Thinking through the demand curve

We spoke about the law of demand in the previous post: the fact that there is an inverse relationship between the price of something and the quantity demanded of that thing. We also spoke about how you could ask a person to respond to a series of questions about how much she would be willing to buy of a thing at a particular price point, and construct a demand curve by plotting their responses.

But that’s where the problems begin. The responses given by that person are going to depend upon the time of the day, the month of the year – why, they even depend upon the mood of the person! Have you ever gone shopping to “cheer yourself up”? But in this post, we are going to speak about how thinking about demand curves is even more difficult than we have thought about so far.

Here’s the first problem: has anyone actually ever asked you what quantities of Coke you will be willing to buy at various price points? Odds are, they haven’t. But is it not reasonable to think that the marketing department of Coke has some idea of the market demand for Coke? Well, if nobody asked you, but Coke knows the answer – how do we reconcile these two statements?

Well, in practice, the demand curve for a product is estimated as the result of a survey. That is, some people in the market are asked these kind of questions, and their results, aggregated, are treated as being representative of the entire population. Kind of like an exit poll, but hopefully more accurate than that.

Demand curves could also be constructed by actually offering goods at different price points, and recording a change in the actual (not hypothetical) quantity demanded. What if we raise the price of atta by one rupee in this particular store? Will the demand for atta go down? If yes, by how much? What if the store in which we change the price is in an affluent neighbourhood? What if it’s not?

Here’s the second problem: your answer is likely to change, and keep on changing, because of so many reasons. For example, the demand curve for the Nokia 3310 before and after the iPhone was launched is likely to look very different. Same product, same questions – but my demand for the 3310 is, well, zero – after 2007. As it turns out, the demand for a particular thing also depends upon the availability (or not) of other things in the market.

In fact, here’s the thing in a nutshell: while it is true that the demand curve shows simply an inverse relationship between the price of something, and the quantity demanded of that thing, it is also true that it depends on so many other things: changing income, tastes, preferences, availability of other goods – all of these things affect the relationship shown by the demand curve.

The demand curve looks very simple indeed, but it hides a world of complexity within it. As does the supply curve, which we shall take a look at next.

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