• Chapter 4: Demand

    Lesson 1: Vocabulary

    Content Vocabulary
    • demand
    • microeconomics
    • demand schedule
    • incentive
    • demand curve
    • Law of Demand
    • market demand curve
    • marginal utility
    • diminishing marginal utility
    Academic Vocabulary
    • prevail
    • inversely

    How does demand help societies determine WHAT, HOW, AND for WHOM to produce?

    Demand describes the various amounts of a product that someone is willing and able to buy over a range of possible prices at one point in time. Microeconomics is the part of economic theory that deals with behavior and decision making by individual units, such as people and firms. Firms often try to influence demand in a number of different ways. To see how, analyze a television, print, or online ad for a product.

    An Introduction to Demand

    What is the relationship between the price of an item and the quantity demanded?

    In a market economy, people and firms act in their own best interest to answer the basic WHAT, HOW, and FOR WHOM questions. Demand is central to this process, so an understanding of the concept of demand is essential if we are to understand how the economy works.

    Demand Illustrated

    Fortunately, the calculation of demand comes down to only two variables—the price of a product and the quantity available at a given point in time. For example, we might want to know how many people would choose to see a movie on a given afternoon if the ticket price were $5. Or we might want to know how many would choose to view it if the price were $10. To keep things simple, economists employ a simple assumption called ceteris paribus, or other things held constant. So if the price changes from $5 to $10, or to any other price, we assume that nothing else changes. By assuming ceteris paribus, we rule out any changes in other factors such as the number of other movies playing, how easy it is to purchase tickets, and whether it's a holiday weekend. 

    An Individual’s Demand Schedule

    To understand the effect of changes in price on the quantity demanded, look at Panel A in Figure 4.1. It shows the amount of burritos that a consumer, whom we’ll call Mike, would be willing and able to purchase over a range of possible prices which go from $1 to $10. The information in Panel A is known as a demand schedule. The demand schedule shows the various quantities demanded of a particular product at all prices that might prevail in the market at a given time.

    demand schedule and curve

    As you can see, Mike would not buy any burritos at a price of $9 or $10, but he would buy one if the price fell to $6, and he would buy two if the price were $4, and so on. Just like the rest of us, he is generally willing to buy more units of a product at lower prices. Of course, these numbers may not be entirely realistic but are intended to keep the example simple. For Mike, prices are an incentive, a motivating influence that causes him to act. When the price goes up, he will buy less, and when the price goes down, he will buy more. His income, hunger, and many other factors will feed into his desire, willingness, and ability to buy. If these factors are held constant, then a change in price will be the single incentive that affects the quantity he will buy.

    The Individual’s Demand Curve

    The demand schedule in Panel A of Figure 4.1 can also be shown graphically as the downward-sloping line in Panel B. If we transfer each of the price-quantity observations in the demand schedule to the graph, we can then connect the points to form the curve. Economists call this a demand curve, which shows the quantity demanded at each price that might prevail in the market.

    For example, point a in Panel B shows that Mike would purchase two burritos at a price of $4 each, while point b shows that he will buy three at a price of $3. The demand schedule and the demand curve show the same information—one in a table and the other as a graph.

    The Law of Demand

    Why do economists think of demand as a “law”?

    The prices and quantities in Figure 4.1 point out an important feature of demand: for practically every good or service that we might buy, higher prices are associated with smaller amounts demanded. Conversely, lower prices are associated with larger amounts demanded. This is known as the Law of Demand, which states that the quantity demanded varies inversely with its price. When the price of something increases, the quantity demanded decreases. Likewise, when the price goes down, buyers have an incentive to purchase more, and so the quantity demanded goes up.

    Demand and Marginal Utility

    How does the principle of diminishing marginal utility explain the price we would be willing to pay for another unit of a good or service?

    As you learned earlier, economists use the term utility to describe the amount of usefulness or satisfaction that someone gets from the use of a product. Marginal utility—the extra usefulness or additional satisfaction a person gets from acquiring or using one more unit of a product—is an important extension of this concept because it explains so much about demand.

    The reason we buy something in the first place is because we feel that the product is useful and will give us utility, or satisfaction. However, as we use more and more of a product, we usually encounter diminishing marginal utility. That means that the extra satisfaction we get from using additional quantities of the product begins to decline.

    Because of our diminishing satisfaction—our diminishing marginal utility—as we consume every additional unit, we usually are not willing to pay as much for the second, third, and fourth unit, and so on, as we did for the first. This is why our demand curve is downward-sloping, and this is why Mike and Julia won’t pay as much for the second burrito as they did for the first.

    Diminishing satisfaction happens to all of us. For example, if you are very thirsty, you might be willing to pay a high price for a bottle of water. Once you consume it and are less thirsty, the second bottle will give you less satisfaction and so you might not be willing to pay the same price as you did for the first.