## A Deeper Look at the Demand Curve

Instructor: Tyler Cowen, George Mason University

This video looks at both the horizontal and vertical methods for reading the demand curve, how demand curves shift, and consumer surplus.

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## Transcript

Hi, everyone. You've already had a brief introduction to demand. We're going to recap that material quickly, then we're going to look at new material including two different ways of reading the demand curve, how demand curves shift, and consumer surplus. Okay, let's go.

Here's the definition. A demand curve is a function that shows the quantity demanded at different prices. By quantity demanded, we mean the quantity that buyers are willing and able to purchase at a particular price. That's a little bit mysterious, so let's give an example of a market and then show the demand curve in that market.

Here are some hypothetical numbers in a table which illustrate the idea of the demand curve for oil. Suppose that at a price of oil of \$55 per barrel, the quantity of oil demanded would be five million barrels of oil per day. At a lower price, the quantity of oil demanded is going to be greater, higher. At for example, a price of oil per barrel of \$5 a barrel, let's suppose that the quantity of oil demanded would be 50 million barrels a day.

We can turn this table into a diagram, into a chart. Let's put the price of oil per barrel on the vertical axis, and the quantity of oil demanded on the horizontal axis. We can now graph our three points. Let's connect them with a line. That's the demand curve for oil. The demand curve for oil shows us the quantity demanded at each price. At a price of \$55 per barrel, we can read from the demand curve that the quantity of oil demanded is five million barrels a day. At a price of \$20 per barrel, the quantity demanded is greater- it would be in this case 25 million barrels of oil per day. At a price of \$5 per barrel, the quantity demanded would be 50 million barrels per day.

A key point of the demand curve is that it slopes downwards- that is, at a lower price, the quantity demanded is greater. That should be pretty intuitive. When the price of something falls, people want more of it. But we'll say a little bit more about that in a few minutes.

We're going to be dealing with demand curves throughout the course, so it's very important that you be comfortable with reading them. In fact, they can be read in two different ways.

The first method, the horizontal method, is the one I've already shown you. It says, for example, at a price of \$55 per barrel, we read horizontally over to the demand curve and down to find that at that price consumers are willing and able to purchase five million barrels of oil per day. At a price of \$5 per barrel, consumers are willing and able to purchase 50 million barrels of oil per day.

The second way of reading the demand curve, the vertical method, begins at the bottom and works its way up. It tells us the maximum price that buyers are willing to pay for a particular unit of oil. We pick a quantity along the horizontal axis and we say, for this quantity, for the fifth millionth barrel of oil, what is the maximum amount consumers are willing to pay? We read vertically up to the demand curve. We find that for the fifth millionth barrel of oil, consumers are willing to pay at most \$55 for that barrel of oil. Similarly, pick another quantity. For the 25th millionth barrel of oil, consumers are willing to pay for that barrel at most \$20.

Both the horizontal reading and the vertical reading of the demand curve are useful. For some problems, it's easier to solve the problem using the horizontal reading. For other problems, it's easier to solve using the vertical reading. It's important that you be comfortable with both ways of reading the demand curve.

One further important concept for this lecture is consumer surplus. Consumer surplus is the consumer's gain from exchange. It's the difference between the maximum price that consumer is willing to pay for a given quantity, and the market price the consumer actually has to pay. Total consumer surplus is the sum of the consumer surplus of all buyers, and graphically, consumer surplus is measured by the area below the demand curve and above the price.

Again, that's a little bit mysterious and something of a mouthful, but with a diagram, I think this will become clearer. This will also give us a little bit of a chance to practice reading a demand curve vertically. So let's take a look.

Let’s begin as usual with the demand curve and let's pick a particular quantity. Let’s remember from our vertical reading that the height of the demand curve at that quantity gives the maximum willingness to pay for that particular barrel of oil. In this case, the maximum willingness to pay for the barrel of oil indicated is a little bit below \$80.

Now suppose that the price of a barrel of oil is \$20 per barrel. The willingness to pay is closer to 80, and the actual price is only 20. In other words, the person is required to pay 20 for something which they value at close to 80. The difference between the maximum willingness to pay and the actual price is again called consumer surplus. In this case, consumer surplus would be a little bit less than 60.

We can indicate the consumer surplus by this green area. That might be the consumer surplus of one particular person who happens to really value oil, and they value it a little bit less than 80, and they only have to pay 20, so their consumer surplus again is about 60.

Another consumer might value the oil less. They have a less value demand for the oil. Joe's consumer surplus is, let's say, down here. By adding up the consumer surplus for all consumers over all units, what we see is that the total consumer surplus is the area beneath the demand curve and above the price. We're just adding up the consumer surpluses for all individuals for all units of the good. In fact, we often want to get a measure of this.

When we have a linear demand curve it's easy to quantify this. Remembering from our high school geometry that the area of a triangle is equal to one half base times height, we can see that the total triangle here is 80 minus 20, so that's 60, times 90, divided by two, or 2,700. This would be in millions, 2.7 billion. That would be the total consumer surplus from this market for oil.

Again we'll be using this calculation quite often, so just remind yourself of how to calculate the are underneath the triangle, which I know you're all familiar with.

That's it for this lecture, but let me tell you what we're going to do next time because we haven't finished market demand. What we're going to do next time is to ask what could cause an increase or decrease in demand. An increase in demand is going to look like this, a shifting out of the demand curve. A decrease in demand will look like the reverse, namely a shifting in of the demand curve.

We'll say more about that in the next lecture. For now, take a look at the course links. There'll be some questions for you to test your knowledge of what we've covered so far, and that is how to read a demand curve and that is consumer surplus. Thanks.

In the scenario you describe, the demand curve is shifting down over time as people lose interest in the poster (being old news). As the demand curve drops, the equilibrium point where it intersects the supply curve also drops.

I suspect this will be covered in the next video (The Demand Curve Shifts).

The confusion clears up as soon as you become familiar with the difference between DEMAND and QUANTITY DEMANDED. The demand is the whole curve, showing the quantity demanded at ANY given price. The quantity demanded is each single point on a specific demand curve. In your example, it's not the quantity demanded of posters that went down, but the demand itself! When the posters were fresh, there were many willing buyers for them at a price of 10\$. As they got older and older, at the same price there were less and less willing buyers. It's not a movement ALONG the curve. It's the whole curve moving down and to the left as the demand shrinks. Over time, you're looking at AN ENTIRELY DIFFERENT CURVE. Confronted with this new curve, which reflects a lower DEMAND (at ANY given price, there are now less buyers), the store had to LOWER the price, in order to bring the QUANTITY DEMANDED back up again (and sell the leftover stock of posters). Time changes the demand. Price, instead, is the one thing that can NEVER change the demand, but can only ever impact the quantity demanded.. If it isn't next lesson, it's the one after that. You'll see... :)

That's exactly the answer I've been looking for! Man I had to make an account just to give you a thumbs up :)

I'm no expert, but I think the answer is that the lower the price goes, the more posters will theoretically be demanded. The elasticity or steepness of the curve may vary, but the principle still works that if they lower the price more people will be willing to buy them and thus more posters will be demanded.

It seems to me that the demand curve for the 2014 World Cup posters were quite inelastic or slightly vertical. This could be the case because, as James mentioned, the store was charging " 10 per poster." As long as World Cup fever persisted, suppliers could set this price and customers gladly went along. After all, buying a poster is not like purchasing a car. The Poster's cost relative to the average person's income in a developed country is small. But that same cost to a fan is even less of an issue. Thus, an impulse buy occurs. However, as time passes, and lets says your club is knocked out of the tournament then the value to you and other heart broken fans of owning the poster that reminds you of that tragic lose is most likely going to remain zero. In fact, only the fans who's club was still standing at the end would continue to demand such a poster. Therefore, it takes a drastic reduction in price to even move a small amount of inventory. So to recap, at the beginning producers could charge whatever they wanted for the posters so long as it remained a small percentage of a fan's disposable income, but once a champion had been crowned, all other fans of the sport no longer had a reason to purchase such a poster. That meant that even at two dollars per poster the stores couldn't even give those things away. In short, being a supplier in a market with an inelastic demand is great when people are clamoring for your product, but as people's taste changes you might find yourself bankrupt trying to sell a good that nobody wants.

Just to add the little I have learnt to the above conversation. First and foremost remember that the explanation in the videos are theories and do not hold in some cases for real life situations due to the fact that real life situations are complex and there are many considerations to be taken into account. Secondly, it will be incorrect to look at the question you posed in a simplistic sense of the word, by that I mean the demand for the 2014 World Cup posters was event specific and hence after the event the value of the posters to consumers would have falling drastically over time and hence reflective of the price if all other things were held constant (cet. par.) (income and substitution effects) for example. In summary the demand curve does not describe the event, and by that I mean it doesn't describe how much posters an individual or group of people actually bought but rather a "hypothetical relationship" that tells us how much an individual would be prepared to buy at each price, in a given time period cet. par.

Just to buttress the [point the original question was highlighting, read about the Giffen good. This is a good where at higher prices a larger quantity is demanded.

Vincent's explanation above does make sense if your question was framed to suite his answer :).

Ceteris paribus or "Everything else remains the same" is the basic assumption while making demand and supply prediction. During world cup, the demand and supply will react just as mentioned in video. During no world cup, again the demand and supply will reach just as mentioned in video. You are comparing demand and supply at two different environment. New environment (start of world cup) triggers change in demand and supply and so will the change in environment (end of world cup) trigger new change in demand and supply.

It's a surplus of wealth. Here is how it works: let's say I want a new smartphone, and I am willing to pay \$200 to get one. In other words, for me, having a smartphone is the same as having \$200, and I am equally happy either way. But let's say I go to the store, and see that they are selling smartphones for only \$150 dollars, so of course I buy one.

Now, when I walked into the store, I had \$200 in my pocket, which remember is the same to me as 1 smartphone. But when I walked out of the store, I had a smartphone, which is equivalent to \$200, AND \$50 more dollars, so it is like I have \$250. I have gained \$50! This is my surplus.

I have not "really" gained any physical money, but I am as pleased with my possessions now as I would be if I had \$250 and no smartphone. Because this is \$50 more than I had before, we infer that I am happier than I was before, and we are going to measure this happiness in dollars because this is an economics class ;)

Similarly, the store likely values those phones at less than \$150 each, so it also gains a surplus when I buy one.

Sean well explained.

It seems so, even in construction industries likeGarage floor epoxybusiness, reference always goes back to oil.

You would show it by expressing the chance of being injured in a car accident as the "price" of driving quickly. If we increase the safety of the car being driven, that price of speed would go down, so the quantity of speed demanded would go up.