The Law of the Downward Sloping Demand Curve

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• 0:05 Introduction
• 1:05 Law of Demand
• 2:27 The Substitution Effect
• 3:44 The Demand Curve
• 5:23 Demand Shifters
• 6:55 Lesson Summary

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Lesson Transcript
Instructor: Jon Nash

Jon has taught Economics and Finance and has an MBA in Finance

Discover the relationship between the quantity demanded and price of a good or service in a market. This lesson explains why the demand curve is downward sloping and what factors will lead to a shift in demand.

Introduction

Economics is the study of how people use scarce resources in order to satisfy unlimited needs and wants. When people buy goods and services, we call it demand. They demand products and services. The way we describe demand at different prices is called quantity demanded.

You know this on an everyday level when you go into a grocery store. It's whether or not you want tangerines or oranges instead. It's whether or not you want one bunch of bananas or three bunches.

When people make decisions with their money as to what goods and services to buy, there is a pattern that emerges for almost every good or service in an economy, which we call the law of demand. It shows us the relationship between quantity demanded and price. You know from observing this many times that when you're in the grocery store and the price of something goes down, you tend to want to buy more of it.

The Law of Demand

The law of demand says that, all other things equal, if the price of a good or service goes up, the demand for it will decrease, and if the price of a good or service goes down, the demand for it will increase.

How do we know this? Well, we can look at a demand schedule, which is a table illustrating the quantity demanded for a good or service at different prices. For example, the demand for bananas can be seen by looking at a demand schedule for bananas, and here it is:

Market Demand Schedule for US Bananas
30 cents 96,000 tons of bananas per week
40 cents 75,000 tons of bananas per week
50 cents 65,000 tons of bananas per week
60 cents 60,000 tons of bananas per week

As you can see, this market demand schedule tells us that if the price of bananas were 50 cents, then people would buy 65,000 tons of bananas each week. However, if the price fell to only 40 cents, then demand would increase from 65,000 to 75,000. That means consumers would be willing and able to buy 10,000 additional tons of bananas each week at this price. This dynamic is exactly the same no matter what the price is. The lower the price becomes, the more demand people have for this good. The higher the price becomes, the less demand people have for this good.

The Substitution Effect

Why does demand change this way? What makes the law of demand true?

One thing that we can observe is called the substitution effect. The substitution effect happens when the price of one good goes down enough so that it becomes cheaper than something else, and because of this decline in price, people actually change their behavior and substitute the cheaper good for something else they would normally buy. This is because people make some of their decisions based on how much products and services cost relative to other products and services. When the price of a good goes down far enough, they will substitute this cheaper product for another more expensive one.

If I'm standing in the grocery store, and I'm looking at oranges and tangerines (and let's just say I like these equally), then I might buy one container of tangerines each week. But if I come back to the same store next week and the price of the oranges has declined by 25%, then I decide to buy oranges instead of tangerines, which are now more expensive relative to the oranges. I'm willing to substitute oranges for tangerines, and that's one of the main reasons why the law of demand works.

The Demand Curve

In economics, we illustrate demand using the downward sloping demand curve, which is a graph that illustrates the relationship between price and quantity demanded for a good or service. The demand curve is a visual representation of the demand schedule, which shows quantity demanded at different prices. If we're talking about bananas, then we take the demand schedule for bananas and we use it to create the demand curve for bananas.

Market Demand Schedule for US Bananas
30 cents 96,000 tons of bananas per week
40 cents 75,000 tons of bananas per week
50 cents 65,000 tons of bananas per week
60 cents 60,000 tons of bananas per week

As you can see, the demand curve for bananas is downward sloping, just like almost every demand curve is. As price changes, we travel from one place to another on the demand curve. At a price of \$0.60, we're up high on the demand curve, and at a price of \$0.30, let's say, we're down at the bottom of the curve.

Now, demand for a product or service can change even if the price stays the same. It can either increase or decrease. If demand increases, then the downward sloping demand curve will increase also by shifting to the right. If demand decreases, on the other hand, then the demand curve shifts to the left.

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