In a competitive market, demand for and supply of a good or service determine the equilibrium price.

The law of demand

Markets have two agents: buyers and sellers. Demand represents the buyers in a market. Demand is a description of all quantities of a good or service that a buyer would be willing to purchase at all prices.
According to the law of demand, this relationship is always negative: the response to an increase in price is a decrease in the quantity demanded.
For example, if the price of scented erasers decreases, buyers will respond to the price decrease by increasing the quantity of scented erasers demanded. A market for a good requires demand and supply.

The determinants of demand

What influences demand besides price? Factors like changes in consumer income also cause the market demand to increase or decrease. For example, if the number of buyers in a market decreases, there will be less quantity demanded at every price, which means demand has decreased.
For instance, if scented erasers are normal goods, then when buyers have more income they will buy more scented erasers at every possible price; this would also shift the demand curve to the right.

Key Terms

Term Definition
demand all of the quantities of a good or service that buyers would be willing and able to buy at all possible prices; demand is represented graphically as the entire demand curve.
demand schedule a table describing all of the quantities of a good or service; the demand schedule is the data on price and quantities demanded that can be used to create a demand curve.
demand curve a graph that plots out the demand schedule, which shows the relationship between price and quantity demanded
law of demand all other factors being equal, there is an inverse relationship between a good’s price and the quantity consumers demand; in other words, the law of demand is why the demand curve is downward sloping; when price goes down, people respond by buying a larger quantity.
quantity demanded the specific amount that buyers are willing to purchase at a given price; each point on a demand curve is associated with a specific quantity demanded.
change in quantity demanded a movement along a demand curve caused by a change in price; a change in quantity demanded is a movement along the same curve
change in demand when buyers are willing to buy a different quantity at all possible prices, which is represented graphically by a shift of the entire demand curve; this occurs due to a change in one of the determinants of demand.
determinants of demand changes in conditions that cause the demand curve to shift; the mnemonic TONIE can help you remember the changes that can shift demand (T-tastes, O-other goods, N-number of buyers, I-income, E-expectations)
normal good a good for which demand will increase when buyers’ incomes increase.
inferior good a good for which demand will decrease when buyers’ incomes increase.
substitute goods goods that can replace each other; when the price of a good increases, the demand for its substitute will increase.
complement goods goods that tend to be consumed together; when the price of a good increases the demand for its complement will decrease.

 

Common misperceptions

Change in demand vs. change in quantity demanded

  • A change in demand and a change in quantity demanded are not the same thing. Demand changes only when one of the determinants of demand change (recall the elements of the mnemonic TONIE). For instance, rising consumer incomes (one of the determinants) will increase demand for new cars, a normal good, which would shift the entire demand curve to the right. More cars will be demanded at every price when demand increases.
  • Price is not a determinant of demand, thus a change in price does not cause demand to increase or decrease. If the price of new cars changes, ceteris paribus, there will be a change in the quantity demanded and a movement along the demand curve.

How a price change affects quantity demanded for a good and demand for related goods

  • A change in the price of a good will cause the quantity demanded for that good to change, but a change in the demand for related goods (complements and substitutes) causes the demand curve to shift.
  • For example, when the price of hot dogs falls three things happen: Quantity demanded for hot dogs increases, demand for hot dog buns (a complement) increases, and demand for hamburgers (a substitute) decreases