What’s it: A demand curve is a two-dimensional graphical representation to illustrate the relationship between quantity demanded and price. It uses price as the Y-axis and quantity as the X-axis.
The curve shows the quantity demanded at any given price. And a change in the good’s price causes a change in the quantity demanded and moves along the curve. Meanwhile, changes in other factors cause changes in demand, where the quantity changes for each price level and shifts the curve to the right or to the left.
In most cases, the curve is a straight line with a downward slope (negative). It outlines the law of demand, where the price is inversely related to quantity, assuming other factors are unchanged or ceteris paribus. But, in some specific cases, the law does not apply.
What are the types of demand curves?
In most of our everyday economic phenomena, the relationship between quantity demanded and price follows the law of demand. When the price increases, the quantity demanded falls. In contrast, when the price falls, the quantity demanded increases.
But, in specific cases, the law does not apply. Let’s discuss them one by one.
Downward-sloping demand curve
A downward-sloping demand curve follows the law of demand. It has a negative slope to show the inverse relationship between price and quantity. Such relationships apply to most goods. A higher price causes the quantity demanded to decrease. In contrast, a decrease in price causes the quantity demanded to increase.
When prices rise, consumers’ purchasing power (real income) falls. Hence, for the same amount of money, they get fewer goods. For example, they have $40. At $4, they can buy 10 units. But if it costs $8, they can only get 5 units. In addition, rising prices encourage them to look for cheaper alternatives (substitutes).
Conversely, when prices fall, consumers’ real incomes rise. So with the same dollar as before, they can get more. For example, on $40, if the price drops from $4 to $2, they can get 20 units, more than before (10 units).
Then, the decline in prices, ceteris paribus, also prompted some consumers to switch from substitute products to the product. A lower price attracts them because they can spend fewer dollars. Remember: we are, here, assuming the price of the substitute product does not change.
In conclusion, an increase in price results in a decrease in the quantity demanded. But, on the other hand, a decrease in price causes an increase in the quantity demanded.
Then, when the price changes, the quantity demanded also changes. But, it occurs along the same demand curve, for example, from point A to point B on curve DC1.
Meanwhile, a change in other factors causes a change in demand. Its curve shifts to the right or left and changes the quantity for any given price level. For example, when price increases, the curve shifts to the right (from DC1 to DC2), where quantity changes from point A to point C.
Upward-sloping demand curve
The upward-sloping demand curve shows a positive correlation between price and quantity demanded. When prices rise, consumers demand more. And, when prices fall, consumers ask for less. It violates the law of demand.
Two examples of goods with such a curve are Veblen goods and Giffen goods. Veblen goods are luxury goods in which their rising prices make wealthy consumers like them even more. A higher price symbolizes higher status or prestige. Conversely, if the price drops, they will avoid it because it can damage their image.
Meanwhile, Giffen goods are categorized as inferior goods. But, unlike other inferior goods, the demand for them is directly proportional to the price. Thus, when prices rise, their quantity demanded rises. But, if their prices go down, consumers tend to avoid them.
Examples of Giffen goods are used clothes. When the price drops, consumers perceive it to be of poorer quality, so they are unwilling to buy it. But, conversely, if the price goes up, they buy more.
Such a relationship occurs because the income effect outweighs the substitution effect. A decrease in prices actually produces a negative income effect. Consumers’ real incomes did rise. But, because Giffen goods were inferior goods, it caused their demand to drop.
Meanwhile, the substitution effect is positive. The increase in prices made some consumers switch from substitute products to Giffen goods.
Then, when prices rise, the income effect is positive. Real incomes fell, prompting consumers to ask for more Giffen goods.
Meanwhile, the substitution effect is negative. Consumers switch from Giffen goods to substitutes, reducing the quantity demanded.
Because the income effect exceeds the substitution effect, the quantity of Giffen goods demanded falls as their price falls. In contrast, it increases when the price goes up.
A kinked demand curve
A kinked demand curve occurs when the demand for a product has a different elasticity. Thus, the quantity demanded responds differently when the price rises or falls. You can find this curve when learning about the oligopoly model.
In the simple model, the curve consists of two straight lines. On the one hand, demand is elastic to price increases. Thus, when the price rises, the quantity demanded falls by a higher percentage. For instance, if the price increases by 10%, the quantity decreases by more than 10%. Thus, consumers are sensitive to any price increases.
On the other hand, demand is inelastic concerning falling prices. When the price falls, the quantity increases but at a lower percentage. For example, a 10% decrease in price leads to a less than 10% increase in demand. In other words, consumers are less responsive to price reductions.
How do we draw the demand curve from a demand function?
Economists derive a demand curve based on the inverse demand function. That’s because the curve uses price as the Y-axis and quantity as the X-axis. Thus, the slope of the curve is not a price coefficient in the demand function. Instead, it’s the quantity demanded coefficient in the inverse demand function.
Take a simple linear demand curve as a simple example. Say, the demand function is as follows:
- Qd = 24 – 0.5P
The equation shows us the quantity demanded as a function of price (P). The number 0.5 is not a coefficient of the demand curve. Instead, to get it, we have to reverse the above equation to get the inverse demand function.
In the inverse demand function, we define price as a function of quantity demanded. So, to get it, we have to reverse the above equation. We move P to the left and Qd to the right of the equals sign, so we get:
- P = 48 – 2Qd
From this equation, the slope of the demand curve is -2. And, the negative sign indicates an inverse relationship between price and quantity (the curve has a downward slope).
We can also calculate the slope by dividing the change in price by the change in quantity (ΔP / Qd). Alright, for the calculation, let’s simulate using the data to show whether the slope value of the curve is -2.
We need quantity figures for each different price level. Say, the product price is $6, $12, $18, and so on. Enter the price into the demand function. So, for example, at prices of $6 and $12, we get a quantity equal to:
- Qd = 24 – 0,5 * 6 = 21
- Qd = 24 – 0,5 * 12 = 18
And the following table shows us the calculation results at different price levels.
| Qd | P ($) |
| 21 | 6 |
| 18 | 12 |
| 15 | 18 |
| 12 | 24 |
| 9 | 30 |
| 6 | 36 |
| 3 | 42 |
Back to calculating the slope. Since it is defined as ΔP / ΔQd, we need two data points to calculate it. Say, we use data for prices of $6 -$12 and $30-$36. The slope at these two points is:
- (12 – 6)/(18 – 21) = -2
- (36 – 30)/(6 – 9) = -2
Then, to draw the above function into a curve, we can plot each price and quantity combination in the table. Each combination represents one point on the curve. Then, we can draw a straight line to connect the points. The results are as follows:
Why is the demand curve downward sloping?
The slope of the curve, for one, can be explained by the diminishing marginal utility. Utility means the satisfaction we get from consuming the product. Marginal means additional or extra. Thus, diminishing marginal utility is the extra satisfaction we get from consuming one more unit, which decreases each time we increase consumption.
Because we get less and less extra satisfaction, we are willing to buy the next unit only if its price is lower. Thus, each subsequent additional unit must cost less.
Now, take a simple example. You buy pizza. The first pizza gives the highest satisfaction because it tastes delicious and fulfills your hunger. Then, you decide to buy a second pizza. But, because you are a little full, the extra enjoyment of the second pizza is not as high as the first pizza. And so on, every time you add, you get fuller and the less satisfaction you get.
Because satisfaction decreases, you are willing to buy a second pizza if the price is lower than the first pizza. If not, the first pizza might be enough for you. Likewise, you will buy the third pizza if the price is lower than the second pizza and so on.
In this case, the price affects your willingness to buy pizza. The lower the price, the more you are willing to buy.
What are the determinants of demand and their implications for the curve?
The price is the main determinant of the demand for an item. If it changes, the quantity demanded also changes, which moves along the curve. However, it doesn’t cause the curve to shift. It assumes other factors are unchanged or ceteris paribus.
In fact, other factors also affect demand, not only price. Their change causes a change in demand and shifts the demand curve to the right or left. A shift causes the quantity demanded for any given price to also change.
An increase in demand shifts the curve to the right. Meanwhile, a decrease in demand shifts the curve to the left. The curve shifts to the right because:
- Consumer incomes increase, so more dollars can be spent.
- Consumers are more appetizing or prefer the product over alternatives.
- The price of substitute goods increases.
- The price of complementary goods decreases.
- Consumers anticipate price increases in the future, prompting them to buy now.
- More consumers in the market who are willing and able to buy.
