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Demand
By David R. Henderson
One of the most important building blocks of economic analysis is the concept of demand. When econo-
mists refer to demand, they usually have in mind not just a single quantity demanded, but what is called a de-
mand curve. A demand curve traces the quantity of a good or service that is demanded at successively different
prices.
The most famous law in economics, and the one that economists are most sure of, is the law of demand. On
this law is built almost the whole edifice of economics. The law of demand states that when the price of a good
rises, the amount demanded falls, and when the price falls, the amount demanded rises.
Some of the modern evidence for the law of demand is from econometric studies which show that, all other
things being equal, when the price of a good rises, the amount of it demanded decreases. How do we know that
there are no instances in which the amount demanded rises and the price rises? A few instances have been cited,
but they almost always have an explanation that takes into account something other than price. Nobel Laureate
George Stigler responded years ago that if any economist found a true counter-example, he would be "assured
of immortality, professionally speaking, and rapid promotion". And because, wrote Stigler, most economists
would like either reward, the fact that no one has come up with an exception to the law of demand shows how
rare the exceptions must be. But the reality is that if an economist reported an instance in which consumption of
a good rose as its price rose, other economists would assume that some factor other than price caused the in-
crease in demand.
The main reason economists believe so strongly in the law of demand is that it is so plausible, even to non-
economists. Indeed, the law of demand is ingrained in our way of thinking about everyday things. Shoppers buy
more strawberries when they are in season and the price is low. This is evidence for the law of demand: only at
the lower, in-season price are consumers willing to buy the higher amount available. Similarly, when people
learn that frost will strike orange groves in Florida, they know that the price of orange juice will rise. The price
rises in order to reduce the amount demanded to the smaller amount available because of the frost. This is the
law of demand. We see the same point every day in countless ways. No one thinks, for example, that the way to
sell a house that has been languishing on the market is to raise the asking price. Again, this shows an implicit
awareness of the law of demand: the number of potential buyers for any given house varies inversely with the
asking price.
Indeed, the law of demand is so ingrained in our way of thinking that it is even part of our language. Think
of what we mean by the term on sale. We do not mean that the seller raised the price. We mean that he or she
lowered it. The seller did so in order to increase the amount of goods demanded. Again, the law of demand.
Economists, as is their wont, have struggled to think of exceptions to the law of demand. Marketers have
found them. One of the best examples was a new car wax. Economist Thomas Nagle points out that when one
particular car wax was introduced, it faced strong resistance until its price was raised from $.69 to $1.69. The
reason, according to Nagle, was that buyers could not judge the wax's quality before purchasing it. Because the
quality of this particular product was so important – a bad product could ruin a car's finish – consumers "played
it safe by avoiding cheap products that they believed were more likely to be inferior".
Many non-economists are skeptical of the law of demand. A standard example they give of a good whose
quantity demanded will not fall when the price increases is water. How, they ask, can people reduce their use of
water? But those who come up with that example think of drinking water, or using it in a household, as the only
possible uses. Even for such uses, there is room to reduce consumption when the price of water rises. House-
holds can do larger loads of laundry, or shower instead of bathe, for example. The main users of water, how-
ever, are agriculture and industry. Farmers and manufacturers can substantially alter the amount of water used
in production. Farmers, for example, can do so by changing crops or by changing irrigation methods for given
crops.
It is not just price that affects the quantity demanded. Income affects it too. As real income rises, people
buy more of some goods (which economists call normal goods) and less of what are called inferior goods. Ur-
ban mass transit and railroad transportation are classic examples of inferior goods. That is why the usage of
both of these modes of travel declined so dramatically as postwar incomes were rising and more people could
afford automobiles. Environmental quality is a normal good, which is a major reason that Americans have be-
come more concerned about the environment in recent decades.
Another influence on demand is the price of substitutes. When the price of Toyota Tercels rises, all else be-
ing equal, demand for Tercels falls and demand for Nissan Sentras, a substitute, rises. Also important is the
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