IB Economics - The Law of Demand

This IB Economics study note covers the Law of Demand

The Negative Causal Relationship Between Price and Quantity Demanded

Definition:

• The law of demand states that, ceteris paribus (all other things being equal), as the price of a good or service decreases, the quantity demanded increases, and vice versa. This inverse relationship is a fundamental principle of economics.

Explanation:

• Substitution Effect: When the price of a good falls, it becomes cheaper relative to other goods. Consumers will substitute the cheaper good for more expensive alternatives.
• Income Effect: A lower price increases consumers' real income, enabling them to buy more of the good. Conversely, a higher price decreases their purchasing power.

Real-World Examples:

• Gasoline Prices: When gasoline prices fall, people tend to buy more fuel and may even drive more frequently or choose larger vehicles.
• Technology Products: The decline in the prices of smartphones over the years has led to a significant increase in their quantity demanded worldwide.

Diagrams:

• Demand Curve: A downward-sloping curve on a price-quantity graph, illustrating the inverse relationship between price and quantity demanded.

Relationship Between an Individual Consumer's Demand and Market Demand

Individual Demand:

• Refers to the quantity of a good or service that a single consumer is willing and able to purchase at various prices.

Market Demand:

• The total quantity of a good or service that all consumers in a market are willing and able to purchase at various prices. It is the horizontal summation of all individual demand curves.

Explanation:

• Aggregation: Market demand is derived by summing the individual demand of all consumers at each price level. This captures the overall demand in the market.

Real-World Examples:

• Concert Tickets: The market demand for concert tickets is the sum of all individual demands from fans willing to attend the concert at different price points.
• Groceries: The market demand for apples in a city represents the total demand from all households in that city at various prices.

Contributions of Key Economists

Alfred Marshall:

• Introduced the concept of price elasticity of demand, which measures how quantity demanded responds to price changes. His work laid the foundation for modern demand theory.

Joan Robinson:

• Developed the theory of imperfect competition, contributing to the understanding of how market structures affect demand and pricing.

Esther Duflo:

• A modern economist whose research on poverty and development economics often involves understanding demand for goods and services in low-income settings.

Richard Thaler:

• A pioneer in behavioral economics, Thaler's work helps explain deviations from traditional demand theory due to psychological and behavioral factors.

Janet Yellen:

• Her work in labor economics and macroeconomic policy has implications for understanding aggregate demand in the economy.

Glossary of Key Terms

• Ceteris Paribus: A Latin phrase meaning "all other things being equal," used to isolate the relationship between two variables.
• Demand Curve: A graph showing the relationship between the price of a good and the quantity demanded.
• Income Effect: The change in consumption resulting from a change in real income.
• Individual Demand: The demand of a single consumer for a good or service.
• Market Demand: The total demand for a good or service from all consumers in a market.
• Price Elasticity of Demand: A measure of the responsiveness of quantity demanded to a change in price.
• Substitution Effect: The change in quantity demanded due to a change in the relative price of goods.

Related Topics for Further Exploration

1. Price Elasticity of Demand: Investigate how demand responds to changes in price and the factors affecting elasticity.
2. Income Elasticity of Demand: Explore how changes in income levels affect demand for various goods.
3. Consumer Behavior: Study how psychological factors influence purchasing decisions.
4. Supply and Demand Equilibrium: Examine how market equilibrium is achieved and the effects of shifts in supply and demand.
5. Market Structures: Analyze how different market structures (e.g., monopoly, oligopoly) impact demand and pricing.

Possible IB Economics Essay-Style Questions

1. Explain how the substitution effect and income effect contribute to the law of demand. Provide real-world examples to support your explanation.
2. Discuss the factors that can cause a shift in the demand curve. Use diagrams and examples to illustrate your points.
3. Evaluate the importance of understanding price elasticity of demand for businesses. How can this knowledge influence their pricing strategies?
4. Analyze the relationship between individual demand and market demand. How does this relationship affect market outcomes?
5. To what extent do behavioral economics challenge the traditional law of demand? Discuss with reference to specific studies and examples.