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The Law of Demand - Demand and Supply (1/4) | Principles of Microeconomics - YouTube
Channel: Inspirare
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In this lecture we鈥檒l cover supply and demand
theory.
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I encourage you to watch this particular series
multiple times if need be, because the theory
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that I will be covering forms a basis for
all of the future analysis that I will be
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presenting.
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The syllabus includes discussing the laws
of supply and demand, equilibrium theory,
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and the determinants of supply and demand.
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Determinants of supply and demand is just
a fancy way of saying the things that change
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supply and demand overall.
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Let鈥檚 start by introducing the law of demand.
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What does it mean to actually demand something?
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In economic terms, a person demands a good
if they want it, can afford it, and plan to
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buy it.
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Wants are our desires, and unfortunately for
us most of them won鈥檛 be fulfilled.
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Looking at demand gives us an idea of what
wants we see as more important relative to
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others.
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In order to demand something, we need to be
able to afford it.
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If we can鈥檛 afford it then there鈥檚 no
way that we鈥檇 be able to buy it, so it would
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be irrelevant in the process of analyzing
what happens in a market.
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The last criteria for demanding something
is that the consumer plans to buy it.
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Again, if the consumer wants something and
can afford it, but they don鈥檛 plan to buy
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it, it鈥檚 irrelevant to us.
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I also want to take the time to make an important
distinction.
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When we refer to demand, at least when we
compare demand with price, we will almost
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always be referring to quantity demanded.
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The quantity demanded of a good is the amount
that consumers plan to buy during a given
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period at a given price.
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Mind you, this isn鈥檛 necessarily the same
as the quantity bought for reasons that may
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include a producer who is unable to produce
enough to keep up with demand.
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But more on that later.
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For now, just remember that to demand a good
you must want it, you must be able to afford
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it, and you must plan to buy it.
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The law of demand describes an inverse relationship
between the price of a good and the quantity
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demanded of a good.
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This just means that, ceteris paribus, and
in general, when we increase the price of
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a good, we see a decline in the quantity demanded.
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Conversely, when we decrease a price of that
same good, we expect to see an increase in
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the quantity demanded of that same good.
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Think about it in your daily life.
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Let鈥檚 say that you were out on a hot day
and you hadn鈥檛 had any water in hours.
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You walk into a store and you see Gatorade
for sale at a price of $3.
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You might want two bottles to quench your
thirst.
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If it were priced at $6, you might only buy
one, if any at all.
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This is a generalization that can be applied
to most goods in the economy.
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Not all, but most.
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Two effects come together to reduce the quantity
demanded when the price of a good increases.
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The substitution effect works as follows:
you walk into that same store after the price
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of Gatorade has increased to $6 but you see
a bottle of water for $3.
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So you buy the bottle of water instead.
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You have substituted water for Gatorade because
the relative price of water to Gatorade is
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less.
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The opportunity cost of Gatorade increases,
and so its relative price increases, decreasing
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its quantity demanded.
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The income effect describes the fact that
when the price of a good increases, assuming
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that people鈥檚 incomes remain the same, they
can鈥檛 afford as much of that good.
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Remember how in order to demand a particular
quantity of a good you need to be able to
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afford it?
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Well, if you can鈥檛 afford it anymore then
you can鈥檛 demand it anymore.
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So the quantity demanded of a good will decrease.
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More formally, as price increases, it increases
relative to income.
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Thus, less of that good can be afforded, and
the quantity demanded of that good will decrease.
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The term demand refers to the entire relationship
between the price of a good and the quantity
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demanded of a good.
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It describes all the prices and their corresponding
quantities.
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We can see this relationship on a graph, as
illustrated on the screen right now.
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The demand curve is just a graph of the inverse
relationship between price and quantity demanded
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when all the other influences on a consumer鈥檚
buying plans remain the same.
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As we can see, with a decrease in price we
see an increase in quantity.
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We can figure out a particular quantity demanded
by taking any point on the curve.
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This works for the entire curve.
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If you remember the definition of marginal
benefit from one of the first parts of the
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series on microeconomics, you鈥檒l notice
a similarity.
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The benefit that people gain from consuming
a good is measured by how much they are willing
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to pay for a given quantity of that good.
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You have some people who are willing to pay
a lot for a good and others who won鈥檛 pay
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more than a few dollars.
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The amount that people are willing to pay
for an additional unit of a good is called
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the marginal benefit.
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This is exactly what the demand curve shows
us.
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When any factor other than price influences
buying plans changes, we say that there is
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a change in demand.
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The graph shows an example of an increase
in demand, but just know that we can also
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have decreases in demand.
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A decrease in demand would just mean that
the demand curve shifts down and to the left
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instead of up and to the right.
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When demand increases, the quantity demanded
at each price increases.
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This means that people want to buy more of
the good at any price than they did before.
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There are six main factors that can cause
this type of a change.
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The first factor is the prices of substitutes
and complements.
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A substitute is a good that can be used in
place of another.
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Water can be consumed instead of Gatorade.
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It might not be an exact substitute, but it
provides the same basic benefits.
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If we are looking at the market for water,
and the price of Gatorade increases, then
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people will want to buy more water in general.
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They will want more water at $3, $4, $5, etcetera.
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It works the other way too.
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If the price of Gatorade decreases from its
original $3, then people will buy that instead.
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In this case, the demand for water would decrease.
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A complement is a good that is used in conjunction
with another good.
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Hamburgers and fries, for example, are complements.
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If we are examining the market for fries,
and we are told that the price of hamburgers
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has increased, then we can infer that the
demand for fries would decrease, because less
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people buy hamburgers and fries together,
thus less people buy fries on the whole as
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well.
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The second factor that can change demand is
the expected future price of a good.
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If I expect that two weeks from now the price
of a granola bar is going to increase, I might
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as well buy it today while it is cheaper.
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Thus, the demand for granola bars today would
increase.
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In the same way, if the price for granola
bars was expected to fall two weeks from now,
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the demand for granola bars would decrease
today.
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The third factor that affects the demand for
a good is a consumer鈥檚 income.
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If I have more money, I can buy more books.
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If I have less money, then I can buy less
books.
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I would advise a word of caution here, though,
because this does not apply to all goods.
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Let me explain.
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A normal good is one for which demand increases
as income increases.
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This is what I have just described.
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However, there exists a type of good known
as an inferior good, for which the exact opposite
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is true.
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For inferior goods, demand increases as a
consumer鈥檚 income decreases, and demand
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decreases as a consumer鈥檚 income increases.
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A classic example of an inferior good is SPAM,
the meat product.
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For those who don鈥檛 know, it鈥檚 a really
low quality meat-like product.
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As people鈥檚 incomes increase, they stop
buying SPAM and they buy real meat like steak
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because they can afford it.
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But if their incomes decrease, then they can鈥檛
afford steak so they switch over to SPAM,
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and thus the demand for SPAM would increase.
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The fourth factor that could change demand
is a change in expected future income.
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If I know that I will be earning more money
in the future, I would start spending more
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money on any good today.
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If I knew that my income was going to decrease
in the future, I would save my money from
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now and spend less on any given good.
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The fifth factor that influences demand is
the population.
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If the population increases, then the demand
for any given good increases.
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If the population decreases, then the demand
for any given good decreases.
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The last factor that can change demand is
people鈥檚 preferences.
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If people, for some or the other reason, begin
to really like orange juice, then the demand
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for orange juice will increase.
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On the other hand, if someone proves that
orange juice is bad for you then people may
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not want to drink as much of it anymore, so
they would demand less.
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I would like to reiterate this again, but
all of the influences that I have just described
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have nothing to do with the price of the good
that we are looking at.
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When I talked about substitutes and complements
I did mention price, but not of the good that
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we were looking at.
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I mentioned the prices of related goods.
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A change in the influences on buying plans
can either be brought about by price, or some
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non-price factor.
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If price is the factor that is changing, then
it is only quantity demanded that changes,
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not the entire demand.
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This would be illustrated by a movement along
the curve from one point to another.
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If, on the other hand, one of the six factors
that I described earlier changes, then we
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can model this as a change in demand rather
than quantity demanded alone.
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This would warrant a shift in the curve itself.
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