The law of demand states: more of good will be bought the lower its price, less will be
bought the higher its price, ceteris paribus.
Well, what does it MEAN?
All the law of demand really says is that there is an inverse relationship between price
and the quantity demanded.
Price goes up, amount bought goes down.
At a low price, people are much more willing to buy; at a high price, people don't want
buy much.
What about that last part, the Latin -- ceteris paribus?
Well, ceteris paribus means “all else being equal,” or “other things the same.”
So the law of demand says that there will be an inverse relationship between price and
quantity demanded, as long as nothing else changes.
Look at it this way: if you are a consumer, what makes you willing to buy (or not willing
to buy) a product or service?
Of course price affects your willingness or unwillingness to purchase, but what else?
Income?
Sure, the amount of income, particularly your disposable income, will affect your willingness
and/or ability to buy.
Luxury or necessity?
Absolutely.
What about differing tastes and preferences?
Naturally, your tastes and preferences help to determine your willingness or unwillingness
to purchase, but what determines your tastes and preferences?
Of course your personal tastes and preferences have been a lifetime in the making, and are
always changing, but a few determining factors are: age, gender, religion, and social status.
What else affects your willingness to buy?
How about… weather, or climate?
What about expectations for the future?
How many factors are there, that affect an individual's willingness to buy -- or not?
The number of factors is endless, and I for one, don't like to think about an infinite
number of things at once.
If I'm going to model the willingness to purchase, I want to narrow my focus to only two factors.
What will the two factors be?
Well, think back to the Law of Demand: the focus is on quantity demanded and price.
Quantity demanded, or what you buy, of course depends on all the factors just mentioned.
Quantity demanded is a function of: price of the product, price of substitute products,
price of complementary goods, it depends on the income, it depends on the weather, politics…
all this stuff!
But if I were to focus just on quantity demanded and price, what do I do with everything else?
Well, remember that “all else constant” part?
We recognize that all of these other factors are important to the decision, but for right
now, we’ll assume that they’re constant, and unchanging.
How does this work?
Well, imagine that you are in the market to buy a house.
You consider a lot of variables, right?
Your income, mortgage rates, which neighborhoods have good schools and other amenities.
Is this just a starter home, or will you be there for a long time?
And of course you will look it home pricing.
Suppose you’ve already given thought to your budget, mortgage rates, neighborhood
amenities, whether a Walmart is being built nearby, etc., and you also find that right
now, housing is going for $150 a square foot.
At this price, and given all those other factors, you have determined that you would be willing
to purchase a 1500 ft.? house.
What the market slows down, and price per square foot drops to $100?
Keep in mind that all the other variables will be unchanged -- same income, same mortgage
rates, same neighborhood amenities, same everything -- except that the price per square-foot has
changed.
The Law of Demand says that you would then be willing to purchase more square footage
(well, wouldn’t you…?), perhaps 2000 ft.?.
What if the market headed up again such the price per square foot increases to $200.
All else constant, you would not be willing, or able, to buy as much house as before -- maybe
at $200 per square foot, everything else remaining the same, the quantity demanded will be more
like 1000 ft.?.
In the end if you were to plot out each of these price-quantity combinations, you would
start to see the inverse relationship described by the Law of Demand.
Now of course there are more possible prices than just these three, but we can see the
general pattern now, and other prices would fit in with that existing pattern.
Do you notice that these points are starting to trace out a line?
Well, this line – really, this collection of all possible price-quantity demanded combinations
-- is the demand curve.
NEXT TIME: Change in demand versus change in quantity demanded
TRANSCRIPT00EPISODE 11: DEMAND