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Demand Curve

Definition, Types and How It Works


demand curve

Demand curves usually slope down because the quantity demanded rises as the price falls.

demand curve shift

When a determinant of demand other than price changes, the entire demand curve shifts.

The demand curve plots the relationship between the quantity demanded of a good or service, and its price. The curve depicts in a graphical way the demand schedule. Both of these follow the law of demand, which states that the quantity demanded will drop as the price rises, ceteris paribus (which means "all other things being equal). Those other things are the five determinants of demand, which are price, price of related goods, income, tastes, and expectations. For aggregate demand, there is an obvious sixth determinant -- the number of potential buyers in the market.

Demand Schedule

The demand schedule is a table that shows the quantity of a good or service will be purchased at various prices. Remember, this table is a general relationship because you are assuming that all the other determinants of demand are not changing. If any of the other determinants change, you will have to do a new table. This is known as a demand shift.

Demand Curve

The demand curve simply plots the demand schedule on a graph. This is helpful because you can easily look at the shape of the curve and quickly determine how much price affects demand for your product.

If a drop in price causes a huge increase in quantities bought, the curve looks low and flat. This is known as elastic demand because, like a stretchy rubber band, the quantity demanded moves easily with just a little change in prices. An example of this would be ground beef. If prices drop just 25%, you might buy three times as much as you normally would, because you know you'll use it and you'll just put the extra in the freezer.

If the curve looks steep and narrow, then demand is inelastic. That's because a drop in price isn't able to increase the quantities purchased. This is more like a rope, since it takes a lot of effort to get it to change. An example of this is bananas. No matter how cheap they are, there's only so many you can eat at one time, and they go bad in about a week. You can't really freeze or preserve them, so you won't buy three bunches even if the price falls 25%.

By the way, the reason you react more to a sale in ground beef than bananas is because of the marginal utility of each additional unit. Marginal utility means the usefulness (utility) of each additional unit the further out on the margin you go. Because you can freeze ground beef, the third package is just as good to you as the first. The marginal utility of ground beef is high. However, that third bunch of bananas won't be very appealing, so its marginal utility is low.

Again, these curves assume all other determinants of demand remain the same. If they change, and the demand curve shifts, then the entire curve will move to the right, if demand increases. This means that larger quantities will be demanded at every price. If the entire curve shifts to the left, it means total demand has dropped for all price levels. For example, if you just lost your job, you might not buy that third package of ground beef, even if it is on sale. You might just buy the one package, and be glad it's 25% off.

Aggregate or Market Demand Curve

The market demand curve describes the quantity demanded by the entire market for a category of goods or services. An example of this is gasoline prices overall. When the cost of oil goes up, all gas stations must raise their prices to cover their costs. Even if the price drops 50%, drivers aren't going to increase the amount bought by that much. That's why, when the price skyrockets from $3.20 - $4.00 a gallon, people get very upset. They can't cut back their driving to work, school and the grocery store very easily, and so they are forced to pay more for gas.

By the way, this lowers their incomes for things other than gas. Income is another determinant of demand, so that means the demand curve for other things they would like to buy, like ice cream, will drop. This is called a demand shift. In this case, the entire demand curve for ice cream shifts to the left. Since buyers have less income, they will purchase a lower quantity of ice cream even at the same price.

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