Demand Theory, Part II

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AGEC/FNR 406
LECTURE 5
Collecting fragments of coal in a rail yard in
China
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Demand
Demand is the desire for a good or service plus
the willingness and ability to acquire it.

• Demand arises as the combination of two
  forces1. an individuals desire to acquire
  something2. the purchasing power to acquire it

• Patterns of demand are used by economists to
  infer the value of goods by individuals and
  society(e.g. cars, national parks, clean water).

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Demand Curve

• Decreasing marginal utility combined with
  substitution between goods leads to a demand
  curve that slopes downward.

P
As price falls, quantity demanded increases.
Conversely, as price rises, demand falls.
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Q
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Demand Curve
P

• A demand curve measures marginal values based on
  an individuals willingness to pay for additional
  units of a good.Each point on the curve
  represents the PRIVATE value of a unit to a
  consumer.

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Features of demand curves
P
1. Downward sloping.
2. A function of price, income, and
tastes.
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Changes in demand
P
1. A price change induces a movement
along the demand curve













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Changes in demand, continued
P
2. A shift of the demand curve represents
a change in some other factor. The change
might be a change in the price of a
substitute, a change in income, or a change
in tastes.
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Example sunscreen
P
Q Suppose the price of sunscreen falls
from P1 to P2. What happens?

P1
A The price reduction leads to greater
demand, so the quantity goes up
from Q1 to Q2.

P2
D
Q1
Q2
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Example sunscreen
Q Now suppose it is reported that a hole
in the ozone has appeared over West
Lafayette. What happens?
P


P1
A The news leads to a shift in the
demand curve. More sunscreen is
demanded at the old price.
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Q1
Q2
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Market demand curve

• A market demand curve is a horizontal summation
  of individual demand curves

Individual 2
Individual 1
Market
(1 unit)
(2 units)
(3 units)
P
D
D
D
Q
1
2
3
Q
Q
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Indirect measurement of demand
It is often the case that one cannot easily
place a value on the environment. However,
it may be possible to value the environment, or
environmental services, by examining the market
for closely related goods, i.e. substitutes or
complements. For example, the value of a clean
stream might be estimated by annual expenditures
by fly fishermen.
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Key points regarding demand
1. The demand curve represents a marginal
value function (i.e. values of additional
units) 2. The demand curve can be thought of
as measuring the willingness to pay. 3.
The demand curve represents only the BUYERs
side of the market (private). 4. The
negative relationship between price and
quantity reflects diminishing marginal utility.
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