INDEX: A measure of the relative average of a group of items compared to a given base value. Index measures are commonly used in economics to combine and compare diverse measures. One common type of index measure is for prices, such as the Consumer Price Index and the Dow Jones Industrial Average of corporate stock prices. Another noted type of index measure is to track macroeconomic activity, especially the index leading economic indicators. Indexes are usually weighted averages rather than simple arithmetic means that are measured relative to a base value or period. The Consumer Price Index, for example, measures the prices of consumer good, weighted by the quantities purchased. The value of a given period is then stated relative to a base year value, which generates a pure, "unitless" number in the range of 100 (give or take).
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The willingness and ability to buy a range of quantities of a good at a range of prices, during a given time period. Demand is an inverse relation between price (demand price) and quantity (quantity demanded). Demand is one half of the market exchange process--the other is supply. This demand side of the market draws inspiration from the unlimited wants and needs dimension of the scarcity problem. Demand is a fundamental aspect of market exchanges and economic activity. Even more, it is an essential feature of human existence. People demand goods and services to satisfy their unlimited wants and needs.
A Closer LookThree aspects of demand are worthy of further consideration:
- Willingness and Ability: Demand requires both willingness and ability. To demand a good, a buyer must have a WILLINGNESS to buy it. Willingness generally arises because the good satisfies a want or need. But while wants and needs in total are essentially unlimited, everyone does NOT necessarily want or need every good. Duncan Thurly, for example, does not like asparagus. He considers asparagus vile, nasty stuff. As such, he has NO demand for asparagus because he has NO willingness.
Demand, however, also requires ABILITY. While demand can be constrained by the physical ability to purchase a good, income is often more important. Wants and needs may be unlimited, but income is not. A buyer must have enough income to make a purchase. Lisa Quirkenstone, for example, loves asparagus. Unfortunately, she is between jobs and deeply in debt. She lacks the income needed to buy asparagus. As such, she has NO demand for asparagus because she has NO ability to buy.
- Range of Prices and Quantities: Demand is a range of prices and quantities. It includes not just the quantity purchased at the current price, but any and all quantities that would be purchased at other prices--higher and lower. Gerald Johnson, for example, is NOT willing and able to purchase asparagus if the price is $1 a pound. However, if the price is to 50 cents a pound, he is inclined to purchase a few stalks. If the price is even lower, say 25 cents a pound, Gerald will purchase an even larger quantity.
Practicing the fine art of economic analysis--market style--involves a lot of "What if?" questions, such as: "What would happen in the asparagus market if the price is $1 a pound, or 25 cents a pound, or $0 a pound, or...?" Limiting analysis ONLY to the current price, ignores a vast range of alternatives that might occur. And this eliminates a lot, in fact almost all, of the really important analyses of markets.
- Given Time Period: Demand is identified for a specified time period. The analysis of asparagus demand needs information on the time period. Is the demand for an hour, a day, a week, a month, a year, or a decade? Presumably, people buy a larger quantity of asparagus, at a given price, over a decade than over a week. When economists work with demand they identify a specific time period. Like adding apples and oranges, it makes no sense to combine Gerald Johnson's daily asparagus demand with Lisa Quirkenstone's annual asparagus demand.
Price and QuantityDemand is a range of prices and quantities. The price part of this relation is termed demand price and the quantity part is termed quantity demanded.
Demand price and quantity demanded come together as matched pairs. One demand price, one quantity demanded. Demand is then the combination of these matched price-quantity pairs.
- Demand Price: This is the maximum price that buyers are willing and able to pay for a given quantity of a good. They would be willing to pay less than this price, but not more. Demand price is based on the satisfaction derived from the good.
- Quantity Demanded: This is the specific amount of a good that buyers are willing and able to purchase at a given demand price. The quantity demanded is the maximum amount of the good that buyers are willing and able to buy at the given price.
The Law of DemandThe specific demand relation between price and quantity is termed the law of demand. The law of demand is the inverse relation between demand price and quantity demanded. If, in other words, the demand price increases, then the quantity demanded decreases. The law of demand is one of the most important and most fundamental economic principles identified in the study of markets and economics.
The law of demand is attributable to two effects.
- Income Effect: This is a change in the purchasing power of income caused by a change in the price of a good, which then affects how much of the good is purchased. If the price increases, for example, buyers cannot purchase as much of the good with existing income.
- Substitution Effect: This is a change in the relative price of substitute goods caused by a change in the price of a good, which then affects how much of the good is purchased. If the price increases, for example, buyers tend to purchase less of the good because they are purchasing more of other goods.
A Demand Curve
The demand relation between demand price and quantity demanded is commonly represented by a demand curve. A demand curve is nothing more than a graphical representation of the law of demand. The demand curve presented in this exhibit shows the relation between the demand price, measured on the vertical axis, and quantity demanded measured on the horizontal axis.
|A Demand Curve
The negative slope of the demand curve graphically illustrates the inverse law of demand relation between demand price and quantity demanded. As the demand price declines from $50 to $5, the quantity demanded increases from 0 to 90. Buyers are willing and able to buy more at lower prices.
Five DeterminantsWhile demand price is the most important factor that affects the purchase of a good, it is not the only factor. Five other factors, termed demand determinants, are also important. These determinants cause a change in the demand for a good, that is, more or less of the good is purchased at existing prices.
- Buyers' Income: The amount of income that buyers have available to spend affects the ability to purchase a good. In general, if buyers have more income, then they buy more of a good. However, in some circumstances, extra income actually induces buyers to buy less of a good. A normal good exists if demand increases with an increase in income and an inferior good exists if demand decreases with an increase in income.
- Buyers' Preferences: The satisfaction derived from a good affects the willingness to purchase a good. If buyers like a good more, then they buy more of a good.
- Prices of Other Goods: The demand for one good is interrelated with the purchase of other goods, and the prices of those goods. Some goods are substitutes, purchased in place of, others are complements, purchased together with. If the price of a substitute good increases, then buyers switch from that good and buy more of this good. If the price of a complement good increases, then buyers buy less of both goods.
- Buyers' Expectations: Buyers decide how much to purchase based on a comparison of current and expected future prices. If buyers expect a higher price in the future, then they buy more of a good today.
- Number of Buyers: The total number of buyers participating in a market affects how much of a good is demanded. If there is an increase in the number of buyers, then there is a greater demand for the good.
Two ChangesThe study of demand highlights two related, but distinct, changes. To understand these changes, first considered two related, but distinct, notions of demand.
Two interrelated changes are implied directly from these two notions.
- Quantity Demanded: This is the specific amount that buyers are willing and able to purchase at a specific price. It is indicated as a single point on a given demand curve.
- Demand: This, in contrast, is the entire set of price-quantity pairs that reflect buyers willingness and ability to purchase a good. It is the entire demand curve.
The difference between a change in demand and a change in quantity demanded is essential for understanding how the market adjusts to external shocks.
- A Change in Quantity Demanded: This is a change in the specific amount of the good that buyers are willing and able to purchase. It is caused by a change in the demand price and is indicated by a movement along the demand curve from one point to another.
- A Change in Demand: This a change in the overall demand relation, a change in all price-quantity pairs. It is caused by a change in one of the five demand determinants and is indicated by a shift of the demand curve.
DEMAND, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 21, 2024].
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