Demand curve


A demand curve is a graph depicting the inverse demand function, a relationship between the price of a certain commodity and the quantity of that commodity that is demanded at that price. Demand curves can be used either for the price-quantity relationship for an individual consumer, or for all consumers in a particular market.
It is generally assumed that demand curves slope down, as shown in the adjacent image. This is because of the law of demand: for most goods, the quantity demanded falls if the price rises. Certain unusual situations do not follow this law. These include Veblen goods, Giffen goods, and speculative bubbles where buyers are attracted to a commodity if its price rises.
Demand curves are used to estimate behaviour in competitive markets and are often combined with supply curves to find the equilibrium price and the equilibrium quantity of that market.
Movement [|"along the demand curve"] refers to how the quantity demanded changes when the price changes.
Shift of the demand curve [|as a whole] occurs when a factor other than price causes the price curve itself to translate along the x-axis; this may be associated with an advertising campaign or perceived change in the quality of the good.
Demand curves are estimated by a variety of techniques. The usual method is to collect data on past prices, quantities, and variables such as consumer income and product quality that affect demand and apply statistical methods, variants on multiple regression. The issue with this approach, as outlined by Baumol, is that only one point on a demand curve can ever be observed at a specific time. Demand curves exist for a certain period of time and within a certain location, and so, rather than charting a single demand curve, this method charts a series of positions within a series of demand curves. Consumer surveys and experiments are alternative sources of data. For the shapes of a variety of goods' demand curves, see the article price elasticity of demand.

Shape of the demand curve

In most circumstances the demand curve has a negative slope, and therefore slopes downwards. This is due to the law of demand which conditions that there is an inverse relationship between price and the demand of commodity. As price goes up quantity demanded reduces and as price reduces quantity demanded increases.
For convenience, demand curves are often graphed as straight lines, where a and b are parameters:
The constant a embodies the effects of all factors other than price that affect demand. If income were to change, for example, the effect of the change would be represented by a change in the value of "a" and be reflected graphically as a shift of the demand curve. The constant b is the slope of the demand curve and shows how the price of the good affects the quantity demanded.
The graph of the demand curve uses the inverse demand function in which price is expressed as a function of quantity. The standard form of the demand equation can be converted to the inverse equation by solving for P:

Curvature

The demand is called convex if the curve bends upwards, concave otherwise.
The demand curvature is fundamentally hard to estimate from the empirical data, with some researchers suggesting that demand with high convexity is practically improbable. Demand curve are, however, considered to be generally convex in accordance with diminishing marginal utility. Theoretically, the Demand curve is equivalent to the Price-offer curve and can be derived by charting the points of tangency between Budget Lines and indifference curves for all possible prices of the good in question.

Assumptions underlying the derivation of the demand curve

  1. Income of the consumer remains constant.
  2. Price of other related goods remain constant.
  3. Preference, tastes, habits and fashions of consumer remains constant.
  4. Number of buyers remain constant.

    Three categories of demand curves

  • Individual demand curve: the relationship between the quantity of a product a single consumer is willing to buy and its price.
  • Market demand curve: the relationship between the quantity of a product that all 'consumers' in the market are willing to buy and its price. The market demand curve can be obtained by adding up the individual demand curves of individual consumers in the industry horizontally.
  • Firm demand curve: It refers to the relationship between the number of customers willing to buy a certain product from the enterprise and its price.
The slope of the market industry demand curve is greater than the slope of the individual demand curve; the slope of the enterprise demand curve is less than the slope of the industry demand curve.
The slope of a firm's demand curve is less than the slope of the industry's demand curve.

Shift of a demand curve

The shift of a demand curve takes place when there is a change in any non-price determinant of demand, resulting in a new demand curve. Non-price determinants of demand are those things that will cause demand to change even if prices remain the same—in other words, the things whose changes might cause a consumer to buy more or less of a good even if the good's own price remained unchanged.
Some of the more important factors are the prices of related goods, income, population, and expectations. However, demand is the willingness and ability of a consumer to purchase a good under the prevailing circumstances; so, any circumstance that affects the consumer's willingness or ability to buy the good or service in question can be a non-price determinant of demand. As an example, weather could be a factor in the demand for beer at a baseball game.
When income increases, the demand curve for normal goods shifts outward as more will be demanded at all prices, while the demand curve for inferior goods shifts inward due to the increased attainability of superior substitutes. When a good is a neutral good its demand want change by a change of income.
With respect to related goods, when the price of a good rises, the demand curve for substitute goods shifts out, while the demand curve for complementary goods shifts in.
With factors of individual demand and market demand, both complementary goods and substitutes affect the demand curve.
  • Complementary goods are goods A and B where the demand for the former and the price of the latter have an inverse relationship, with an increase in the price of the former leading to a decrease in the demand for the latter and vice versa, but there is no relationship between them as capital goods and consumer goods.
  • Substitutes are those goods for which there is a positive relationship between the demand for good A and the price of good B and which are in competition with each other.

    Factors affecting individual demand

  • Changes in the prices of related goods
  • Changes in disposable income, the magnitude of the shift also being related to the income elasticity of demand.
  • Changes in tastes and preferences. Tastes and preferences are assumed to be fixed in the short-run. This assumption of fixed preferences is a necessary condition for aggregation of individual demand curves to derive market demand.
  • Changes in expectations.

    Factors affecting market demand

In addition to the factors which can affect individual demand there are three factors that can cause the market demand curve to shift:
  • a change in the number of consumers,
  • a change of tastes among consumers,
  • a change in the distribution of income among consumers with different tastes.
Some factors which increase the demand
  • Decrease in price of a substitute
  • Increase in price of a complement
  • Decrease in income if good is normal good
  • Increase in income if good is inferior good

    Movement along a demand curve

There is movement along a demand curve when a change in price causes the quantity demanded to change. It is important to distinguish between movement along a demand curve, and a shift in a demand curve. Movements along a demand curve happen only when the price of the good changes. When a non-price determinant of demand changes, the curve shifts. These "other variables" are part of the demand function. They are "merely lumped into intercept term of a simple linear demand function." Thus a change in a non-price determinant of demand is reflected in a change in the x-intercept causing the curve to shift along the x axis.

Elasticity of demand for a good with respect to its own price

The price elasticity of demand is a measure of the sensitivity of the quantity variable, Q, to changes in the price variable, P. The elasticity of demand for a good with respect to its own price is the percentage of change in quantity divided by the percentage of change in price. For example an elasticity equals to -2 means that if the price increases by 4% the quantity decreases by 2%. This is thus important in determining how revenue will change. Formally, the elasticity of demand for good X with respect to its price is calculated as following:
. If we have a specific differential function we can use derivatives:
The elasticity of demand indicates how sensitive the demand for a good is to a price change. If the elasticity's absolute value is between zero and 1, demand is said to be inelastic; if it equals 1, demand is "unitary elastic"; if it is greater than 1, demand is elastic. If it is smaller than 1, wh have inelastic demand, which implies that changes in price have little influence on demand. High elasticity indicates that consumers will respond to a price rise by buying much less of the good. For examples of elasticities of particular goods, see the article section, "Selected price elasticities".
The elasticity of demand usually will vary depending on the price. If the demand curve is linear, demand is inelastic at high prices and elastic at low prices, with unitary elasticity somewhere in between.
There does exist a family of demand curves with constant elasticity for all prices. They have the demand equation , where c is the elasticity of demand and a is a parameter for the size of the market. These demand curves are smoothly curving with steep slopes for high values of price and gentle slopes for low values.
A demand function that exhibits a constant elasticity of demand with respect to the price is formulated as follows:
where. .