Section 2: The Demand Curve

Graphing the Demand Curve

We can graph demand data in a diagram. The two variables we consider are the price of the product (P) and the amount of the product purchased during a certain period of time (Q). Economists measure the price of the product on the vertical axis and the quantity on the horizontal one.

A demand schedule and a corresponding demand curve represent buyers’ willingness and ability to purchase the product. For demand to exist,  buyers cannot merely desire the product, but they must also be able to afford it.

In the diagram below, two points are plotted for a hypothetical product. At a price of $7 per product, 13 units are sold. At a price of $14 per product, only 6 units are sold. Other points can be plotted and a line or curve can be connected through these points to arrive at the demand curve. A demand curve usually extends from the upper left to the lower right. It is “downward sloping.”

For a video explanation of how to graph a demand curve, please watch:

Demand, Utils, Total Utility, and Marginal Utility

The willingness of buyers to purchase a product depends on the value buyers expects to receive from purchasing the product relative to the price. Economists call the value or satisfaction buyers receive from a product utility. Marginal utility is the additional value buyers receives from purchasing one additional product. Typically, buyers’ marginal utility decreases as they consume more of a product. For example, if you visit the grocery store to purchase oranges, the marginal utility of each orange decreases as you purchase more oranges. Let’s assume that you really like oranges, you don’t have any oranges at home, and that you haven’t had eaten one for a while. As you enter the store, the first orange looks very appealing (get it?) to you. Let’s say for comparison purposes that this first orange is worth 100 utils to you. A util is an imaginary measure of satisfaction. Because satisfaction differs per person, no one really knows how much a util is. However, we use utils for comparison purposes. For example, we know that if you have already bought the first orange, then the second orange by itself does not provide as much utility (satisfaction) as the first orange. If you already have two oranges, then the third orange does not provide as much utility as the first or the second orange. Analogously, if you were to buy a car, owning a car provides you with considerably more utility if you don’t already have one, compared to owning a second car if you already own a car. This illustrates the Law of Diminishing Marginal Utility.

The Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility states that the more you have of a product, the less satisfaction you receive from buying additional products. Certain exceptions apply. Beer and other substances, which create certain (un)desired effects after not one, but several servings, may be subject to the law of increasing marginal utility (at least up to a certain point).

Let’s look at an example of the law of diminishing marginal utility and how it determines your demand for a product. Let’s say that you have the following marginal utility values when you buy gasoline:

The above table illustrates that if you don’t have any gasoline, and you are offered to buy your first gallon, then your satisfaction from using this gallon of gasoline is 350 utils. If you already own one gallon, and you are offered a second, your utility increases by 250 utils, and so forth. So how will you decide how many gallons of gasoline to purchase? The answer to this question depends on the value you attach to what you have to give up to purchase the gasoline (the price of gasoline). This relates to your affordability to purchase the product.

Let’s assume, for our example here, that the price of gasoline is $5 per gallon. This is the cost to you and what you have to give up. Money has utility, just like products do. Let’s assume that $5 is worth 150 utils to you, and let’s assume that this remains constant even as you spend your money throughout the month (realistically, as you have less money at the end of the month, the marginal utility of your money increases. But, in our example, for simplicity, we will assume that your money has constant marginal utility).

Using the marginal utility values in the above table, and knowing that $5 (our hypothetical price of gasoline) is worth 150 utils to you, how many gallons of gasoline will you choose to purchase?

Answer: 10 gallons.

Explanation: When you buy your first gallon, you gain 350 utils in gasoline satisfaction. You give up 150 utils because one gallon of gasoline costs $5 (equal to 150 utils). On balance you gain 200 utils, so you decide to buy your first gallon of gasoline. Will you decide to buy your second gallon? You gain 250 gasoline utils, while you give up 150 money utils. You will decide to buy your second gallon. You go through the same process through the tenth gallon. The tenth gallon only gives you 151 utils, while you give up 150 utils. It may not seem much, but you are still gaining one util in addition to the utils from the first nine gallons. Will you decide to buy your eleventh gallon? It gives you 147 utils in additional gasoline utility, while it costs you 150 money utils. If you were to buy your eleventh gallon, you would lose 3 utils. Clearly, you would not do this, and you would buy ten gallons, but not eleven.

What happens if the price of gasoline decreases to $4.50? Let’s assume that $4.50 is worth 135 utils to you. Applying the analysis above, you conclude that you will purchase 15 gallons of gasoline, as this will maximize your satisfaction.

The same can be done for any other price. Below is a table that indicates these value preferences. This table also represents your individual demand curve for gasoline.

Your Own Individual Demand Curve

The graph in the previous paragraph shows the market demand for one product. Market demand is the total demand for a product by all consumers. Total demand is the sum of all individual buyers’ demand.

In the next table we look at one individual buyer’s demand curve for gasoline.

A graph of this buyer’s demand schedule for gasoline looks like this:

The Market Demand Curve

To arrive at the market demand curve we add every individual buyer’s demand schedule. For example, if the market for gasoline consists of 1,000 buyers, then the market demand schedule looks like as follows (for simplicity, we assume that every buyer’s demand schedule is identical to the individual in the previous table; the numbers in the following table are multiplied by 1,000 relative to the previous table because there are 1,000 buyers):

Based on the numbers in the table above, the graph of the market demand schedule for gasoline looks like this: