How Does Demand Change with Price and Income?

TL;DR

A lower price increases quantity demanded but does not change demand itself. Demand shifts only when tastes and preferences, the number of consumers, related-goods prices, income, or expectations change. The downward-sloping demand curve reflects substitution, purchasing power, and diminishing marginal utility, while shifts show that buyers want a different quantity at every price.

Transcript

Hey! How are you doing Econ students? This is Mr. Clifford, welcome to AC/DC Econ. Right now we're going to talk about demand, and since demand has to do with buyers and consumers, I'm going to explain it all consuming this gallon of milk. So here we go, let's start it out. That first taste of milk is just wonderful, right? Cold, refreshing. The fi... Read More

Key Insights

• The law of demand is an inverse relationship between price and quantity demanded. When a product's price falls, its quantity demanded rises, and when its price rises, its quantity demanded falls, assuming the demand curve itself has not shifted.
• A demand curve is a downward-sloping graph created by plotting the quantities buyers want at different prices. Movement along that curve represents a change in quantity demanded caused only by a change in the product's own price.
• The substitution effect is buyers' tendency to purchase more of a product after its price falls because alternatives become relatively more expensive. When milk becomes more expensive, buyers can move toward substitute products instead.
• The income effect is the change in purchasing power created by a price change. A lower milk price allows each dollar to purchase more milk, while a higher price reduces how much milk each dollar can buy.
• Diminishing marginal utility is the decline in additional satisfaction from consuming successive units. Because later gallons of milk provide less additional utility, the price must fall to persuade buyers to purchase greater quantities.
• A change in demand is a shift of the entire demand curve caused by something other than the product's price. A rightward shift indicates more purchasing at every price, while a leftward shift indicates less purchasing at every price.
• The five demand shifters are tastes and preferences, the number of consumers, prices of related goods, income, and expectations. Each can alter how much consumers want to purchase at every possible price.
• Income affects normal and inferior goods differently. Higher income increases demand for a normal good but decreases demand for an inferior good, while lower income decreases normal-good demand and increases inferior-good demand.

Questions & Answers

Q: What is the law of demand?

The law of demand states that price and quantity demanded have an inverse relationship. When the price of milk decreases, consumers purchase a greater quantity of milk. When its price increases, consumers purchase a smaller quantity. A demand schedule displays this relationship numerically, and plotting its price and quantity points produces a downward-sloping demand curve.

Q: Why does the demand curve slope downward?

The demand curve slopes downward because of the substitution effect, the income effect, and diminishing marginal utility. A lower price makes the product cheaper relative to substitutes, increases buyers' purchasing power, and compensates for the declining additional satisfaction received from successive units. Together, these effects explain why buyers purchase larger quantities at lower prices.

Q: How does the substitution effect influence quantity demanded?

The substitution effect causes buyers to move toward a product when its price falls because competing products become relatively more expensive. If milk becomes cheaper, consumers may purchase more milk instead of juice. If milk becomes more expensive, consumers may reduce milk purchases and seek a substitute. This response produces movement along the existing demand curve.

Q: How does the income effect explain the law of demand?

The income effect describes how a product's price changes consumers' purchasing power. If a gallon of milk costs one dollar, each dollar can buy more milk, so consumers can purchase a greater quantity. If the price rises, each dollar buys less milk, purchasing power falls, and consumers reduce the quantity of milk they demand.

Q: What is diminishing marginal utility?

Diminishing marginal utility means that each additional unit consumed eventually provides less additional satisfaction. The first gallon of milk can provide substantial utility for cereal or milk and cookies, while later gallons provide progressively less additional utility. Because extra units are less satisfying, buyers must face a lower price before they will purchase a greater quantity.

Q: What factors shift the demand curve?

The five determinants that shift demand are tastes and preferences, the number of consumers, prices of related goods, income, and expectations. These factors change how much buyers want at every price. Favorable changes can shift demand right, indicating an increase, while unfavorable changes can shift it left, indicating a decrease in demand.

Q: How do substitutes and complements affect demand?

Substitutes can replace one another, so a higher almond milk price increases demand for cow's milk, while a lower almond milk price decreases it. Complements are consumed together, so a lower cereal price increases demand for milk. These related-good price changes shift milk's demand curve because milk's own price has not changed.

Q: What is the difference between demand and quantity demanded?

Quantity demanded changes only when the product's own price changes, producing movement along one demand curve. For example, moving from point A to point B occurs when price falls from three dollars to two dollars and quantity rises from ten to twenty units. Demand changes when a determinant shifts the entire curve, even if price remains unchanged.

Summary & Key Takeaways

• The law of demand states that price and quantity demanded have an inverse relationship. When milk becomes cheaper, buyers purchase more; when it becomes more expensive, buyers purchase less. Plotting the quantities buyers want at different prices creates a downward-sloping demand curve and illustrates movement caused specifically by price changes.

• The demand curve slopes downward because of the substitution effect, income effect, and diminishing marginal utility. Buyers switch toward relatively cheaper goods, gain purchasing power when prices fall, and receive less additional satisfaction from successive units. Consequently, sellers must offer a lower price to encourage consumption of additional quantities.

• Demand shifts when something other than the product's price changes. Its five determinants are tastes and preferences, the number of consumers, prices of substitutes and complements, income, and expectations. A rightward shift means more is demanded at every price, while a leftward shift means less is demanded at every price.