What Is the Law of Demand?

     The law of demand is the result of two separate behavior patterns that overlap, the substitution effect and the income effect.

     These two effects describe different ways that a consumer can change his or her spending patterns for other goods.

The Substitution Effect and Income Effect

The Substitution Effect

     The substitution effect occurs when consumers react to an increase in a good’s price by consuming less of that good and more of other goods.

The Income Effect

     The income effect happens when a person changes his or her consumption of goods and services as a result of a change in real income.

The Demand Schedule

     A demand schedule is a table that lists the quantity of a good a person will buy at each different price.

     A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price.

The Demand Curve

     A demand curve is a graphical representation of a demand schedule.

     When reading a demand curve, assume all outside factors, such as income, are held constant.

Shifts in Demand

     Ceteris paribus is a Latin phrase economists use meaning “all other things held constant.”

     A demand curve is accurate only as long as the ceteris paribus assumption is true.

     When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts.

What Causes a Shift in Demand?

     Several factors can lead to a change in demand:

Prices of Related Goods

     Complements are two goods that are bought and used together.  Example: skis and ski boots 

     Substitutes are goods used in place of one another.  Example: skis and snowboards

What Is Elasticity of Demand?

     Demand for a good that consumers will continue to buy despite a price increase
is inelastic.

     Demand for a good that is very sensitive to changes in price is elastic.

Calculating Elasticity

Elastic Demand

Inelastic Demand

Factors Affecting Elasticity

     Several different factors can affect the elasticity of demand for a certain good.

Elasticity and Revenue

     A company’s total revenue is the total amount of money the company receives from selling its goods or services.

     Firms need to be aware of the elasticity of demand for the good or service they are providing.

     If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.