MyLab Economics
3.1 Demand
What determines the demand for any given product? How will Canadian consumers respond to the next sudden change in the price of gasoline or coffee? What is the impact on the demand for kale once consumers decide it is the latest superfood? We start by developing a theory to explain the demand for some typical product.
Quantity Demanded
The total amount of any particular good or service that consumers want to purchase during some time period is called the quantity demanded of that product. It is important to notice two things about this concept.
First, quantity demanded is a desired quantity. It is the amount that consumers want to purchase when faced with a particular price of the product, other products’ prices, their incomes, their tastes, and everything else that might matter. It may be different from the amount that
consumers actually succeed in purchasing. If sufficient quantities are not available, the amount that consumers want to purchase may exceed the amount they actually purchase. (For example, you may try to buy an airline ticket for reading week only to find that all flights are already sold out.) To distinguish these two concepts, the term quantity demanded is used to refer to desired purchases, and such phrases as quantity bought or quantity exchanged are used to refer to actual purchases.
Second, quantity demanded refers to a flow of purchases, expressed as so much per period of time: 1 million units per day, 7 million per week, or 365 million per year. For example, being told that the quantity of new cars demanded (at current prices) in Canada is 50 000 means nothing
unless you are also told the period of time involved. For a country as large as Canada, 50 000 cars demanded per day would be an enormous rate of demand, whereas 50 000 per year would be a very small rate of demand.
The important distinction between stocks and flows is discussed in Extensions in Theory 3-1.
Extensions in Theory 3-1
The Distinction Between Stocks and Flows
An important conceptual issue that arises frequently in
economics is the distinction between stock and flow variables.
Economic theories use both, and it takes a little practice to keep them straight.
As noted in the text, a flow variable has a time dimension—it is so much per unit of time. For example, the quantity of Grade A large eggs purchased in Edmonton is a flow variable. No useful information is conveyed if we are told that the number
purchased was 2000 dozen eggs unless we are also told the period of time over which these purchases occurred. Two thousand dozen eggs per hour would indicate a much more active market in eggs than would 2000 dozen eggs per month.
In contrast, a stock variable is a variable whose value has meaning at a point in time. Thus, the number of eggs in the egg producer’s warehouse on a particular day—for example, 10 000 dozen eggs on September 3, 2019—is a stock variable. All those eggs are there at one time, and they remain there until something happens to change the stock held in the warehouse.
The terminology of stocks and flows can be understood using an analogy to a bathtub. At any moment, the tub holds so much
The total amount of some product that consumers in the relevant market want to buy during a given time period is influenced by the following important variables: [2 ]
Product’s own price Consumers’ income Prices of other products Consumers’ tastes
water. This is the stock, and it can be measured in terms of the volume of water, say, 100 litres. There might also be water flowing into the tub from the tap; this flow is measured as so much water per unit time, say, 10 litres per minute.
The distinction between stocks and flows is important. Failure to keep them straight is a common source of error. Note, for example, that a stock variable and a flow variable cannot be added together without specifying some time period for which the flow persists. We cannot add the stock of 100 litres of water in the tub to the flow of 10 litres per minute to get 110 litres. The new stock of water will depend on how long the flow persists; if it lasts for 20 minutes, the new stock will be 300 litres; if the flow persists for 60 minutes, the new stock will be 700 litres (or the tub will overflow!).
The amount of income earned is a flow; it is so much per year or per month or per hour. The amount of a consumer’s
expenditure is also a flow—so much spent per week or per month or per year. The amount of money in a bank account (earned, perhaps, in the past but unspent) is a stock—just so many thousands of dollars. The key test is always whether a time dimension is required to give the variable meaning.
Population
Significant changes in weather
We will discuss the separate effects of each of these variables later in the chapter. For now, we focus on the effects of changes in the product’s own price. But how do we analyze the distinct effect of changes in this one variable when all variables are likely to be changing at once? Since this is difficult to do, we consider the influence of the variables one at a time. To do this in our theory, we hold all variables constant except the product’s own price. Then we let the product’s price vary and study how its change affects quantity demanded. We can do the same for each of the other variables in turn, and in this way we can come to understand the importance of each variable.
Holding all other variables constant is often described by the expressions
“other things being equal,” “other things given,” or the equivalent Latin phrase, ceteris paribus. When economists speak of the influence of the price of gasoline on the quantity of gasoline demanded, ceteris paribus, they refer to what a change in the price of gasoline would do to the quantity of gasoline demanded if all other variables that influence the demand for gasoline did not change.
Quantity Demanded and Price
We are interested in studying the relationship between the quantity demanded of a product and that product’s price. We therefore hold all other influences constant and ask, “How will the quantity demanded of a product change as its own price changes?”
A basic economic hypothesis is that the price of a product and the quantity demanded are related negatively, other things being equal. That is, the lower the price, the higher the quantity demanded; the higher the price, the lower the quantity demanded.
The great British economist Alfred Marshall (1842–1924) called this fundamental relation the “law of demand.” In Chapter 6, we will derive the law of demand as a prediction that follows from more basic
assumptions about the behaviour of individual consumers. For now, let’s simply explore why this relationship seems reasonable.
Products are used to satisfy desires and needs, and there is almost always more than one product that will satisfy any desire or need. Hunger may be alleviated by eating meat or vegetables; a desire for green vegetables can be satisfied by broccoli or spinach. The desire for a vacation may be satisfied by a trip to the ocean or to the mountains; the need to get there may be satisfied by different airlines, a bus, a car, or a train. For any general desire or need, there are almost always many different products that will satisfy it.
1
Changes in prices lead most consumers to alter their choices. For
example, as prices for hotel rooms fall, vacationers may be more likely to take weekend trips.
REDPIXEL.PL/Shutterstock
Now consider what happens if income, tastes, population, and the prices of all other products remain constant and the price of only one product changes. As the price goes up, that product becomes an increasingly expensive means of satisfying a desire. Many consumers will decide to switch wholly or partly to other products. Some consumers will stop buying it altogether, others will buy smaller amounts, and still others may continue to buy the same quantity. But the overall effect is that less will be demanded of the product whose price has risen. For example, as meat becomes more expensive, some consumers will switch to meat
substitutes; others may forgo meat at some meals and eat less meat at others. Taken together as a group, consumers will want to buy less meat when its price rises.
Conversely, as the price goes down, the product becomes a cheaper way of satisfying a desire. Households will demand more of it as they
substitute away from other products whose prices have not fallen. For example, if the price of tomatoes falls, many shoppers will buy more tomatoes and less of other vegetables.
1 In this chapter we explore a product’s demand curve for the market as a whole—what we often call the market demand curve. In Chapter 6 we discuss how this market demand curve is derived by adding up, or aggregating, the demands of different individuals.
Figure 3-1 The Demand for Apples
Demand Schedules and Demand Curves
A demand schedule is one way of showing the relationship between quantity demanded and the price of a product, other things being equal.
It is a table showing the quantity demanded at various prices.
The table in Figure 3-1 shows a hypothetical demand schedule for apples. It lists the quantity of apples that would be demanded at various prices, given the assumption that all other variables are held constant.
The table gives the quantities demanded for five selected prices, but in fact a separate quantity would be demanded at every possible price.
Both the table and the graph show the total quantity of apples that would be demanded at various prices, ceteris paribus. For example, row W
indicates that if the price of apples were $60 per bushel, consumers would desire to purchase 65 000 bushels of apples per year, holding constant the values of the other variables that affect quantity demanded. The demand curve, labelled D, relates quantity of apples demanded to the price of apples; its negative slope indicates that quantity demanded increases as price falls.
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A second method of showing the relationship between quantity demanded and price is to draw a graph. The five price–quantity combinations shown in the table are plotted in Figure 3-1 . Price is plotted on the vertical axis, and the quantity demanded is plotted on the horizontal axis.
The curve drawn through these points is called a demand curve It shows the quantity that consumers would like to buy at each price. The negative slope of the curve indicates that the quantity demanded increases as the price falls. Each point on the demand curve indicates a single price–quantity combination. The demand curve as a whole shows something more.
The demand curve represents the relationship between quantity demanded and price, other things being equal; its negative slope indicates that quantity demanded increases when price decreases.
When economists speak of demand in a particular market, they are referring not just to the particular quantity being demanded at the
moment (i.e., not just to one point on the demand curve) but to the entire demand curve—to the relationship between desired purchases and all the possible prices of the product.
The term demand therefore refers to the entire relationship between the quantity demanded of a product and the price of that product. In contrast, a single point on a demand schedule or curve is the quantity demanded at that point. This distinction between “demand” and “quantity demanded” is an extremely important one and we will examine it more closely later in this chapter.
Shifts in the Demand Curve
Figure 3-2 An Increase in the Demand for Apples
A demand curve is drawn with the assumption that everything except the product’s own price is being held constant. But what if other things change, as they often do? For example, consider an increase in average household income while the price of apples remains constant. If
consumers spend some of their extra income on apples, the new quantity demanded cannot be represented by a point on the original demand curve. It must be represented on a new demand curve that is to the right of the old curve. Thus, a rise in income that causes more apples to be demanded at each price shifts the demand curve for apples to the right, as shown in Figure 3-2 . This shift illustrates the operation of an important general rule.
An increase in annual household income increases the quantity demanded at each price (for all normal goods). This is shown by the rightward shift in the demand curve, from to When average income rises from $50 000 to $60 000 per year, quantity demanded at a price of
$60 per bushel rises from 65 000 bushels per year to 95 000 bushels per year. A similar rise occurs at every other price.
A change in any of the variables (other than the product’s own price) that affect the quantity demanded will shift the demand curve to a new position.
D0 D1.
Figure 3-3 Shifts in the Demand Curve
A demand curve can shift to the right or to the left, and the difference is crucial. In the first case, more is desired at each price—the demand curve shifts rightward so that each price corresponds to a higher quantity than it did before. This is an increase in demand. In the second case, less is
desired at each price—the demand curve shifts leftward so that each price corresponds to a lower quantity than it did before. This is a decrease in demand. Figure 3-3 shows increases and decreases in demand, and the associated shifts in the demand curve.
A rightward shift in the demand curve from to indicates an increase in demand; a leftward shift from to indicates a decrease in demand. An increase in demand means that more is demanded at each price. A decrease in demand means that less is demanded at each price.
Let’s now consider five important causes of shifts in the demand curve.