A downward-sloping demand curve holds true in most of our day-to-day cases. It shows a negative relationship between price and quantity demanded. It complies with the law of demand.
By the law of demand, a higher price lowers consumers’ willingness and ability to buy, causing the quantity demanded to fall. Conversely, lower prices increase consumers’ willingness and ability to buy, increasing the quantity demanded. If we plot such a relationship on a graph, it results in a downward-sloping demand curve.
Economists explain the reasons for a downward-sloping demand curve through three concepts: diminishing marginal utility, the income effect, and the substitution effect. It relates price changes to our satisfaction, real income, and choices.
Is the demand curve always downward sloping?
In the specific case, the negative relationship between price and quantity demanded does not hold. The demand for some goods is just the opposite. A higher price increases the quantity demanded. In other cases, a lower price lowers the quantity demanded. Or, in other words, their demand curve is upward sloping (positive).
Two goods with an upward-sloping demand curve are Giffen goods and Veblen goods. Giffen goods are inferior goods. But, unlike other inferior goods, a decrease in their price lowers the quantity demanded. Consumers associate lower prices with less worth or poorer quality.
Meanwhile, we can find Veblen goods in various luxury items such as diamonds or luxury cars. Their demand curve has a positive slope because higher prices increase image or prestige. Wealthy consumers buy them to show status. Thus, wealthy consumers are increasingly interested in them when their prices rise, increasing the quantity demanded.
In other cases, the law of demand also does not apply if consumers consider other factors more than price. Take, for example, income. When consumers’ incomes rise, they increase the demand for a product, even when its price rises. That’s because they not only want the product but have a higher ability to buy it as their income increases. So with more money, the price may not be an issue.
What are three reasons to explain a downward-sloping demand curve?
Economists propose three important concepts to explain the slope of the demand curve. They are:
- Diminishing marginal utility
- Income effect
- Substitution effect
The first describes the satisfaction we get at the price we are willing to pay. Meanwhile, the last two relate prices to our real income and choices.
Diminishing marginal utility
Marginal utility means the extra satisfaction we get when we consume one more unit. Economists use it to explain the slope of the demand curve by relating it to the price we are willing to pay.
According to the law of diminishing marginal utility, the more we consume a good, the less extra satisfaction we feel for each additional unit. Hence, we are only willing to consume and pay for the next unit if its price is lower than the previous unit.
Let’s take a simple example. At one time, we craved pizza. So, even though there are no discounts or vouchers, we still buy them. Assume we have enough money to buy a lot to just satisfy our desires.
We buy pizza first. After eating it, we feel somewhat full and satisfied. Then, we add a second pizza, making us feel more full and satisfied.
The first pizza gives a higher satisfaction than the second because we really want it. When we eat it, it tastes really good. Meanwhile, the second pizza gives less satisfaction because apart from being quite full, we are also quite satisfied with the first pizza.
Even though we still have money in our pocket, we will think twice about buying pizza a third time. We’re already full. So, the enjoyment from the third pizza is not as high as the second or first pizza. But, we might pick it up if the price is lower than the second pizza.
The case shows how marginal utility decreases each time we add more units to consume. This is because we are relatively satisfied with the previous unit we consumed. Thus, we will be willing to buy each additional unit only if the price is getting lower. That’s because each successive unit we consume yields less and less benefit.
The income effect relates price changes to changes in our real income and our willingness and ability to buy. And, we can use it to explain why the demand curve is downward sloping.
Real income is our income measured by how many goods we get with the money we have. For example, let’s say we spend $1,000 on an item for $10. And, we get 100 units. The income worth 100 units is our real income.
How many units we buy does not only depend on our nominal income. But, it also depends on the price of the item. Now, let’s assume our nominal income doesn’t change, staying at $1,000.
If the price of the good falls, our real income rises. With the same income, we can get more goods. It prompts us to ask for more.
Let’s say the price drops to $5. Now, we can buy as many as 200 units for $1,000.
Conversely, when prices rise, our real income falls. We cannot buy as much as before with our current income. It prompts us to reduce the quantity demanded.
For example, the price goes up to $20. So now, we can only buy 50 units.
In conclusion, a decrease in price increases real income, increasing the quantity demanded. But, if prices rise, our real income falls, prompting us to reduce the quantity demanded. Note: this relationship only applies to normal goods.
The substitution effect deals with our choices. What do we do when the price of a product changes? Economists attribute it to the choices available: a product vs. substitute product.
We have several alternatives in consumption. We can choose a product or its substitute product, depending on which one is more attractive. Choosing one means abandoning the other because they satisfy the same need. It doesn’t make sense to choose both because our money is limited or because the two products are basically the same.
Hence, for the same money, we choose one of two alternatives. Assuming other factors are constant, relative price is our consideration. We will choose the cheaper one and leave the more expensive one.
For example, product A has the same use as product B. Assume that only one product experiences a price change. If the price of product A rises, then we will switch to its substitute, product B. Since the price of product B remains constant, it is now cheaper, increasing its quantity demanded.
Conversely, an increase in the price of product B will encourage us to switch to product A because it is relatively cheaper. As a result, its quantity demanded increases.
In conclusion, when the price of a product rises, some consumers turn to its substitutes, reducing its quantity demanded. But, conversely, if its price falls, some consumers switch from substitutes to it, increasing its quantity demanded.
What to read next
- Demand Curve: Types, How to Draw It From a Demand Function
- Reasons For a Downward-Sloping Demand Curve
- What is the difference between a movement and a shift in the demand curve?
- What is the Law of Demand? How does it work?
- Three Assumptions Underlying the Law of Demand
- What Are the Five Exceptions to the Law of Demand?
- What is the difference between a change in demand and a change in quantity demanded?
- Individual Demand: Definition, Its Curve, Determinants
- Market Demand: Definition, How to Calculate, Determinants
- What are the six non-price determinants of demand? Examples.
- What Are The Types of Demand?
- Demand in Economics: Meaning and Determinants