The Demand Curve
For almost any good the quantity demanded by an economy as a whole will tend to be strongly related to the selling price of the good. For example, as televisions become cheaper, more people will be able to afford them and hence the quantity sold will go up. In contrast, as televisions get more expensive less people will want them and the quantity sold will go down. However, even if the price of televisions was zero, there would only be a limited quantity bought, as people would only want a certain number of them in their house. Conversely, there will be a certain price above which no one would buy a television as they would be too expensive. Between these two prices, there exists a demand curve, where a certain increase in price would result in a certain decrease in the quantity sold.
Unfortunately, it is almost impossible to empirically measure how this varies, as a change in the price of a good rarely occurs on its own. For example, when the price of televisions fall, the price of computers, CD players and other similar goods are likely to fall as well, and the price of these goods may also affect the price of the television. However, economists will generally attempt to analyse what would theoretically occur if the price of a good changed whilst all other economic factors remained constant. They then use these results to create a demand schedule, which is a table of prices and quantities demanded, and use this table to construct a demand curve.
In general, demand curves show the quantity demanded on the x axis, and the price on the y axis. The law of demand states that, for a normal good, price will always move in the opposite direction from the quantity; hence the demand curve for normal goods slopes downwards. Goods where the demand curve slopes upwards are known as Giffen goods.
It is important to note that, in real life, the relationship between supply and demand is rarely linear: social and psychological factors can often affect it. For example, the demand for a good which cost £5 would be considerably less than one which cost £4.99 due to the psychological impact of the price falling into the under £5 bracket. However, for simplicity, the demand curve is often drawn as a straight line for analysis purposes.
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In addition, the use of a simple demand curve shape such as a straight line allows a demand function to be produced defining the behaviour of the demand curve. For a linear curve, the demand function is the equation for a straight line:
y = mx + c
Where y is the quantity and x is the price. Therefore:
Quantity = m * Price + c
Note that, for normal goods, m must be negative and is referred to as the price elasticity of demand. Also note that the equation above is written in the opposite way to the demand curve convention, where price is on the y axis and quantity on the x axis.
The demand function demonstrates that, as the price changes, so the quantity changes and moves along the demand curve.
As discussed above, the demand curve assumes that all other factors are held constant. However, if there is a change in an external factor other than the price of the good or the quantity demanded, the entire demand curve may shift. The curve is said to shift to the left or to the right, as the quantity of goods demanded at a certain price either decreases or increases respectively. For example, in the case of televisions, if the number of free to air channels increased dramatically, televisions would provide people with more entertainment. In this case, the demand curve would shift to the right as more people would be likely to buy televisions.
There are a significant number of factors which can change the demand for a product at a certain price, and arguably any change in social or economic factors can affect the quantity demanded for a wide number of goods. Some of the more common factors are:
- Changes in customer preferences
- The price and availability of substitutes: if television can be viewed on a PC then people may be less likely to buy separate televisions
- The price and availability of complementary goods: if DVD players and DVDs fall in price, the demand for televisions will increase as TVs are needed to use DVD players
- Income levels: as the economy grows, so people have more money and more people can afford a TV at the same price
- Size of the market: If a television company starts exporting to a new market, it will sell more TVs overall, as it is trying to sell to a larger number of buyers
- Expectations of future prices: The price of televisions tends to fall over time, hence people often hold off from buying the latest TVs in the expectation of the price falling in the future