The Demand Curve - (Consumer Behavior, Demand and Supply)

Diminishing marginal utility is the principle that, as a consumer consumes more units of a good, the extra (marginal) satisfaction gained from each additional unit falls (1) — so the consumer is only willing to buy more units at a lower price (1).

A movement along the demand curve is caused only by a change in the good's own price (1). If the price rises, quantity demanded falls (a contraction); if the price falls, quantity demanded rises (an extension) — but the curve itself does not move (1).

A shift of the demand curve is caused by a change in a non-price condition of demand, such as real income, tastes, advertising or the price of a related good (1). This changes the quantity demanded at every price, moving the whole curve right (an increase in demand) or left (a decrease) (1).

Chicken and beef are substitutes — goods that satisfy a similar want, so consumers can switch between them. A rise in the price of chicken makes chicken relatively more expensive, so some consumers switch towards beef.

This is a change in a condition of demand for beef (the price of a related good), not a change in beef's own price, so it shifts the demand curve for beef to the right, from D to D₁: more beef is demanded at every price.

On a demand and supply diagram, with the supply of beef unchanged, this rightward shift creates a shortage at the original price. This pushes the price of beef up, and the quantity of beef traded rises to a new, higher equilibrium (P₁, Q₁).

Therefore a rise in the price of a substitute (chicken) raises both the equilibrium price and quantity of beef — the classic result of a rightward demand shift.

An increase in demand for new houses means the whole demand curve shifts rightward, so more houses are demanded at every price. Two conditions of demand can cause this.

Factor 1 — a fall in interest rates. Most houses are bought with a mortgage, so a fall in interest rates lowers the cost of borrowing and reduces monthly repayments. Housing becomes more affordable, so more consumers are willing and able to buy. Demand for new houses therefore rises and the curve shifts to the right, raising the equilibrium price and quantity.

Factor 2 — a rise in real incomes. Housing is a normal good, so as real incomes rise, consumers can afford larger and better homes and more first-time buyers enter the market. This increases demand at every price, again shifting the demand curve rightward. Rising incomes may also raise confidence, reinforcing the effect.

On a demand and supply diagram, both factors shift demand from D to D₁; with supply relatively fixed in the short run, the effect is a higher equilibrium price and quantity of new houses.

Cars and petrol are in joint (complementary) demand — they are used together, so demand for petrol is partly derived from the demand for cars. A large rise in the price of new cars will, other things equal, reduce the quantity of new cars bought.

The main effect. With fewer new cars being bought and driven, the demand for petrol falls: petrol's demand curve shifts leftward from D to D₁ (a decrease in demand, not a movement along petrol's own curve). On a demand and supply diagram for petrol, with supply unchanged, this creates a surplus at the old price, so the equilibrium price and quantity of petrol both fall to (P₁, Q₁). Because petrol is a complement to cars, the change in car prices feeds through to the petrol market via the complementary relationship.

Evaluation — how large is the effect? The size of the fall is uncertain and probably small in the short run, for several reasons.

First, the effect depends on the existing stock of cars, not just new sales. Most petrol is bought by people who already own cars; a rise in new-car prices does little to their driving in the short run, so petrol demand may barely move.

Second, it depends on the price elasticity of demand for new cars. If demand for cars is inelastic (people still need to replace cars), the fall in car sales — and hence in petrol demand — is small.

Third, petrol itself is a necessity for existing drivers with few substitutes, so its own demand is highly price-inelastic; the leftward shift changes quantity more than it changes behaviour.

Judgement. A rise in new-car prices does shift the demand for petrol to the left, lowering its equilibrium price and quantity, but the effect is likely to be modest, especially in the short run, because petrol demand is dominated by the large existing stock of cars and is itself price-inelastic. The effect would be larger in the long run, as the car stock gradually shrinks or people switch to alternatives.

Demand is the quantity of a good consumers are willing and able to buy at each price, and the demand curve can be shifted rightward (an increase in demand) by any favourable change in a condition of demand. Advertising is one such condition, but it is only one of several, so its importance must be weighed against the others.

The case that advertising is very important. Successful advertising changes consumers' tastes and preferences and raises awareness, making a good more desirable. It can shift the demand curve to the right, so more is demanded at every price, raising the equilibrium price and quantity. Advertising is powerful because it is within the firm's control — unlike income or interest rates, a firm can choose to spend on it — and it can also make demand more brand-loyal and less price-sensitive, protecting sales. For products such as soft drinks, fashion and cosmetics, brand advertising is clearly a major driver of demand.

The case that other factors matter more. First, real income is often the dominant influence: in a boom, demand for normal and especially luxury goods rises regardless of advertising, and in a recession even heavily advertised goods see demand fall. For big-ticket items this income effect can dwarf any advertising campaign. Second, the prices of related goods matter: a fall in the price of a substitute can pull demand away however much a firm advertises, while a cheaper complement can raise demand with no advertising at all. Third, interest rates and the availability of credit are decisive for goods bought on finance (cars, houses, furniture) — cheaper borrowing can lift demand far more than an advert. Fourth, demographics and population shape demand for whole categories (e.g. an ageing population and healthcare), and expectations can trigger surges of buying independent of advertising.

Evaluation and judgement. The importance of advertising depends on the type of good and the context. For low-cost, brand-differentiated consumer goods where tastes are easily influenced, advertising may indeed be the single most important factor a firm can use. But for goods whose demand is dominated by income, credit conditions or the prices of substitutes and complements, advertising is secondary — a firm can advertise heavily and still lose sales if incomes fall or a rival cuts its price. Moreover, advertising is subject to diminishing returns and can be matched by competitors, so its net effect on demand may be limited. The most defensible conclusion is that advertising is an important controllable shifter of demand, but rarely the most important one overall: for most goods, real income and the prices of related goods exert a larger and more reliable influence on demand.