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Demandcurves

Demandcurves
Athigherprices,thequantitydemandedislessthanatlowerprices.Ademandschedule
indicatesthat,typically,thereisaninverserelationshipbetweenthepriceofaproductandthe
quantitydemanded.Thisrelationshipiseasiesttoseewhenagraphisplotted,asshown.

Demandcurvesgenerallyhaveanegativegradientindicatingtheinverserelationshipbetween
quantitydemandedandprice.
Thereareatleastthreeacceptedexplanationsofwhydemandcurvesslopedownwards:
1. Thelawofdiminishingmarginalutility
2. Theincomeeffect
3. Thesubstitutioneffect

Diminishingmarginalutility
Oneoftheearliestexplanationsoftheinverserelationshipbetweenpriceandquantity
demandedisthelawofdiminishingmarginalutility.Thislawsuggeststhatasmoreofaproduct
isconsumedthemarginal(additional)benefittotheconsumerfalls,henceconsumersare
preparedtopayless.Thiscanbeexplainedasfollows:
Mostbenefitisgeneratedbythefirstunitofagoodconsumedbecauseitsatisfiesalloralarge
partoftheimmediateneedordesire.
Asecondunitconsumedwouldgeneratelessutilityperhapsevenzero,giventhatthe
consumernowhaslessneedorlessdesire.
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Withlessbenefitderived,therationalconsumerispreparedtopayratherlessforthesecond,
andsubsequent,units,becausethemarginalutilityfalls.
Considerthefollowingfiguresforutilityderivedbyanindividualwhenconsumingbarsof
chocolate.Whiletotalutilitycontinuestorisefromextraconsumption,theadditional(marginal)
utilityfromeachbarfalls.Ifmarginalutilityisexpressedinamonetaryform,thegreaterthe
quantityconsumedthelessthemarginalutilityandthelessvaluederivedhencetherational
consumerwouldbepreparedtopaylessforthatunit.
Utility
Whiletotalutilitycontinuestorisefromextraconsumption,theadditional(marginal)utilityfrom
eachbarfalls.Ifmarginalutilityisexpressedinamonetaryform,thegreaterthequantity
consumedthelowerthemarginalutilityandthelesstherationalconsumerwouldbeprepared
topay.
BARS

TOTALUTILITY

1
2
3
4
5
6
7
8
8

100
190
270
340
400
450
490
520
540

MARGINAL
UTILITY

90
80
70
60
50
40
30
20

Theincomeeffect
Theincomeandsubstitutioneffectcanalsobeusedtoexplainwhythedemandcurveslopes
downwards.Ifweassumethatmoneyincomeisfixed,theincomeeffectsuggeststhat,asthe
priceofagoodfalls,realincomethatis,whatconsumerscanbuywiththeirmoneyincome
risesandconsumersincreasetheirdemand.

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Therefore,atalowerprice,consumerscanbuymorefromthesamemoneyincome,and,
ceterisparibus,demandwillrise.Conversely,ariseinpricewillreducerealincomeandforce
consumerstocutbackontheirdemand.

Thesubstitutioneffect
Inaddition,asthepriceofonegoodfalls,itbecomesrelativelylessexpensive.Therefore,
assumingotheralternativeproductsstayatthesameprice,atlowerpricesthegoodappears
cheaper,andconsumerswillswitchfromtheexpensivealternativetotherelativelycheaper
one.

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Itisimportanttorememberthatwheneverthepriceofanyresourcechangesitwilltriggerboth
anincomeandasubstitutioneffect.

Exceptions
Itispossibletoidentifysomeexceptionstothenormalrulesregardingtherelationshipbetween
priceandcurrentdemand.

GiffenGoods
Giffengoodsarethosewhichareconsumedingreaterquantitieswhentheirpricerises.These
goodsarenamedaftertheScottisheconomistSirRobertGiffen,whoiscreditedwithidentifying
thembyAlfredMarshallinhishighlyinfluentialPrinciplesofEconomics(1895).
Inessence,aGiffengoodisastaplefood,suchasbreadorrice,whichformsarelarge
percentageofthedietofthepoorestsectionsofasociety,andforwhichtherearenoclose
substitutes.Fromtimetotimethepoormaysupplementtheirdietwithhigherqualityfoods,and
theymayevenconsumetheoddluxury,althoughtheirincomewillbesuchthattheywillnotbe
abletosave.Ariseinthepriceofsuchastaplefoodwillnotresultinatypicalsubstitution
effect,giventherearenoclosesubstitutes.Iftherealincomesofthepoorincreasetheywould
tendtoreallocatesomeofthisincometoluxuries,andifrealincomesdecreasetheywouldbuy
moreofthestaplegood,meaningitisaninferiorgood.Assumingthatthemoneyincomesof
thepoorareconstantintheshortrun,ariseinpriceofthestaplefoodwillreducerealincome
andleadtoaninverseincomeeffect.However,mostinferiorgoodswillhavesubstitutes,hence
despitetheinverseincomeeffect,ariseinpricewilltriggerasubstitutioneffect,anddemand
willfall.InthecaseofaGiffengood,thistypicalresponsedoesnothappenasthereareno
substitutes,andthepricerisecausesdemandtoincrease.
Example
Forexample,afamilylivingontheequivalentofjust$150amonth,maypurchasesomebread
(say50loavesat$2each,whichistheminimumtheyneedtosurvive),andaluxuryitemat
$50.Ifthepriceofbreadrisesby25%to$2.50perloaf,continuingtopurchase50loaves
wouldcosttheindividual$125,makingtheluxuryunaffordable.Theycannotreducetheir
consumptionofbread,giventhattheircurrentconsumptionistheminimumtheyrequire,and
theycannotfindasuitablesubstitutefortheirstablefood.Notbeingabletoaffordtheluxury
wouldleavethefamilywithanextra$25tospend,and,givennoalternativestobread,they
wouldpurchase10moreloaveseachmonth.Hencethe25%priceincreasehasresultedina
20%increaseinthedemandforbreadfrom50to60loaves.

Veblengoods
Veblengoodsareasecondpossibleexceptiontothegenerallawofdemand.Thesegoodsare
namedaftertheAmericansociologist,ThorstenVeblen,who,intheearly20thcentury,
identifieda'new'highspendingleisureclass.AccordingtoVeblen,ariseinthepriceofhigh
statusluxurygoodsmightleadmembersofthisleisureclasstoincreaseintheirconsumption,
ratherthanreduceit.Thepurchaseofsuchhigherpricedgoodswouldconferstatusonthe
purchaseraprocesswhichVeblencalledconspicuousconsumption.
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