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5. DEMAND THEORY

5. Demand Theory

Demand theory. This article explains what the demand theory is and will go on to expound upon the demand law and how demand for a good and price of a good are inversely related. Furthermore, the article will discuss movements along and shifts in the demand curve.

5. DEMAND THEORY

Welcome to Simply Economics. This article is the fifth in a series to explain economics to those who want to broaden their scope of the subject. Click here to find out more about the series.

WHAT IS DEMAND?

Demand is different from just wanting to buy a certain good. Demand is the amount of a good or service is bought at a certain price over a certain period of time. It is a want followed by the ability to pay.

DEMAND THEORY AND THE DEMAND CURVE

Demand theory is the relationship between the demand for a good and the price of a good. The relationship is as follows: as the price of a good rises and all other factors affecting demand remains the same (ceteris paribus), the demand for the good will fall. This relationship can be represented through a diagram as shown below:

Screenshot 2

As shown above, the demand curve is modelled as a straight line sloping downward. The downward slope shows that the price and the demand move in opposite directions (i.e. as one goes up the goes down). The demand curve shows the quantity of a good that is demanded over a range of prices in a given time period.

The reason why the demand curve is downward-sloping is because as the price of a good falls, it becomes cheaper compared to substitute goods hence people would buy the cheaper good. Furthermore, as price falls then more of the good can be purchased from those who have lower incomes.

MOVEMENT ALONG A DEMAND CURVE

Screenshot 1 1

As shown in the diagram above, the demand for a good can move along the demand curve. This only happens when there is a change in the price of the good.

If the price of the good falls, then demand moves from point A to point B. This is known as an extension in demand.

If the price of the good rises, then demand moves from point A to point C. This is known as a contraction in demand.

SHIFTS IN THE DEMAND CURVE

Screenshot 3

An increase in demand means the whole demand curve shifts outwards, from D to D1

decrease in demand means the whole demand curve shifts inwards, from D to D2.

There are many reasons why the demand curve may shift for a good. For example, demand for an ice-cream may increase because of:

·A fall in the price of complementary goods – if the price of extra sprinkles or strawberry sauce on the ice-cream falls, then the demand may increase

·A rise in the price of substitute goods – if the price of ice-pops increases, then it may cause an increase in demand for ice-cream because ice-pops become less accessible to those who have less money.

·An increase in real incomes – if households have more wealth then the ice-cream becomes more affordable to buy and therefore demand may increase.

·A change in taste – if consumers no longer like the taste of ice-pops or consumers begin to like the taste of ice-cream more, demand may increase for ice-cream.

·An increase in credit accessibility – if it is easier to get money in order to pay for goods, then the demand for ice-creams may increase.

·An increase in advertising – if there is an increase in advertisements for ice-creams then it may cause an increase in demand because consumers become more aware of the product.

·An increase in real incomes – if households have more wealth then the ice-cream becomes more affordable to buy and therefore demand may increase.

In conclusion, demand is the amount of good that is purchased at a given price over a certain time period. Demand will contract if the price of a good is increased and will extend if the price of a good is decreased. An increase in demand means an outward shift in the demand curve. A decrease in demand means an inward shift in the demand curve.

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