

Increase in demand shifts the demand curve to the right. Increase in demand can be caused by, for example, decrease in price of a complementary good (see cross elasticity of demand) or increase in income (see income elasticity of demand). Decrease in demand shifts it to the left. Decrease can be caused by, for example, expectations of lower future prices or decrease in population and market size.

Discreteness of amounts

If a commodity is sold in whole units, and these are substantial for a consumer, then the individual demand curve can hardly be approximated by a continuous curve. It is a step function of the price, defined by a price above which no unit is bought, a price range for which one is bought etc.

The price a consumer is willing to pay for the first unit may be small, for the second unit large, and for further units small again (see above); he may then, regardless of price, never buy exactly one unit, and buy none if the price is above a certain price pmax, and two if the price is pmax or lower. This may be the case for travel or theater tickets, if he likes to take a date or friend. If the tickets can be used at any time and they may like to go multiple times the price the consumer is willing to pay for an additional unit may alternatingly be small and large, and eventually tend to zero. In this case the demand may always be even. Geometrically pmax is the slope of the steepest line through the origin and another point of the graph (which consists of discrete points) of the total price the consumer is willing to pay as function of amount.

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 down when tax is introduced, and up when subsidy is introduced.

See also

References

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