The idea of demand

Demand describes the quantity of a good or service that consumers are willing and able to buy at each possible price, given the prices of other goods, their incomes and their preferences. “Willing” captures the strength of desire for the good, and “able” recognises that purchases require sufficient income at the moment of purchase. Demand always relates to a period of time, because willingness and ability are measured over a day, a week or a year rather than in a single instant. When we say demand for cinema tickets is high, we mean that at prevailing prices, consumers plan to buy many tickets per period.

To understand what shapes demand, begin by thinking about a product you know well. You might first consider its price and how that limits how much you can buy. You might also think about whether you enjoy the product, which reflects preferences, and whether you can afford it at all, which brings income into view. Your choices are also affected by the prices of other goods you could buy instead or together with the product in question. These influences can be grouped into four headings: the price of the good itself, the prices of other goods, the level of consumer incomes, and consumer preferences. Most of what follows in this chapter is an orderly way of examining these influences one at a time.

Individual demand and market demand

It is helpful to start with a single consumer and then scale up to the whole market. An individual’s demand shows the quantities that one person would buy at each price in a given period, holding everything else constant. Market demand aggregates across all potential buyers. Conceptually this means summing the individual quantities at each price to find the total quantity that would be purchased by everyone together. If one person would buy two units at a price of £10 and another would buy one unit at the same price, market demand at £10 is three units. Market demand therefore depends not only on the way each buyer responds to price but also on the number of buyers in the market. A product with a small niche following may have modest market demand even if each fan buys a lot; a product with broad appeal may have large market demand even if each person buys only a little.

Types of demand

Sometimes the demand for one good depends on the presence of another. When two goods are used together, demand is described as joint demand. Printers and ink cartridges are the standard example: there is no point in buying one without the other. Some goods serve several purposes, so that a single item is demanded for more than one use; this is composite demand. Water is drunk, used for cooking and cleaning, and used to water plants; a change in demand for one use can leave less available for another. In many cases goods compete to satisfy the same want; different brands of breakfast cereal are substitutes in this sense, and the demand for a particular brand is competitive demand because it competes with others that meet the same need.

Price, ceteris paribus, and the law of demand

When analysing the effect of price, economists invoke the assumption ceteris paribus, meaning “other things being equal.” It instructs us to hold constant income, the prices of other goods and consumer preferences so that we can isolate the relationship between the good’s own price and the quantity demanded. Under this assumption a very robust empirical relationship appears: as the price of a good rises, the quantity demanded tends to fall, and as the price falls, the quantity demanded tends to rise. This inverse relationship is called the law of demand.

The law of demand is so regular that it can be drawn as a curve on a diagram. The demand curve places price on the vertical axis and quantity on the horizontal axis. Each point on the curve shows a price–quantity pair that a market could observe when other conditions are unchanged. Because the relationship is inverse, the curve slopes downwards from left to right. The curve need not be straight; its exact shape shows how sensitive quantity is to price at different points. What matters is the sign of the slope, which summarises the law of demand.

To read numerical values from a demand graph, first choose a price on the vertical axis and then move horizontally to the demand curve. The quantity directly below that point on the horizontal axis is the quantity demanded at that price in the period shown. For example, if the graph shows that at £40 there are 20 thousand purchases per period and at £20 there are 60 thousand purchases, then halving the price increases the quantity demanded by 40 thousand units in that market.

Why demand slopes downward: income and substitution effects

The downward slope of the demand curve has two main explanations. First is the income effect of a price change. When the price of a good rises, a given money income buys less than before, so the consumer is effectively poorer and tends to reduce consumption of normal goods. When the price falls, real purchasing power rises and consumers can afford to buy more. Second is the substitution effect. A rise in the price of one good makes other goods relatively cheaper. Some consumers switch away from the now expensive good toward alternatives, and quantity demanded falls. When the price falls, the good becomes relatively cheap and some consumers substitute into it from other goods. Together, the income and substitution effects underpin the law of demand.

Movements along a demand curve versus shifts of the curve

It is essential to distinguish a movement along a given demand curve from a shift of the whole curve.

A movement along the curve occurs when the good’s own price changes and other influences remain constant. In that case the change is called an extension of demand if price falls and quantity demanded rises, or a contraction of demand if price rises and quantity demanded falls. This occurs due to a shift in the supply curve relative to the demand curve, which will be explored in Chapter 5, the interation of demand and supply.

A shift of the whole curve occurs when some determinant of demand other than the good’s own price changes. A rise in demand caused by such a change moves the entire curve to the right; a fall in demand shifts it to the left. This distinction helps avoid confusion when the data show both price and quantity changing; one must ask whether the underlying cause was the good’s own price or another factor.

Causes of Shifts:

Consumer Incomes

One major cause of a shift in demand is a change in consumers’ incomes. For a normal good, an increase in income, ceteris paribus, leads to an increase in the quantity demanded at each price. The demand curve shifts to the right. (A normal good is normal good one where the quantity demanded increases in response to an increase in consumer incomes.) Foreign holidays are a good example: as average incomes rise, more people can afford to travel abroad, and the market demand for holidays rises at any given airfare. Some goods behave differently. For an inferior good, demand falls when income rises, because consumers switch to higher-quality or more convenient alternatives as they become able to do so. (An inferior good one where the quantity demanded decreases in response to an increase in consumer incomes.) Bus journeys often illustrate this: as incomes rise, some commuters buy a car or use taxis, so bus travel demand may shift left.

Prices of other goods: substitutes and complements

Demand for a product can also shift because the prices of related goods change. Two relationships matter. Substitutes are goods that consumers regard as alternatives. Tea and coffee are substitutes for many people. If the price of tea rises, some consumers switch to coffee, so, ceteris paribus, the demand for coffee shifts to the right. Complements are goods consumed together. Fuel and cars are complements for many households. If the price of fuel rises, less cars are bought, and because fuel and cars go together, the demand for cars shifts to the left. Thus, when the price of the substitute rises, the demand curve for its substitute ("competitor") good shifts outwards, thus increasing; when the price of a complement rises, the demand curve for the paired good shifts inwards.

Preferences, advertising and expectations

Beyond prices and incomes, demand reflects preferences—the many reasons people like or dislike a product. Preferences can change because of new information, shifts in fashion, the influence of friends, or the impact of advertising and branding. If a product becomes popular following a social-media trend, the demand curve shifts to the right at each price; if a product falls out of favour, the curve shifts left. Expectations about the future can also matter. For some goods, especially durable goods and investment items, consumers time their purchases based on expected future prices. If many buyers expect a current high price to fall next month, some may postpone purchases, reducing today’s demand. Alternatively, if buyers expect prices to rise sharply, they may bring purchases forward, temporarily increasing demand.

The “snob effect” and the special case of Giffen goods

Occasionally observers argue that some markets appear to have upward-sloping demand, partly because conspicuous consumption leads certain buyers to prefer goods precisely because they are expensive. This snob effect suggests that for some luxury items a higher price can make the good more attractive to those seeking status, though systematic evidence of entire markets that behave this way is weak. Separately, economic theory identifies a very special possibility known as a Giffen good, named after Sir Robert Giffen. For a staple food that forms a large share of a very poor household’s budget, a rise in price could, in theory, reduce real purchasing power so severely that the household cannot afford substitute foods and must buy more of the staple despite its higher price. This would generate an upward-sloping demand curve. However, confirmed real-world cases are extremely rare, and the example is best treated as a theoretical curiosity rather than a general rule.

Joint and composite demand revisited

The earlier definitions of joint and composite demand help in thinking about shortages and reallocation. When goods are consumed together, a change in the availability or price of one can have knock-on effects on the other. If the supply of games consoles is constrained, the demand for new game titles may fall even if their price is unchanged, because fewer players own the consoles required to use them. Composite demand means that one good serves several distinct uses. An increase in one use can reduce the amount available for others. If dairy processors use more milk in cheese production, less may be available for fluid milk sales at the same price, which can alter pricing and consumption patterns across uses.

Summary of demand influences and the structure of analysis

The main influences on demand are the good’s own price, the prices of other goods, consumer incomes and preferences. The law of demand describes the inverse price–quantity relationship under ceteris paribus conditions. Movements along the curve reflect price changes; shifts of the curve reflect changes in other determinants. Market demand aggregates individual demands and depends on the number of buyers as well as on how each buyer responds to price. Related goods can be substitutes or complements, and income changes can convert a rightward shift for normal goods into a leftward shift for inferior goods. Expectations and preferences add a time dimension, since buyers may postpone or bring forward purchases when they anticipate future price changes.

Consumer surplus

The last part of the chapter investigates consumer surplus, which measures the benefit that consumers receive from purchasing a product at its market price. Essentially, consumer surplus is the difference between how much a person was willing to pay for a good and the actual price, and if they were willing to pay more than the actual market price, there is consumer surplus they gain. The demand curve can be interpreted as a marginal willingness-to-pay curve: at each quantity, the height of the curve shows the highest price the marginal buyer would be willing to pay for that unit. Imagine the market for smartphones with a going price of P*. The consumer who buys the final unit at quantity Q* is just indifferent between buying and not buying at that price. Many other consumers would have been willing to pay more than P* for earlier units; for them, the difference between their individual valuations and the actual price is a surplus.

To make this concrete, draw the demand curve and mark the price line at P*. The rectangle formed by the price P* and the quantity Q* shows total expenditure by consumers, which is price multiplied by quantity. The area under the demand curve up to Q* represents the total value consumers place on those Q* units—the sum of all buyers’ willingness to pay. The triangular area between the demand curve and the price line, from zero to Q*, is consumer surplus. It captures the extra benefit to society from consumption over and above what consumers pay.

Because it reflects the gap between valuations and price, consumer surplus changes when price changes. If price rises while the demand curve stays fixed, the price line moves up the vertical axis. Quantity demanded falls from the initial Q to a lower level, and the triangular area representing consumer surplus shrinks. Some consumers are priced out of the market; others who continue to buy gain less surplus on each unit than before. If price falls, the opposite occurs: more consumers purchase the good and each unit yields a larger surplus, so total consumer surplus expands. The size of the change depends on how responsive demand is to price. A steep demand curve (low responsiveness) means the triangular area shrinks by less for a given price rise than it would with a flatter demand curve (high responsiveness). Later chapters will analyse responsiveness (called elasticity) in detail; for now it is enough to note that the geometry of the diagram allows a clear qualitative comparison.

When reading areas on a diagram, letters are often used to mark key points and label shapes. The rectangle defined by O, P*, B and Q* would represent total spending at price P* and quantity Q*. The triangle with vertices at P*, A and B would represent consumer surplus at that price. If price rises so that the price line moves to a higher level and quantity falls to Q₁, the new consumer surplus is the smaller triangle above the new price line and below the demand curve. The difference between the original and the new triangle represents the loss of consumer surplus caused by the price increase. This graphic method is widely used in welfare analysis because it rests on straightforward geometry and the interpretation of the demand curve as willingness to pay.

Pulling the pieces together

Demand is not a single number but a whole relationship between price and quantity, conditioned by incomes, the prices of other goods and preferences. The demand curve offers a compact way to depict this relationship and to separate movements caused by price changes from shifts caused by other influences. The law of demand gives the basic slope; income and substitution effects explain why the slope is negative; and the categories of normal versus inferior goods and substitutes versus complements organise the many ways in which demand shifts in response to changing circumstances. Preferences and expectations make clear that demand is not purely mechanical, since tastes evolve and buyers think ahead.

Consumer surplus adds a welfare dimension by measuring the benefit to consumers from purchasing at the market price. The triangle between the demand curve and the price line is a precise way of capturing the idea that many purchasers would have been willing to pay more than they actually do, and that changes in price redistribute welfare between buyers and sellers by enlarging or shrinking that triangle. All of these tools will be used repeatedly in later chapters, where they will be paired with supply to analyse equilibrium, price changes and the consequences of shocks and policy interventions.