The Allocation of Resources - Demand

Objective: Drawing and Interpretation of the Demand Diagram

This section focuses on understanding the law of demand and how it is visually represented using a demand diagram. We will learn to construct demand diagrams and interpret shifts in the demand curve caused by changes in various factors.

1. The Law of Demand

The law of demand states that, ceteris paribus (all other things being equal), as the price of a good or service increases, the quantity demanded decreases, and vice versa. This inverse relationship is the foundation of the demand curve.

2. The Demand Curve

A demand curve is a graphical representation of the relationship between the price of a good and the quantity demanded at that price. It typically slopes downwards from left to right, reflecting the inverse relationship described by the law of demand.

Key characteristics of the demand curve:

• Inverse Relationship: As price increases, quantity demanded decreases.
• Negative Slope: The downward slope indicates the inverse relationship.
• Individual vs. Market Demand: Individual demand refers to the demand of a single consumer, while market demand refers to the total demand for a good in the market at a given price. Market demand is the horizontal summation of individual demands.
• Factors Affecting Demand (other than price): Changes in these factors can cause the entire demand curve to shift.

3. Factors that Shift the Demand Curve

Besides price, several other factors can influence the quantity demanded of a good. These factors cause a shift in the entire demand curve.

• Consumer Income:
  • Normal Goods: As income increases, demand increases (positive shift).
  • Inferior Goods: As income increases, demand decreases (negative shift).
• Consumer Tastes and Preferences: Changes in consumer tastes (e.g., due to advertising, fashion trends) can shift the demand curve.
• Prices of Related Goods:
  • Substitute Goods: If the price of a substitute good increases, the demand for the original good increases (rightward shift). Example: 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 (leftward shift). Example: If the price of petrol increases, demand for cars might decrease.
• Consumer Expectations: Expectations about future price changes or income changes can affect current demand.
• Population Size and Composition: A larger population or a population with a different age distribution can alter overall demand.

4. Drawing a Demand Diagram

A demand diagram is a graph that shows the relationship between the price and quantity demanded of a good or service. It typically includes the following:

• Vertical axis: Price (P)
• Horizontal axis: Quantity Demanded (Q)
• Demand Curve: A downward-sloping curve representing the relationship between price and quantity demanded.

5. Interpreting Demand Shifts

A shift in the demand curve indicates a change in demand at every price level. We can analyze these shifts by considering the factors mentioned above.

Example: Consider the market for smartphones. If there is a significant increase in consumer income, the demand for smartphones will likely increase, leading to a rightward shift in the demand curve. This will result in a higher equilibrium price and a higher equilibrium quantity.

6. Table Summary of Demand Factors and Curve Shifts

7. Conclusion

Understanding the law of demand and the factors that influence it is crucial for analyzing market behavior. Demand diagrams provide a valuable tool for visualizing and interpreting changes in the market for goods and services.