Microeconomics Unit 2.1: Demand – Comprehensive Study Notes

Hello future Economists! Welcome to the fundamental building block of Microeconomics: Demand.

This chapter is crucial because it explains consumer behaviour—why we buy what we buy. Once you master Demand, Supply (the next unit) will make perfect sense, and you’ll have the two halves needed to understand how markets work!

Don't worry if the graphs seem intimidating; we will break down every movement and shift step-by-step.

1. Defining Demand and the Law of Demand

What is Demand?

In everyday life, demand means wanting something. In Economics, it’s much more specific.

  • Demand (D) refers to the quantity of a good or service that consumers are willing and able to buy at various possible prices over a given period of time.
  • If you are willing to buy a private jet but don't have the money, your desire is not considered "effective demand" in the market. You must have both the willingness AND the ability to pay.
The Law of Demand

This is the most fundamental concept of consumer behaviour.

  • The Law of Demand states that there is an inverse relationship between the price of a good (\(P\)) and the quantity demanded (\(Q_d\)).
  • As the price of a good increases, the quantity demanded decreases.
  • As the price of a good decreases, the quantity demanded increases.

Analogy: Imagine your favourite brand of chocolate bar. If the price suddenly doubles, you will likely buy less of it, or perhaps switch to a cheaper alternative. If the price halves, you might stock up!

Quick Takeaway: Demand in Economics requires both desire and money. The Law of Demand means price and quantity demanded always move in opposite directions.

2. The Demand Curve and the Ceteris Paribus Assumption

The Demand Schedule and Curve

The inverse relationship described by the Law of Demand is shown visually by the Demand Curve.

  • A Demand Schedule is a table showing the different quantities demanded at different prices.
  • The Demand Curve (D) is a graphical representation of this schedule. It is a line that slopes downward from left to right, reflecting the negative relationship between P and \(Q_d\).
  • Standard Convention: Price (\(P\)) is always plotted on the vertical (y) axis, and Quantity (\(Q\)) is always plotted on the horizontal (x) axis.
The Importance of Ceteris Paribus

To accurately draw the demand curve and understand the Law of Demand, we must use a critical assumption: Ceteris Paribus.

  • Ceteris Paribus is a Latin phrase meaning "all other things being equal" or "all other things held constant."
  • When we examine the relationship between Price and Quantity Demanded, we assume that factors like income, tastes, and the price of other goods are not changing.
  • This allows us to isolate the effect of price alone.

Memory Aid: Think of Ceteris Paribus as the "control group" in a science experiment. We only allow the price (our variable) to change to see its effect on demand.

3. Movements Along vs. Shifts of the Demand Curve

This is perhaps the most important distinction in this chapter and a common area for student error. Get this right!

A. Movement Along the Curve (Change in Quantity Demanded)

A movement along the existing demand curve is caused ONLY by a change in the product's own price, assuming ceteris paribus holds.

1. Contraction of Demand:

  • Occurs when the price of the good increases.
  • Quantity Demanded decreases.
  • This is shown as an upward movement along the fixed demand curve.

2. Extension (or Expansion) of Demand:

  • Occurs when the price of the good decreases.
  • Quantity Demanded increases.
  • This is shown as a downward movement along the fixed demand curve.

Common Mistake to Avoid: Do not say that a change in price causes a "change in demand." A change in price causes a change in the quantity demanded (a movement).

B. Shift of the Curve (Change in Demand)

A shift of the entire demand curve means that at every price level, consumers are now willing and able to buy a different quantity. This is caused by a change in one of the non-price determinants.

1. Increase in Demand (Shift Right):

  • More is demanded at every price.
  • The curve shifts outwards, from \(D_1\) to \(D_2\).

2. Decrease in Demand (Shift Left):

  • Less is demanded at every price.
  • The curve shifts inwards, from \(D_1\) to \(D_3\).

Quick Review Box: The Difference

Movement: Cause = Price of the good. Result = Change in Quantity Demanded.

Shift: Cause = Non-price factor (e.g., income). Result = Change in Demand.

4. The Non-Price Determinants of Demand (The Shifters)

These factors break the ceteris paribus assumption and cause the entire curve to shift. Understanding these factors is essential for real-world analysis.

4.1. Changes in Income (\(Y\))

How demand reacts to a change in consumer income depends on the type of good:

  • Normal Goods: As income increases, demand for the good increases (shifts right). As income decreases, demand decreases (shifts left). Example: Organic food, foreign vacations, new cars.
  • Inferior Goods: As income increases, demand for the good decreases (shifts left). As income decreases, demand increases (shifts right). Example: Cheap ramen noodles, used clothing, public transport (if high quality alternatives are available).
4.2. Changes in the Prices of Related Goods (\(P_R\))

We look at two types of related goods:

a. Substitute Goods: Goods that can be used in place of one another.

  • If the price of Good A (Coffee) rises, the demand for its substitute, Good B (Tea), will increase (shift right).

b. Complementary Goods (Complements): Goods that are usually consumed together.

  • If the price of Good A (Cars) rises, the demand for its complement, Good B (Petrol/Gasoline), will decrease (shift left).
4.3. Changes in Tastes, Preferences, or Fashion (\(T\))

If a good becomes more popular (e.g., due to advertising, social media trends, or celebrity endorsement), demand increases (shifts right). If it becomes unpopular (e.g., due to a negative health report), demand decreases (shifts left).

4.4. Changes in Consumer Expectations (\(E\))

What consumers believe will happen in the future affects their actions today.

  • If consumers expect the price of a laptop to increase next month, current demand for the laptop will increase (shift right).
  • If consumers expect their income to decrease next month (e.g., fear of job loss), current demand for luxury goods will decrease (shift left).
4.5. Changes in the Number of Consumers (Market Size) (\(N\))

The total market demand is the sum of all individual demands.

  • If the population grows or a government opens the border to more immigrants, the overall market size increases, and demand shifts right.
  • If the market becomes restricted (e.g., high tariffs preventing foreign buyers), demand shifts left.

Did you know? The concept of Veblen Goods (status goods like rare art or certain luxury cars) sometimes appears to contradict the Law of Demand, as demand for them may rise when prices rise, precisely because the high price signals exclusivity. While interesting, the Law of Demand holds true for the vast majority of goods examined in this course.

5. Synthesis: Putting it all Together

The full market demand function is written as:

\(Q_d = f(P, Y, P_R, T, E, N, ...)\)

(Quantity Demanded is a function of: Price, Income, Price of Related Goods, Tastes, Expectations, Number of Consumers, and other factors.)

  • If P changes, we move along the curve (changing \(Q_d\)).
  • If any other factor changes (Y, \(P_R\), T, E, N, etc.), the entire curve shifts (changing D).

You must be able to:

  1. Define demand and the Law of Demand clearly.
  2. Draw and correctly label a demand curve showing a negative slope.
  3. Illustrate and explain the difference between a movement (caused by price) and a shift (caused by a non-price determinant).

Congratulations! Understanding demand is the key to unlocking market equilibrium. Take a moment to review the distinction between movements and shifts before moving on to Supply.