What is a demand curve (short answer)
– A demand curve is a graph showing how much of a product buyers will purchase at different prices during a given time period. Price is plotted on the vertical (y) axis and quantity demanded on the horizontal (x) axis. In most cases the curve slopes downward: as price rises, quantity demanded falls, ceteris paribus (all else equal). That relationship is the law of demand.
Key definitions
– Demand: the quantity of a good or service buyers are willing and able to purchase at various prices.
– Demand curve: the graphical relationship between price and quantity demanded.
– Law of demand: holding other factors constant, higher prices lead to lower quantity demanded, and lower prices lead to higher quantity demanded.
– Price elasticity of demand (PED): the responsiveness of quantity demanded to a change in price, computed as PED = (% change in quantity demanded) / (% change in price). PED is normally negative (because price and quantity move in opposite directions); analysts often report its absolute value.
Types of demand curves
– Individual demand curve: shows the price–quantity choices of a single consumer. Example use: how many slices of pizza one person buys at different prices.
– Market demand curve: the horizontal sum of individual demand curves; it shows total quantity demanded by all buyers at each price. Market curves are usually flatter (more elastic) than individual curves because many buyers smooth out individual extremes.
Elasticity and curve shape
– Elastic demand: when quantity demanded changes a lot for a given price change (|PED| > 1). The demand curve is relatively flat. Typical for luxuries and products with many substitutes.
– Inelastic demand: when quantity demanded changes little for a price change (|PED| 1 → elastic (quantity responds more than price)
– |PED| = 1 → unit elastic
– |PED| < 1 → inelastic (quantity responds less than price)
– Determinants of PED: availability of close substitutes, proportion of income spent on the good, time horizon (short run vs long run), and whether the good is a necessity or a luxury.
Worked numeric example (step-by-step)
1. Suppose price falls from $10 to $8 and quantity demanded rises from 100 units to 140 units.
2. Compute changes and averages: ΔP = −2, average P = (10 + 8)/2 = 9. ΔQ = 40, average Q = (100 + 140)/2 = 120.
3. Percent changes: ΔP/average P = −2/9 ≈ −0.2222 (−22.22%). ΔQ/average Q = 40/120 ≈ 0.3333 (+33.33%).
4. PED = (0.3333) ÷ (−0.2222) ≈ −1.5. Absolute value = 1.5 → demand is elastic in this range.
5. Implication (purely educational): for an elastic demand, a price cut increases total revenue (price × quantity); for inelastic demand, a price cut decreases total revenue.
Other elasticities
– Income elasticity of demand (YED): percent change in quantity demanded divided by percent change in income. Positive for normal goods, negative for inferior goods.
– Cross-price elasticity (XED): percent change in quantity demanded of good A divided by percent change in price of good B. Positive → substitutes; negative → complements.
Exceptions to the law of demand (brief)
– Giffen goods: inferior goods for which higher price leads to higher quantity demanded because the income effect (reduction in real income) outweighs the substitution effect. Empirically rare and debated.
– Veblen goods: goods valued as status symbols where higher prices increase their appeal (conspicuous consumption). Often discussed in luxury markets.
Practical checklist for analyzing observed demand changes
1. Identify whether the change is a movement along the curve (own-price change) or a shift of the curve (non-price factors).
2. If it’s a shift, examine: income trends, tastes, prices of substitutes/complements, population/demographics, expectations, and policy (taxes/subsidies).
3. Estimate elasticity if you need to quantify sensitivity to price or income. Use the midpoint formula for discrete changes.
4. Consider time horizon: short-run measures can differ from long-run outcomes.
5. Check for market-specific exceptions (e.g., Giffen or Veblen-like behavior) before applying standard predictions.
Applications (business and policy)
– Firms use demand curves and elasticity estimates to set prices, forecast revenue, and segment markets.
– Policymakers use demand analysis to predict effects of taxes, subsidies, and regulation on consumption and tax revenue.
– Analysts must state the ceteris paribus assumption (holding other factors constant); real markets often see multiple simultaneous changes.
Assumptions and limitations
– Demand curves assume rational behavior and stable preferences; real consumers may face information constraints or behavioral biases.
– Empirical estimation of demand requires reliable data and care with endogeneity (price may respond to demand, not only vice versa).
– Short-run vs long-run elasticities can differ substantially.
Further reading (reputable sources)
– Investopedia — Demand Curve: https://www.investopedia.com/terms/d/demand-curve.asp
– OpenStax — Principles of Microeconomics (free textbook): https://openstax.org/details/books/principles-microeconomics
– Khan Academy — Supply, demand, and market equilibrium (microeconomics resources): https://www.khanacademy.org/economics-finance-domain/microeconomics
– Investopedia — Price Elasticity of Demand: https://www.investopedia.com/terms/p/priceelasticityofdemand.asp
Educational disclaimer
This is general educational information about demand curves and elasticity. It
is not investment advice, tax advice, or a substitute for personalized financial planning. Use it for learning and classroom purposes only. Verify data, state your assumptions explicitly, and consult a licensed financial or tax professional before making decisions that affect your finances.
Further reading and references
– Investopedia — Demand Curve: https://www.investopedia.com/terms/d/demand-curve.asp
– Investopedia — Price Elasticity of Demand: https://www.investopedia.com/terms/p/priceelasticityofdemand.asp
– OpenStax — Principles of Microeconomics (free textbook): https://openstax.org/details/books/principles-microeconomics
– Khan Academy — Supply, demand, and market equilibrium (microeconomics resources): https://www.khanacademy.org/economics-finance-domain/microeconomics
– Federal Reserve Education — Economic resources and explanations: https://www.federalreserveeducation.org