- Demand — how much buyers want at each price · coming soon
- Opportunity cost · coming soon
- Plotting straight-line graphs · coming soon
Everyone knows the answer. Almost nobody can explain it.
A café near your school sells coffee for $4 a cup. One Monday, the price goes up to $5. What happens?
Fewer cups are sold. You knew that before you finished reading the question. Almost everyone does.
But now try two harder questions. First: why do people buy less? "Because it costs more" is not a full answer. Some people still buy at $5, so what exactly changes for the others? Second: a newspaper prints the headline "Coffee prices rise, demand falls". An economist reading it would say the headline is wrong. Not slightly wrong. Wrong in a way that matters.
This lecture answers both questions. The second one holds the most important distinction in the first year of economics. If you get it right now, it protects you in every topic that follows.
What economists mean by demand
In everyday speech, "demand" means wanting something. In economics, it means something more precise. Demand is the quantity of a good that buyers are willing and able to buy at each possible price, in a given period of time.
Each part of that definition does a job.
- Willing and able. Wanting a car is not demand for a car. Demand counts only wanting that is backed by money. Economists sometimes call this effective demand.
- At each possible price. Demand is not one number. It is a whole list: how much at $2, how much at $3, how much at $4, and so on.
- In a given period of time. "300 cups" means nothing until you add "per week" or "per day". Always state the time period.
That whole list is called a demand schedule. Here is one for coffee in a small town.
| Price of a cup ($) | Quantity demanded (cups per week) |
|---|---|
| 2 | 400 |
| 3 | 350 |
| 4 | 300 |
| 5 | 250 |
| 6 | 200 |
Read down the table. As the price rises, the quantity demanded falls. Every $1 on the price takes away 50 cups a week. That pattern is so common that economists gave it the name of a law.
Other things being equal, when the price of a good rises, the quantity demanded falls. When the price falls, the quantity demanded rises.
Notice the first four words: "other things being equal". Economists often write them in Latin, ceteris paribus. They matter a great deal. The law describes what happens when the price changes and nothing else changes: not incomes, not the weather, not the price of tea. In real life, many things change at once. The law of demand looks at the effect of price alone.
Why buyers buy less when the price rises
There are two classic reasons. A third, simpler one sits underneath both.
1. The substitution effect
When coffee rises from $4 to $5, coffee becomes more expensive compared with other drinks. Tea did not change price. Juice did not change price. So some buyers switch, at least some of the time, to a drink that now looks like better value. This is the substitution effect: a higher price makes a good relatively more expensive, so people substitute other goods for it.
2. The income effect
Suppose a student, Ravi, spends $20 a week on coffee. At $4 a cup, $20 buys 5 cups. At $5 a cup, the same $20 buys only 4 cups. Ravi's money income has not changed. But what his money can buy has fallen. Economists call this a fall in real income. Because he is effectively a little poorer, Ravi buys less. This is the income effect.
3. Underneath both: each extra cup is worth less to you
Think about your own coffee. The first cup of the morning is worth a lot to you. A second cup is pleasant. A fourth cup is worth very little. Each buyer keeps buying cups only while the next cup is worth at least the price. At $2, many extra cups pass that test. At $6, only the most valued cups pass it. So a higher price means fewer cups are bought.
This idea gives you a second way to read a demand schedule. "At $4, buyers want 300 cups" also means: "the 300th cup is worth exactly $4 to the buyer who values it least". You will use this reading later, when you measure how much buyers gain from a market.
From a table to a curve
Plot the schedule on a graph. By convention, price goes on the vertical axis and quantity on the horizontal axis. Join the points, and you get the demand curve.
It is called a curve even though this one is a straight line. Real demand curves usually bend a little. Straight lines make the numbers easy to check, so we use them while we learn.
The curve slopes downward from left to right. That slope is the law of demand in a picture: a higher price goes with a lower quantity demanded.
You may wonder why price, the cause, sits on the vertical axis. In mathematics, the cause usually goes on the horizontal axis. The reason is history. The economist Alfred Marshall drew his diagrams this way in 1890, and the convention stayed. It is only a habit, but every examiner expects it.
Market demand is many people added together
The town's demand curve is built from individuals. Here are three buyers at three prices.
| Price ($) | Ama | Ravi | Mei | Market total |
|---|---|---|---|---|
| 2 | 6 | 5 | 4 | 15 |
| 4 | 4 | 3 | 1 | 8 |
| 6 | 2 | 1 | 0 | 3 |
At each price, add the quantities across the row. Look at Mei. At $6 she buys nothing at all. So a higher price lowers market demand in two ways. People who stay in the market buy less. And some people leave the market completely. Both make the market demand curve slope downward.
The distinction that matters most: along the curve, or a new curve?
Now the headline. Two very different things can happen to buyers, and economists use different words for each.
A change in the good's own price moves you along the demand curve. The curve stays exactly where it is. You simply read a different point on it. Economists call this a change in quantity demanded. A rise in quantity demanded is sometimes called an extension, and a fall a contraction.
A change in anything else that affects buyers moves the whole curve. Incomes, the prices of other goods, tastes, the number of buyers, expectations: if one of these changes, buyers want a different quantity at every price. The curve shifts. Economists call this a change in demand. A shift to the right is an increase in demand. A shift to the left is a decrease.
So the headline "Coffee prices rise, demand falls" mixes up the two. The price of coffee rose. Buyers moved along the curve. The quantity demanded fell. Demand itself, the whole curve, did not change at all.
Try it yourself on the graph below. Watch what the price slider does to the curve. Then watch what the income buttons do.
Drag the price slider. Then press an income button. Read the box under the graph each time.
The figures above show the two cases. In numbers:
| What changes | Before | After | Name |
|---|---|---|---|
| Price rises from $4 to $5 | 300 cups | 250 cups | Change in quantity demanded (movement along D) |
| Incomes rise, price stays $4 | 300 cups | 400 cups | Change in demand (D shifts right) |
| Incomes fall, price stays $4 | 300 cups | 200 cups | Change in demand (D shifts left) |
A bad harvest in a coffee-growing country pushes up the price of coffee in shops around the world. Does the demand curve for coffee shift to the left?
Show the answer
No. The harvest is the reason the price rose. But buyers do not see the harvest. They see a higher price for coffee. A change in the good's own price is a movement along the demand curve, and quantity demanded falls. The harvest affects the sellers' side of the market, which economists call supply. You will meet supply soon. For now, hold on to the rule: what matters is what changed for the buyers, not why it changed.
Worked examples
The price of petrol rises from $1.50 to $1.80 per litre. What happens to the demand for petrol?
Ask first: what changed? The price of petrol itself. So this is a movement along the demand curve for petrol, up and to the left.
The quantity of petrol demanded falls. People combine trips, share rides or take the bus a little more. The demand curve for petrol does not shift.
Notice the wording of the question. It says "demand", but the correct answer is about quantity demanded. Examiners set questions like this deliberately. Answer with the precise phrase.
Incomes in the town rise. At every price, buyers now want 100 more cups of coffee a week. Write the new demand schedule and describe the change.
| Price ($) | Before (cups per week) | After (cups per week) |
|---|---|---|
| 2 | 400 | 500 |
| 4 | 300 | 400 |
| 6 | 200 | 300 |
The price did not cause this. Incomes did. So the whole curve moves right, from D₁ to D₂. This is an increase in demand.
The same reasoning works for bigger purchases. When incomes rise, people buy more new cars at every price, so the demand curve for new cars shifts right. Goods that people buy more of when their income rises are called normal goods. The next lecture looks at goods that behave differently.
The price of butter rises. What happens to the demand for margarine?
The price of margarine has not changed. So for margarine, this is not a movement along its curve. Something other than margarine's own price has changed: the price of a related good.
Butter and margarine can replace each other on bread. Goods like this are called substitutes. Dearer butter makes margarine better value by comparison, so at every price of margarine, buyers want more of it. The demand curve for margarine shifts right.
Look at the two markets together. In the butter market, the price rose, so buyers moved along the curve. In the margarine market, the curve itself moved. One event, two different effects. Always ask which market you are drawing.
The policy. On 1 January 2014, Mexico put a tax of 1 peso per litre on drinks with added sugar. The tax was about 10% of the 2013 price of these drinks. The aim was to reduce how much sugar people drank.
What the law of demand predicts. Sellers pass a tax like this on to buyers as a higher price. For the sugary drinks, that is a change in their own price. So we predict a movement along the demand curve: a fall in the quantity demanded. The substitution effect also predicts that people switch to untaxed drinks. And the income effect should be stronger for poorer households, because the price rise takes a bigger share of a small budget.
What happened. Researchers used shopping records from 6 253 households in 53 Mexican cities (Colchero and others, BMJ, 2016). In 2014, purchases of taxed drinks were on average 6% lower than they would have been without the tax. By December 2014 they were 12% lower. Low-income households cut their purchases the most: by 9.1% on average over the year. Purchases of untaxed drinks, mostly bottled water, were about 4% higher.
How did they know? Many things changed in Mexico in 2014, not only the tax. So the researchers used the years 2012–2013 to estimate what purchases would have been without the tax, and compared the real figures with that estimate. This is "other things being equal" turned into a method.
Verdict. Every prediction came true: a fall in quantity demanded, a switch to substitutes, and the biggest response from poorer households. Notice also the bottled water. Its price did not change, but more of it was bought at its old price. So the demand curve for bottled water shifted right, exactly as margarine's did in Worked Example 3.
Now practise the distinction on eight changes. Each one affects the demand for coffee in the town.
Tap a card. Then tap the box where it belongs. You can move a card again at any time.
The rule: if the change is to the price of coffee itself, it is a movement along the curve. If anything else changes, the whole curve shifts.
| Change | Effect on demand for coffee |
|---|---|
| The price of coffee rises from $4 to $5. | Movement along (quantity demanded falls) |
| A café cuts its coffee price for a festival week. | Movement along (quantity demanded rises) |
| A bad harvest pushes up the price of coffee. | Movement along: buyers only see a higher price |
| Incomes in the town rise. | Shift right |
| The price of tea falls. | Shift left: tea is a substitute |
| A study reports that coffee is good for health. | Shift right: tastes change |
| A new university opens and the population grows. | Shift right: more buyers |
| People expect coffee prices to jump next month. | Shift right: buy more now |
Three classic mistakes
When the good's own price changes, demand does not change. Quantity demanded changes. Write "the quantity demanded of coffee falls" and "a movement along the demand curve". This one phrase is tested more often than almost anything else in this topic.
A rightward shift of a downward-sloping curve also looks higher, so "the curve moves up" causes confusion. Describe shifts as right (an increase in demand) or left (a decrease). Label the curves D₁ and D₂, and draw an arrow from the old curve to the new one.
In some years, house prices rise and more houses are sold at the same time. This does not break the law of demand. Other things were not equal: incomes may have risen, or people expected prices to rise further. Those changes shifted the demand curve to the right. The law of demand describes price alone, with everything else held still.
Work each one on paper first. Open a hint only when you are stuck.
-
Use the coffee schedule in this lecture. The price falls from $5 to $3. What happens to quantity demanded? Is this a movement along the curve or a shift?
Hint 1
Read the quantities at $5 and at $3 from the table.
Hint 2
What changed: the price of coffee, or something else?
Full answer
Quantity demanded rises from 250 to 350 cups per week, an increase of 100 cups. Only the price of coffee changed, so this is a movement down and to the right along the same curve (an extension). Demand itself has not changed.
-
Think about the demand for bus rides in a city. For each change, say whether it causes a movement along the curve or a shift, and in which direction: (a) bus fares fall; (b) the price of petrol rises sharply; (c) the city's population grows.
Hint 1
For each change, ask: is this the price of a bus ride itself?
Hint 2
For (b), how do people travel if they do not take the bus? What happens to that choice when petrol costs more?
Full answer
(a) The bus fare is the price of the good itself, so this is a movement along the curve. Quantity demanded rises. (b) Driving is a substitute for the bus. Dearer petrol makes driving more expensive, so at every fare more people want the bus. The demand curve for bus rides shifts right. (c) More people means more buyers at every fare. The curve shifts right.
-
After a change, the coffee schedule becomes: $2 → 320 cups, $4 → 220 cups, $6 → 120 cups per week. Compare it with the original schedule. What kind of change is this? Suggest one possible cause.
Hint 1
Subtract the new quantity from the old one at each price.
Hint 2
If the quantity is lower by the same amount at every price, has the curve moved, or has the point moved along it?
Full answer
At every price, buyers now want 80 fewer cups (400 → 320, 300 → 220, 200 → 120). A change at every price is a shift: the demand curve has moved left, a decrease in demand. Possible causes include a fall in incomes, a fall in the price of tea (a substitute), or a change in tastes away from coffee. A change in the price of coffee is not a possible cause, because that would only move the point along the curve.
-
In the Mexico case, low-income households cut their purchases of taxed drinks by 9.1%, while middle- and high-income households cut theirs by about 5.5%. Use the income effect to explain why the response was bigger for poorer households.
Hint 1
The tax added the same amount to the price for everyone. Compare what that amount means to a household with a small budget and to one with a large budget.
Hint 2
The income effect works through real income. Whose real income falls by a bigger proportion?
Full answer
The tax raised the price of sugary drinks by the same amount for every household. For a poor household, these drinks take a bigger share of a small budget. So the same price rise cuts its real income by a bigger proportion than it cuts a richer household's. A bigger fall in real income means a bigger income effect, so poorer households reduce the quantity they buy by more. (The substitution effect works for every household. The income effect is the part that grows as the budget gets smaller, which is why it explains the gap between the groups.)
A demand curve looks like a simple line. It is actually a summary of millions of private decisions: every buyer weighing what a good is worth against what it costs, and what else the money could buy.
The distinction between moving along the curve and moving the curve is not about words. It is about cause. Every time something happens in a market, an economist first asks: what changed? Was it the price, or something else? Physicists can hold everything still in a laboratory. Economists cannot. "Other things being equal" is how economists hold the world still in their heads. The Mexico researchers did the same thing with data.
- Demand is the quantity buyers are willing and able to buy at each possible price, in a given period of time.
- The law of demand says that, other things being equal (ceteris paribus), a higher price means a lower quantity demanded.
- The demand curve slopes downward because of the substitution effect and the income effect, and because each extra unit is worth less to the buyer.
- A change in the good's own price causes a movement along the demand curve, called a change in quantity demanded.
- A change in anything else that affects buyers shifts the whole curve, called a change in demand: right for an increase, left for a decrease.
- Market demand is the sum of every buyer's demand at each price, and some buyers leave the market entirely as the price rises.