What is the relationship between price and quantity demanded?

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Learning Outcomes

• Explain the law of demand
• Explain a demand curve

Demand describes the amount of goods or services that consumers want to (and are able to) pay in order to purchase that good or service. Before learning more about the details of demand, watch this video to get a basic understanding about what it is and its importance to understanding economic behavior.

You can view the transcript for “Episode 11 – Demand” (opens in new window).

The law of demand states that, other things being equal:

• More of a good will be bought, the lower its price
• Less of a good will be bought, the higher its price

Ceteris paribus means “other things being equal.”

What a buyer pays for a unit of the specific good or service is called the price. The total number of units purchased at that price is called the quantity demanded. A rise in the price of a good or service almost always decreases the quantity of that good or service demanded. Conversely, a fall in price will increase the quantity demanded. When the price of a gallon of gasoline goes up, for example, people look for ways to reduce their consumption by combining several errands, commuting by carpool or mass transit, or taking weekend or vacation trips closer to home. Economists call this inverse relationship between price and quantity demanded the law of demand. The law of demand assumes that all other variables that affect demand are held constant.

An example from the market for gasoline can be shown in the form of a table or a graph. A table that shows the quantity demanded at each price, such as Table 1, is called a demand schedule. Price in this case is measured in dollars per gallon of gasoline. The quantity demanded is measured in millions of gallons over some time period (for example, per day or per year) and over some geographic area (like a state or a country).

A demand curve shows the relationship between price and quantity demanded on a graph like Figure 1, below, with quantity on the horizontal axis and the price per gallon on the vertical axis. Note that this is an exception to the normal rule in mathematics that the independent variable (X) goes on the horizontal axis and the dependent variable (Y) goes on the vertical. Economics is different from math! Note also that each point on the demand curve comes from one row in Table 1. For example, the uppermost point on the demand curve corresponds to the last row in Table 1, while the lowermost point corresponds to the first row.

Figure 1. A Demand Curve for Gasoline (derived from the data in Table 1).

The demand schedule (Table 1) shows that as price rises, quantity demanded decreases, and vice versa. These points can then be graphed, and the line connecting them is the demand curve (shown by line D in the graph, above). The downward slope of the demand curve again illustrates the law of demand—the inverse relationship between prices and quantity demanded.

The demand schedule shown by Table 1 and the demand curve shown by the graph in Figure 1 are two ways of describing the same relationship between price and quantity demanded.

Demand curves look somewhat different for each product. They may appear relatively steep or flat, or they may be straight or curved. Nearly all demand curves share the fundamental similarity that they slope down from left to right. In this way, demand curves embody the law of demand: as the price increases, the quantity demanded decreases; and conversely, as the price decreases, the quantity demanded increases.

In economic terminology, demand is not the same as quantity demanded. When economists talk about demand, they mean the relationship between a range of prices and the quantities demanded at those prices, as illustrated by a demand curve or a demand schedule. When economists talk about quantity demanded, they mean only a certain point on the demand curve, or one quantity on the demand schedule. In short, demand refers to the curve, and quantity demanded refers to the (specific) point on the curve.

Change in Demand vs. Change in Quantity Demanded

It’s hard to overstate the importance of understanding the difference between shifts in curves and movements along curves. Remember, when we talk about changes in demand or supply, we do not mean the same thing as changes in quantity demanded or quantity supplied.

A change in demand refers to a shift in the entire demand curve, which is caused by a variety of factors (preferences, income, prices of substitutes and complements, expectations, population, etc.). In this case, the entire demand curve moves left or right.

Figure 2. Change in Demand. A change in demand means that the entire demand curve shifts either left or right. The initial demand curve D0 shifts to become either D1 or D2. This could be caused by a shift in tastes, changes in population, changes in income, prices of substitute or complement goods, or changes in future expectations.

A change in quantity demanded refers to a movement along the demand curve caused only by a change in price. In this case, the demand curve doesn’t move; rather, we move along the existing demand curve.

Figure 3. Change in Quantity Demanded. A change in the quantity demanded refers to movement along the existing demand curve, D0. This is a change in price caused by a shift in the supply curve.

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The total amount of goods and services that consumers need or want and are willing to pay for over a given time

Quantity demanded is the total amount of goods and services that consumers need or want and are willing to pay for over a given time. The important factor in a demand curve is the price consumers are charged for a good or service, irrespective of whether that is the market equilibrium price.

The relationship between the quantity demanded of a good or service in the marketplace by consumers, and its price is called the demand curve. When demand changes in relation to price, it is called the elasticity of demand.

Change in Quantity Demanded

If a buyer is willing to buy more or less quantity of a specific good or service, the marketplace will experience a change in the quantity demanded. A price increase or decrease is the main reason for a change in the number of goods and services.

A graphical representation of the relationship between price and quantity is displayed on the demand curve, and the change in demand is a movement along the demand curve. The formula to calculate the relative change is y = mx + c, where mx = gradient of the slope * value on the x-axis, and c = intercept on the y-axis.

Inverse Price Relationship

The quantity demanded by consumers will determine the price of goods and services. The relationship between quantity and price can be understood from the demand curve. If the quantity demanded moves from Quantity 1 to Quantity 2, then the price paid for the good or service moves from price 1 to price 2.

Hence, the price of a good or service and the quantity demanded demonstrates an inverse relationship, and the inverse relationship between the two factors is the law of demand.

Price Elasticity of Demand

The change in the amount of quantity demanded concerning price is called the elasticity of demand. When a good or service is highly elastic, the quantity demanded of the good or service varies widely at different price points. For example, a 5% increase in price will lead to a 20% decrease in demand for the good or service.

On the other hand, an inelastic good or service is when the quantity demanded is relatively static at varying price points. For example, when the price of bread – a necessity – increases, the demand does not change in relation to the price.

Different Types of Demand

1. No Demand

No Demand is where the consumer is unaware and has inadequate information about the good or service, or the consumer is indifferent. To prevent such a type of demand, the company’s marketing department should emphasize promotional campaigns and persuade potential customers to use the company’s goods or services.

A popular strategy used to differentiate a good or service in a competing market is to differentiate the company’s offering through emphasizing their Unique Selling Proposition (USP).

2. Negative Demand

Negative Demand is present when the market response to a good or service is negative. It means that consumers are not aware of the features and benefits of the good or service offered. It is the marketing department’s goal to understand the reason for the rejection of their good or service. Therefore, a strategy is needed to transform the negative demand into positive demand.

3. Latent Demand

Latent Demand is when it is not possible for certain goods or services to address all the needs and wants of society. In an economy, latent demand exists at any given time, and it should be looked at as a business opportunity.

For example, a passenger traveling in an economy class on an airplane dreams of traveling in business or first class. Hence, latent demand is a gap between desirability and affordability.

4. Seasonal Demand

Seasonal Demand is when a good or service does not have a year-round demand but fluctuates according to the season. All over the world, seasonal demands are diverse. Therefore, it is important to understand the demand pattern by studying the different segments of the market.

It is important for service organizations to study demand patterns, as service companies need to keep up their service offerings to the change in demand. They must create a system to map demand fluctuations, which helps them in predicting the demand cycle.

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