The Allocation of Resources - Demand

This section explores the concept of demand, linking individual consumer choices to the overall market demand. Understanding demand is crucial for analyzing how resources are allocated in an economy.

Individual Demand

Individual demand refers to the quantity of a good or service that a specific consumer is willing and able to purchase at different price levels during a given period. It is based on the consumer's preferences, income, and the prices of other goods.

Key Principles of Demand:

• Law of Demand: Generally, as the price of a good increases, the quantity demanded decreases, and vice versa. This inverse relationship is represented by a downward-sloping demand curve.
• Income and Demand:
  • Normal Goods: As income increases, the demand for normal goods increases.
  • Inferior Goods: As income increases, the demand for inferior goods decreases.
• Prices of Related Goods:
  • Substitute Goods: If the price of a substitute good increases, the demand for the original good increases (e.g., if the price of coffee increases, demand for tea might increase).
  • Complementary Goods: If the price of a complementary good increases, the demand for the original good decreases (e.g., if the price of petrol increases, demand for cars might decrease).
• Consumer Expectations: Expectations about future price changes can influence current demand. For example, if consumers expect a price increase, they may increase their current demand.

Market Demand

Market demand is the total quantity of a good or service that all consumers in the market are willing and able to purchase at different price levels during a given period. It is the horizontal summation of individual demands.

Demand Curve and Market Demand: The market demand curve is derived from the individual demand curves of all consumers in the market. It also typically slopes downwards, reflecting the law of demand.

Factors Shifting the Demand Curve: Changes in factors other than price can shift the entire demand curve. These include:

• Consumer Income: An increase in income shifts the demand curve for normal goods to the right and the demand curve for inferior goods to the left.
• Consumer Tastes and Preferences: Changes in consumer tastes can shift the demand curve.
• Prices of Related Goods: Changes in the prices of substitute and complementary goods can shift the demand curve.
• Consumer Expectations: Expectations about future prices or income can shift the demand curve.
• Population Size: A larger population generally leads to a higher market demand.

Relationship between Individual and Market Demand

Market demand is the aggregate of individual demands. The market demand curve is simply the sum of all the individual demand curves in the market. The key principle is that the market demand curve reflects the collective willingness and ability of all consumers to purchase a good or service at different price levels.