5/16/11

Defining the law of Demand, and diminishing marginal benefit/utility


This is a fundamental rule of economics that should make sense to most people.  It basically states that as the price of something goes down, people will be willing to purchase more of it.  Of course, economics in theory is much easier than economics in reality, but lets consider some examples.

First think of the whole market for cars.  There are some people who would like to buy a car now, but are unable too because they are just a little too expensive.  By decreasing the price, these people are now able to afford cars, and therefore buy them.  So everything else equal (ceteris paribus) as the price goes down, more of the goods (cars) are going to be sold.  This idea is what makes the demand curve downward sloping, as shown in the graph below:


The downward sloping nature of the demand curve can also be related to diminishing marginal benefits (MB, or marginal utility MU) .  Imagine you are eating tacos, as you eat more tacos, your happiness from each additional taco is not as high as the previous one (your marginal benefit is decreasing).  Because you are not as happy with each taco, your willingness to pay goes down as the quantity of tacos consumed goes up.  This makes shows us that the demand curve has exhibits a negative relationship between quantity and price.

Another example could focus only on you, the individual.  Imagine going to the store and seeing t-shirts on sale.  If the t-shirt is $50, you may only buy one, but if it is on sale, you may buy one, or more than one.  If the price gets very low, say $10, then maybe you will buy three or ten!  The point is, as the price goes down, we are willing to purchase more of the good, with everything else equal.

It is important to keep in mind the everything else equal part of this discussion.  Some argue that a $30 t shirt and a $50 t shirt cannot be the same because of quality, or brand name issues.  This is where the theory and real world collide.  Economists make the simplifying assumption that is possible to have IDENTICAL products where the only difference is in price.  If this truly is the case, then we get the download sloping demand curve common in all of the textbooks.

Look here if you would like to see how to make a demand curve.

 REMEMBER:  D is for demand, and D is for down!
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