See Changes in Demand

Buying goods is like voting with money. Firms view "dollar votes" as signals about how to most profitably satisfy consumer wants. Items with the highest prices relative to their production costs earn the greatest profits. Firms compete to provide these items so that the wants consumers perceive as most pressing tend to receive top priority.

 

            You may wonder if available resources can accommodate everyone's "needs," but "needs" are ambiguous. Most Americans find a car a "necessity", and many of us suffer withdrawal symptoms if deprived of television for even a day or two. And in a wealthy society like ours, even meals are often recreational and unnecessary.

 

            What is absolutely required for survival? Life could be sustained for $1,000 a year if, for example, you lived in a cardboard shack, ate soybean curd and vitamins, and wore secondhand clothes to prevent sunstroke or frostbite. Most of us, however, view people living so meagerly as still needy. Economists stress consumer demands because "needs" are both vague and normative.

 

Demand is the quantity of a specific good that people are willing and able to buy during a specific period, given the choices available.

            Consider a typical consumption choice. You probably attend concerts, buy CDs, and watch television. The market price of watching an extra hour of TV is roughly $0, CDs are about $15, and concert tickets range from $16 to $100 apiece. If you are typical, you spend a lot more time watching TV than attending concerts, with listening to CDs or tapes falling somewhere in between. This example suggests that the market prices of goods and the amounts consumers purchase are negatively related. Purchasing patterns depend on two sets of relative prices.

 

Market prices are the prices charged for goods whether we buy them or not; demand prices reflect the relative values an individual subjectively places on having a bit more or less of a good.

            Prices in airports are typically higher than those in grocery stores, yet you may still be desperate enough to buy a small pack of chewing gum for about $1 to relieve the pressure on your eardrums during a flight.  Whether market prices and our demand prices are aligned is partially determined by our budgets. BMWs are "worth the money" to their owners, but demand prices for BMWs for the rest of us fall far below their market price. Given our budgets, a BMW subjectively "is not worth the price" to us, and we drive cheaper cars, if we drive at all.

 

The Law of Demand

Most goods have many possible uses. How extensively a good is used depends on its price. When a good's relative price falls, it becomes more advantageous to substitute it for other goods, while substitutes are used to displace goods that become more expensive. This substitution effect of a change in relative prices is the foundation for the law of demand, a basic concept in the economics of consumer behavior.

The law of demand: All else equal, consumers buy more of a good during a given period the lower its relative price, and vice versa.

            Substitution is pervasive. For example, caviar is now a high-priced delicacy, but it might replace baloney on children's sandwiches if its price fell to $0.50 per pound. Were it free, we might use it for dog food, hog slop, and fertilizer. We would use diamonds as a base for highways if they cost less than gravel. On the other hand, if gasoline was $10 a gallon, cities would be more compact and we would rely far more on bicycles, walking, or public transit; few people would waste fuel on meandering pleasure trips or hit-and-run shopping. If peanut butter were $50 per pound, gourmets might consider it a delicacy to be savored on fancy crackers at posh parties.

 

            The critical point is that people find substitutes for goods that become relatively more costly, and wider uses for goods that become cheaper.

 

            A facet of the law of diminishing returns partially explains why substitution occurs:

The principle of diminishing marginal utility (satisfaction): The more you have of any good relative to other goods, the less you desire and are willing to pay for additional units of that good.

For example, you would probably not find a ninth double fudge pecan brownie as satisfying as the first you ate on a given day. This principle applies to demands for face-lifts, bungee jumping, affection from your latest heartthrob, or any other good.

            Another reason purchases of a good rise when its price falls is that the purchasing power of a given money income increases—so you can buy more of the good while maintaining or even increasing your other purchases. This is the income effect of a price change. Income effects usually reinforce the negative slopes of demand curves, but they tend to be less direct and far less important than substitution effects. Only if the good for which price fell absorbed big chunks of your budget (e.g., rent) would the income effect of a price change be very large.[1]

 

Individuals' Demand Curves

The law of demand's negative relationship between the price of any good and the quantity consumed yields a negatively-sloped demand curve.

A demand curve depicts the maximum quantities of a good that given individuals are willing and able to purchase at various prices during a given period, all else assumed equal.

An equivalent perspective that, in some cases, is also useful, views demand curves as reflecting the maximum price people are willing to pay for an additional unit of a good, given their current consumption. Thus, demand curves reflect subjectively-determined marginal benefits of goods.

            Arlene is an avid reader.  Figure 2 shows how lower market prices for paperbacks could induce her to buy more[2]. She buys 30 novels annually when each is $1, only 10 at $5, and none if prices rise to $7 (she might watch more TV or renew her library card instead). Suppose she currently buys 14 books at an average of $4.20 apiece. Her demand price (the maximum she would pay) for a fifteenth book is $4 (point a).

Notice that Arlene's demand curve for books does not move when prices change. Instead, a price change causes a move along her demand curve for books—not a shift of the entire curve. Figure 2 also includes Arlene's demand schedule—a table that summarizes important points (price-quantity combinations) on a demand curve.

 

 

 

Market Demand Curves

Business firms and government policy makers are far more interested in market demands than in individual demands. Firms, for example, are much more concerned about how much they will sell at various prices than about which individuals buy which good.

A market demand curve is the horizontal summation of the individual demand curves of all potential buyers of a good.

            Figure 3 depicts the demand curves of Arlene and Bert, the market demand curve if they are the only paperback buyers, and the corresponding demand schedules. Horizontal summation involves summing the quantities per period that individuals buy at each price. At $5 each, Arlene buys 10 paperbacks annually while Bert buys none. Thus, at $5, the quantity demanded in this market is 10 books (10+ 0). At $2, Arlene buys 25 books and Bert buys 15, so the quantity demanded is 40 (25+ 15), and so on.

            Market behavior is a somewhat erratic process of discovery. Measuring actual demands is complex because markets are volatile and "all else" is seldom equal. (Whether a shopper has eaten recently, or whether a child is along may be as important as prices in determining what winds up in a family's grocery cart.) Rapid changes in the many influences on buying and selling can yield foggy information about prices and quantities. Economists who estimate market demands must unravel fragmentary data with sophisticated statistical methods beyond the scope of this book. Nevertheless, most influences on buying patterns are conceptually simple.

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