Source: Image of Demand Graph created by Kate Eskra
Hi, welcome to macroeconomics. This is Kate. This tutorial is on the law of demand. As always, my key terms are in red, and my examples are in green.
In this tutorial we'll be talking about the law of demand. You'll be able to interpret a demand schedule and see what a demand graph looks like. We'll talk about why a demand curve is downward sloping. And we'll discuss like ceteris paribus is important when discussing demand. Finally, you'll understand that a change in price causes movement along a demand curve and is known as a change in quantity demanded.
So just to get you thinking about demand in your life. Really and truly, we use the law of demand every day. So think about the last time you bought something because it was on sale. Or you used a coupon or an ad to get a deal. Or maybe you didn't buy something, because its prices was too high.
In all of those situations, you were using demand. Because demand means that you want something, and you have the ability to afford it-- or the willingness to pay for it. That's why demand is sometimes called willingness to pay.
I'm using the example of Granny Smith apples. They tend to be my favorite kind of apple. So this is what's called a demand schedule.
Notice that here's the price of the apple, and here's the quantity. You can think of this like if I were surveyed, or if somebody was surveyed how many apples would you purchase each week, if they were these different prices. Notice I'm saying that if each apple was $2, I would not purchase any.
As the price goes down, OK, at $1.50, you know what, I really do like Granny Smith apples, so maybe I'll buy one a week and treat myself. If they were only $0.50 an apple, I would purchase five. If they were $0.25, I'd purchase six. And if they're free, I really can't eat more than an apple a day, so I would buy seven.
When we graph this relationship, what we do is we put price on the y-axis and the quantity that I'm willing and able to purchase on the x-axis. All I did was plot these points. And you can see that when I plot the points, I am faced with a downward sloping demand curve.
The idea here is as the price of Granny Smith apples falls, I tend to buy a greater quantity. So this right here is really the law of demand. And notice there is an inverse or negative relationship between the price and the quantity. This would also work in reverse. Obviously as price would rise, the quantity would fall.
So the law of demand is defined as the inverse correlation between price and quantity with all other variables fixed. So why is demand downward sloping? It might make sense to you, it makes sense to a lot of us. But why exactly is there an inverse relationship between price and quantity?
It's actually because of two different reasons. As things get more expensive, first of all, we can't afford as much of it generally, because of the effect on our income. The other reason, and it goes along with this, that we buy less of something as it gets more expensive is because we're usually able to find substitutes to that good or service.
Now we need to talk about the idea that for some goods and services people will respond a lot when the price changes. So for example, if I stick with my Granny Smith apples, when the price goes up for just Granny Smith apples, people will probably respond a lot to this, because there are so many different brands of apples. So either they buy a different brand of apple, or they just purchase a different fruit. And that's because there are many different substitutes, like I said, to Granny Smith apples.
But for some good people will not respond as much when the price changes. So the example I came up with was gasoline. As gasoline gets more expensive, generally speaking, most people still want to drive.
But at some point, people do start to alter their behaviors. Some people do need to make changes as gasoline gets more expensive and impacts their income. And so we see that people begin to carpool more often, go on fewer longer trips, maybe utilize public transportation, or really consider locating closer to work. So here, gasoline is though more difficult to substitute than a brand of apple, so people don't tend to respond as much.
Are there exceptions to this, or is there anything where if the price goes up people still buy the same amount? It's pretty rare, these are special cases. But I'm using a very extreme example here, for like a life-saving medicine that someone needs regardless of price. And this is actually said to be a perfectly inelastic demand, meaning people don't respond at all as the price changes. So that's one example.
But keep in mind, these things are pretty rare. For the most part, as price goes up, people buy less. And as price goes down, people do tend to buy more.
All of this that I've been talking about though, assumes this law of ceteris paribus, which is defined as holding everything else constant. So as I've been talking about the price of Granny Smith apples going up, we can expect that people will buy fewer Granny Smith apples. But what we're assuming here is that only the price of Granny Smith apples has changed. For example, the price of Gala apples didn't change, the price of oranges or bananas didn't change, my income didn't change.
That's why a change in price is going to be seen as movement along a curve. So if I go back to this demand schedule and demand graph, notice as the price of Granny Smith apples, I buy more. Because price is on this axis and quantity is on this axis, it's only involving these two variables here, price and quantity. Since it's just describing a relationship between the y- and x-axis, we just move from one point to the next as price changes, to move along the curve. And this is really important when we talk about how we say this.
This is not a change in demand. You would not say, as the price falls, my demand goes up. You would say, as the price falls, my quantity demanded increases. And so we consider a price change a change in quantity demanded, not a change in demand itself. We'll be talking about that in a different tutorial.
In this tutorial we talked about how the law of demand describes the relationship between price and quantity. And you saw the inverse or negative relationship between them. And I talked about a very rare, special situation where maybe people don't respond at all as price goes up, but typically there is an inverse or negative relationship between them.
Keep in mind that when we're moving along this demand curve, we're holding everything else constant. And that law is the law of ceteris paribus. A change in price causes movement along the demand curve. And that's known as a change in quantity demanded. Thanks so much for listening, have a great day.
Law of Demand
The inverse correlation between price and quantity with all other variables fixed.
Holding all other variables constant.