In a competitive market, demand for and supply of a good or service determine the equilibrium price.
The law of demand
Markets have two agents: buyers and sellers. Demand represents the buyers in a market. Demand is a description of all quantities of a good or service that a buyer would be willing to purchase at all prices.
According to the law of demand, this relationship is always negative: the response to an increase in price is a decrease in the quantity demanded.
For example, if the price of scented erasers decreases, buyers will respond to the price decrease by increasing the quantity of scented erasers demanded. A market for a good requires demand and supply.
The determinants of demand
What influences demand besides price? Factors like changes in consumer income also cause the market demand to increase or decrease. For example, if the number of buyers in a market decreases, there will be less quantity demanded at every price, which means demand has decreased.
For instance, if scented erasers are normal goods, then when buyers have more income they will buy more scented erasers at every possible price; this would also shift the demand curve to the right.
|Demand||All of the quantities of a good or service that buyers would be willing and able to buy at all possible prices; demand is represented graphically as the entire demand curve.|
|Demand schedule||A table describing all of the quantities of a good or service; the demand schedule is the data on price and quantities demanded that can be used to create a demand curve.|
|Demand curve||A graph that plots out the demand schedule, which shows the relationship between price and quantity demanded|
|Law of demand||All other factors being equal, there is an inverse relationship between a good’s price and the quantity consumers demand; in other words, the law of demand is why the demand curve is downward sloping; when price goes down, people respond by buying a larger quantity.|
|Quantity demanded||The specific amount that buyers are willing to purchase at a given price; each point on a demand curve is associated with a specific quantity demanded.|
|Change in quantity Demanded||A movement along a demand curve caused by a change in price; a change in quantity demanded is a movement along the same curve|
|Change in demand||When buyers are willing to buy a different quantity at all possible price, which is represented graphically by a shift of the entire demand curve; this occurs due to a change in one of the determinants of demand.|
|Determinants of demand||Changes in conditions that cause the demand curve to shift; the mnemonic TONIE can help you remember the changes that can shift demand (T-tastes, O-other goods, N-number of buyers, I-income, E-expectations)|
|Normal good||A good for which demand will increase when buyers’ incomes increase.|
|Inferior good||A good for which demand will decrease when buyers’ incomes increase.|
|Substitute goods||Goods that can replace each other; when the price of a good increases, the demand for its substitute will increase.|
|Complement goods||Goods that tend to be consumed together; when the price of a good increases the demand for its complement will decrease.|
Determinants of Demand Mean
- Consumer preferences: personality characteristics, occupation, age, advertising, and product quality, all are key factors affecting consumer behavior and, therefore, demand.
- Prices of related products: an increase in the price of one product will cause a decrease in the quantity demanded of a complementary product. In contrast, an increase in the price of one product will cause an increase in the demand for a substitute product.
- Consumer income: the higher the consumer income, the higher the demand and vice versa.
- Consumer expectations: expectations for a higher income or higher prices increase the quantity demanded. Expectations for a lower income or lower prices decrease the quantity demanded.
- The number of buyers: the higher the number of buyers, the higher the quantity demanded, and vice versa.
- Other factors: the weather and governmental policies that may expand or contract the economy affect the demand for particular products or services.
Let’s look at an example.
Chris wants to fuel his car. At the gas station, he realizes that the gas prices have skyrocketed to $5 a gallon. Chris faces some income problems lately because he lost his job. Therefore, he cannot afford to pay a high gas price. What is Chris going to do?
Because Chris’ car runs on gas and he cannot replace it with a substitute good that would be a car running on electricity, Chris decides to spend less on a complementary good such as tires. So, the next time Chris changes tires, he will buy cheaper tires to trade off for the increase in the gas.
What if Chris thinks that the price of gas will increase further?
If Chris expects that the price of gas will rise, he is more likely to put gas in his car more often. Instead of filling the car every week, he will start filling it every other day to take advantage of the price of gas today.