Question

1. What does it mean to say that price and quantity demanded are inversely related?

2. Demand is a function of five factors. Stated differently, if there is a change in any of these five factors, demand will either increase or decrease. What are these five factors? Describe how increase/decrease in each factor will effect the demand curve.

3. If demand for a good increases, will the demand curve ( that represents the good) shift to the right or to the left?

Answer 1

1. What does it mean to say that price and quantity demanded are inversely related?

According to the law of demand, price and the quantity demanded of a product are inversely related. This means that higher the price of the product, lower the quantity demanded. Demand for a product refers to the quantity that consumers want to buy at that price or more specifically, refers to consumer’s willingness to pay. Since quantity demanded and price of the good is inversely related, the demand curve is downward sloping.

Let us explain this with the help of an example.

Example - Suppose the price of apples is $1 per pound and quantity demanded at $1 = 100 apples. Now, if the seller increases the price of apples from $1 to $3, then quantity demanded at $3 = 50 apples according to the law of demand.

By plotting these two combinations of price and quantity, we can derive the downward sloping demand curve, given by DD.

2. Demand is a function of five factors. Stated differently, if there is a change in any of these five factors, demand will either increase or decrease. What are these five factors? Describe how increase/decrease in each factor will affect the demand curve.

A change in price of the product causes the quantity demanded to change, not the demand for the good. Demand changes when factors except price changes. These factors include income of the consumer, change in taste and preferences, number of buyers, availability and price of alternatives or future expectations, etc.

When quantity demanded changes due to change in price, the movement takes place along the demand curve, but does not shift the demand curve.

However, when demand changes for factors except price, the demand curve shifts to the right or left. When the demand curve shifts to the left (inward), then there is fall in quantity demanded. Similarly, when the demand curve shifts outward to the right, the quantity demanded increases.

Lets us now talk about these five determinants of demand:

1. Income of the buyer – An increase in income of the consumer would increase the demand for the good (i.e., the demand curve will shift to the right). Similarly, a fall in consumer income will lead to decrease in demand for the good, if it is a normal good and the demand curve will shift inward to the left. If the demand for the good varies inversely with income, then they are inferior goods.
2. Change in taste and preferences of the consumer - Favourable change in preferences cause increase in demand causing the demand curve to shift to the right while unfavourable changes lead to decrease in demand, resulting the demand curve to shift to the left.
3. Increase in the number of consumers – More consumers of the good in the market lead to increase in demand for the good (demand curve will shift to the right) and fewer buyers cause demand to fall (demand curve will shift to the left).
4. Change in price of related goods: Goods can be categorised into substitutes and compliments. Substitute goods are those which can be used as a replacement for each other. For example – tea and coffee. If price of substitute good increases, the consumers will demand less of the substitute good and more of this good. So, price of substitute good and demand for the other good are directly related.

However, in case of complements, the goods need to be used to be used together. For example – tea and sugar. If the price of tea increases, the consumers will demand less of tea and in turn less of sugar as well. So, price of the complement and the other good are inversely related.

5. Future expectations: If buyers of a good expect prices of the good to rise in future, then they will demand more of the good at present. So, demand curve will shift to the right. Similarly, if consumers expect the price of the good to fall in future, then they will demand less of the good at present. So, the demand for the good decreases and the demand curve will shift to the left.

3. If demand for a good increase, will the demand curve (that represents the good) shift to the right or to the left?

If demand for a good increase for the factors that we have discussed above, then the demand curve of the good will shift to the right.