No Such Thing as a Free Lunch: Principles of Economics (Part 12)

Economics is extremely useful as a form of employment for economists.

John Kenneth Galbraith

Demand, Supply, and Market Equilibrium (Part D)

by

Charles Lamson

Shift of a Demand vs. Movement along a Demand Curve

A demand curve shows the relationship between quantity demanded and the price of a good. Such demand curves are derived while holding income, taste, and other prices constant. If this condition of ceteris paribus (all else being equal) were relaxed, we would have to derive an entirely new relationship between price and quantity.

Let us return once again to Anna (see Table 1 and Figure 2 from Part 10 of this analysis and reintroduced below). Suppose that when we derived the demand schedule in Table 1, Anna had a part-time job that paid $300 per month. Now suppose that her parents inherit some money and begin sending her an additional $300 per month. Assuming that she keeps her job, Anna's income is now $600 per month.

The fact that demand increased when income increased implies that telephone calls are normal goods (any goods for which demand increases when income increases) to Anna. 

The condition that were in place at the time we drew the original demand curve have now changed. In other words, a factor that affects Anna's demand for telephone calls (in this case, her income) has changed, and there is now a new relationship between price and quantity demanded. Such a change is referred to as a shift in the demand curve.

It is very important to distinguish between a change in the quantity demanded---that is, some movement along a demand curve---and a shift of a demand. Demand schedules and demand curves show the relationship between the price of a good or service and the quantity demanded per period, ceteris paribus. If price changes, quantity demanded will change---this is a movement along the demand curve. When any of the other factors that influence demand change, however, a new relationship between price and quantity demanded is established---this is a shift of the demand curve. The result, then, is a new demand curve. Changes in income, preferences, or prices of other goods cause the demand curve to shift:

In Figure 4(b), an increase in the price of hamburger from $1.49 to $3.09 a pound causes a household to buy fewer hamburgers each month. In other words, the higher price causes the quantity demanded to decline from 10 to 5 pounds per month. This change represents a movement along the demand curve for for hamburger. In place of hamburger, the household buys more chicken. The household's demand for chicken (a substitute (products that could be used for the same purpose by the consumers) for hamburger) rises---the demand curve shifts to the right. At the same time, the demand for a ketchup (a good that compliments hamburger) declines---its demand curve shifts to the left.

From Household Demand to Market Demand

Market demand is simply the sum of all quantities of a good or service demanded per period by all the households buying in the market for that good or service. Figure 5 shows the derivation of a market demand curve from three individual demand curves. (Although this market demand curve is derived from the behavior of only three people, most markets have thousands or even millions of commanders.) As the table in Figure 5 shows, when the price of a pound of coffee is $3.50, both A and C would purchase 4 pounds per month, while B would buy none. At that price, presumably, B drinks tea. Market demand at $3.50 would thus be a total of 4 + 4 or 8 pounds. At a price of $1.50 per pound, however, A would purchase 8 pounds per month; B, 3 pounds; and C, 9 lb. Thus, at $1.50 per pound, market demand would be 8 + 3 + 9 or 20 pounds of coffee per month.

The total quantity demanded in the marketplace at a given price is simply the sum of all the quantities demanded by all the individual households shopping in the market at that price. A market demand curve shows the total amount of a product that would be sold at each price if households could buy all they wanted at that price. As figure 5 shows, the market demand curve is the sum of all the individual demand curves---that is, the sum of all the individual quantities demanded at each price. The market demand curve thus takes its shape and position from the shapes, positions, and number of individual curves. If more people decide to shop in a market, more demand curves must be added, and the market demand curve will shift to the right. Market demand curves may also shift as a result of preference changes, income changes, or changes in the number of demanders.

As a general rule throughout this analysis, capital letters refer to the entire market and lowercase letters refer to individual households or firms. Thus, in Figure 5, Q refers to total quantity demanded in the market, while q refers to the quantity demanded by individual households. 

*MAIN SOURCE: CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 51-55*

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