Demand is the quantity of a good or service that customers want to buy. We all may want a brand new Ferrari, speedboat and a mansion on a private island, but we can’t all afford them. Our wants become a demand when we have the money to back up our desires. This is called effective demand, in other words, what customers are prepared and able to buy at a particular price.
The Shape of the Demand Curve
The table below shows a class’s weekly demand for 500ml bottles of Coca Cola between 20p and £1.
This demand can be plotted on the chart below.
The demand curve is downward sloping; this means that there is an inverse relationship between the price of a good and the quantity demanded. An increase in the price will lead to a fall in the quantity demanded, while a decrease in the price will lead to a rise in the quantity demanded.
It is possible to distinguish between an individual demand curve and an economy’s demand curve. If you were able to add up all of the individual demand curves for a particular good in an economy, we would call it a market demand curve.
The market demand curve also shows an inverse relationship between price and quantity.
Another way of explaining why the demand curve is downward sloping is to calculate how much satisfaction you get from consuming increasing quantities. If the amount of utility from consuming a good falls, a rational consumer would only be prepared to pay a lower price. Utility is measured in utils – the higher the number of utils, the greater the satisfaction.
It is possible to calculate how much of a good you will purchase by checking the price in a shop. Assuming the price of a Mars Bar is below what you’re prepared to pay for one chocolate bar, you will keep consuming until the satisfaction you receive is worth less than the price Mars are charging. For example, if the satisfaction you will get from the fourth Mars Bar is worth 40p and the Mars Bar costs 50p you wouldn’t but it. If the price a shop charges in above what you are willing to pay for one Mars Bar then, as a rational consumer, you won’t demand any Mars Bars.
Movements Along the Demand Curve
Any change in price will cause a movement along the demand curve. An increase in price will lead to a contraction in demand, whilst a decrease in price will cause an extension in demand.
The above diagram shows how an increase in price from P1 to P3 will cause the quantity to fall from Q1 to Q3. Conversely a fall in price from P1 to P2 leads to the quantity increasing from Q1 to Q2.
Shifts in the Demand Curve
A change in price will lead to a movement along the demand curve, whilst a change in any other factor could cause a shift in demand.
We can see what will happen when there is a shift in demand in the diagram above. This shows what will happen to the quantity demanded if the price stays the same.
There are a number of general factors highlighted economists that will lead to a shift in the demand curve.
Changes in income
When incomes go up there will also be an increase in demand for most goods. When a demand rises for a product after an increase in income, we call the good or service a normal good. There are also some goods, known as inferior goods, which will see a decrease in demand for them after a rise in income.
The price of Substitue goods
If the price of a rival product, known as a substitute good, decreases then demand will fall. For example, a decrease in the price of Pepsi will lead to a decrease in demand for Coca Cola.
The price of complement goods
If the goods are complements then a fall in the price of one good will lead to an increase in demand for the other. For example, if the price of Playstation 3 was to fall, we would expect to see an increase in the demand for Playstation 3 games.
An increase in population is likely to lead to an increase in demand.
Advertising and Publicity
Advertising aims to influence customer decisions. An effective campaign will lead to an increase in demand.
Changes in Fashion
Goods and services will frequently move an out of fashion affecting the level of demand.
Changes in Quality
If the quality of the good improves then you would expect to see demand shifting to the right as more people would want to buy even if the price remained the same.
Changes in the Weather
The demand for some products is heavily influenced by the weather, for example, when the temperature rises above 18 degrees, sales of Bacardi Breezer rise by 8% for every extra degree!
Changes in the Law
The law can impact the level of demand dramatically as certain goods or services are made illegal or compulsory, for example, the demand for guns fell after the were made illegal and cigarette sales fell after the legal age for buying them increased to 18.
Uncertainty over Future Prices
Many commodity markets, such as oil and gas, are affected by what traders think will happen to prices in the future.
This applies when a good is demanded for two or more distinct uses, for example, steel is used in the production of cars and ships.
There are goods which are only demanded because they are needed for the production of other goods, for example, flour is required to produce bread and steel is used in the production of cars. An increase in the demand for cars will lead to an increase in demand for steel.