[This essay is intended for students in my law and economics and my microeconomics class (for law students). Read this essay one time through, ignoring the queries that are interspersed. Go back to the queries after you feel you have understood the essay. The queries test whether you have understood enough to develop a richer understanding of the topic of the essay (demand). These instructions will also apply to future essays.
I have bolded certain words. These are terms that you should know going forward. If you do not understand them, ask your favorite foundational AI model about them.
I will post the python notebook that generates all the figures in this essay in case you are interested in reproducing them.]
A fundamental principle or lesson of economics is that incentives matter. If a person values some reward, and you offer that reward in return engaging in some behavior X, then the person will take that behavior X. If a person dislikes some punishment, and you impose that punishment if they engage in some action Z, then the person will engage less in action Z.
This lesson applies even to animals. I have a dog; his name is Clark (see photo below). He is very food motivated, i.e., he like treats. If I offer him a treat to turn around in a circle, he will do so. Many research labs at universities study rats. Rats like sugar water. If you offer rats some sugar water to press a button or to navigate through a maze, they will do so. Animals care about incentives, much as humans do.
One reward that humans value is consumption. This includes nice food, fancy clothing, a sweet car, a nice pad, entertainment like video games or a play, or the attention of another human. Look at what you spend your budget on. That is consumption. One implication of liking consumption is that taking
Each of the consumption examples can be bought with money. Some directly: a nice pair of Air Jordans. Some indirectly: if you want a friend to spend time with you, offer to treat them to dinner. Maybe you didn’t pay for the companionship, but you paid for something that led to their attention. (When you become a lawyer or consultant, you will see that sometimes people can directly pay for your time.) Because money can help buy consumption, one could say an individual indirectly values money, for the things that money can buy.
(Query: Do you think people value money directly? Hint 1: compare money exchange to bartering. Hint 2: Ask GPT or Claude this question.)
The monetary cost of something you can buy with money is called the price of that thing. Do not confuse the price of a thing with its value to you. If the price of a ticket to a concert is $150, but you only value the concert at $50 because you don’t like the band, then you won’t go. You will only go to the concert if you value seeing the band live more than $150. But however much you value the band, the price remains $150.
(Query: Will you go to a concert if you only value it at $50, but your friend pays for the tickets? Was going to the concert a waste of money?)
Each of us has a budget. If we track this with money, your budget is approximately the income you get from work. If you make $1000 this week, then you have $1000 to spend on consumption this week (ignoring your credit cards and savings accounts). If you spend $100 on a dinner out, then you have only $900 to spend on other things.
(Query: How does saving and borrowing affect your budget? Hint: Think of your money budget constraint today versus your budget tomorrow.)
Budgets apply to time too. You have 24 hours in a day. If you sleep 8, then you have 16 left over to do other things. If you sleep more, say 12, then you have just 12 hours for other things. Sleep has a time cost: you can do fewer other things. Suppose you finish dinner tonight at 10pm and have to be at work by 9am tomorrow, but your friends suggest going to a bar til 2am. If you go to the bar, you have 7 hours to sleep and get ready for work; if you don’t, you have 11. The bar visit costs you not just money, but time. You lose the opportunity to sleep more. Economists call opportunities you lose when you engage in action Z the opportunity cost of Z. Usually opportunity costs refer to costs denominated in time, but are general enough to encompass costs denominated in other things, including money.
What happens if the monetary price of fish increases, so that the price of a seafood dinner goes from $100 to $150 even though the content of the meal remains the same? You have less money for other things. Since you also value other things, increasing the price of a seafood dinner decreases your consumption of those other things. I.e., a higher price of dinner increases the cost of dinner, where cost is ultimately measured in other consumption.
Because you respond to positive and negative incentives—to rewards and punishments—and price is a negative incentive, you will treat the price the same as a punishment. That means you will have fewer seafood dinners if the price of a seafood dinner increases from $100 to $150. This relationship leads to what economists call the law of demand: an increase in the price of something—be it a product like food or a service like a play—decreases your consumption of that thing. This is true whether you measure price in money or time.
(Query: Economists refer to products and services that you value as a “good”, and products and services that you dislike as “bads”. Can you think of an example of a bad that you would pay to avoid? Can you connect this to why janitors on an offshore oil rig may be paid more than janitors at a land-based office?)
If I told you to plot how much you consume of something against the price of that thing, you would draw a downward sloping line on a graph, with the quantity of your consumption on the y-axis and price on the x-axis. This is called a demand curve. One quirk you should know is that economists typically plot price on the y-axis, and quantity on the x-axis—the reverse of what your intuition would suggest (see figure below). If you want to get technical, when economists draw a demand curve, they are actually drawing an inverse demand curve. Regardless, we will–going forward–call a plot of [price versus the quantity that you demand] a plot of your individual demand curve. Rarely will we plot quantity on the y-axis.
You are not the only person that values seafood dinners, a concert or a sneaker. We can combine the individual demands of all the people that value a good into an aggregate demand curve. If we plot quantity demand on the y-axis against price on the x-axis, we would simply vertically stack everyone’s demand curve on top of each other. If, at a price of $150, you would buy 0 tickets to a concert, I would buy 1 ticket, and our mutual friend would buy 4 tickets, then the aggregate of demand across the three of us is 5 tickets at the price of $150. We could ask the same question for other prices: $50, $100, $200, etc. When we draw the resulting plot, we get the aggregate demand curve across the 3 of us. If we include the demand of all people for the concert in our plot, then we get aggregate demand in the population. Recall, however, that economists typically plot price rather than quantity on the y-axis. This means that, instead of vertically summing individual demands to get aggregate demand, economists horizontally sum individual demands to get aggregate demands. Going forward, we will usually be drawing an aggregate demand curve rather than an individual demand curve when we label something simply a “demand curve”.
When the price of fish increases, so that the price of a seafood dinner rises, we say that demand for such dinners falls. We depict this on the demand curve graph by move up and to the left on the demand curve. We do not move the curve! We only shift the curve itself if there is some change in the environment such that, holding the price of a seafood dinner constant, a smaller or a greater number of people consume those dinners. (To restate, a change in quantity demanded due to a change in price is a movement along the demand curve; a change in demand at a given price is a shift in the demand curve. See the figures below.) What can cause a shift in demand? One thing is an increase in income. If you have more income, you will demand more seafood dinners, holding the price of dinners constant. Another thing is new information that fish contains mercury, and mercury is bad for your health. This news will decrease demand for seafood, holding the price of seafood constant.
(Query: You might suspect that an increase in income will increase the price of seafood dinners or that the news about mercury-in-fish will decrease the price of seafood. This is not because of a shift in the demand curve—the topic of the last paragraph. Instead, it is because the market price of a good is set by the intersection of the demand and supply curve—the topic of another essay. The supply curve is a line that is upward sloping: as price rises, the quantity producers supply rises. Suppose we draw a supply curve on the same graph where we have a demand curve. Where the two line cross indicates market price (on the y-axis) and market quantity demand (on the x-axis). Now, can you see why price rises when the demand curve shifts out?)
You do not only consume 1 good. You consume lots of goods. Each has its own demand curve. But those demand curves are related. In some cases, consuming more of one good causes you to consume less of another good. E.g., if you go to an expensive play Saturday night, you may not go out for an expensive meal on Friday and you are unlikely to buy tickets to a movie on Saturday. The reason you do not go out for a fancy meal on Friday is that you have a budget. If you spend all your extra cash on a play, you may not have enough money for a fancy meal too. The reason you do not go to both a play and a movie is that they are alternative forms of entertainment on Saturday. In theory you could do both, but one form of entertainment might exhaust what attention you have for the other. (In addition, they might even be at the same time!) Whether going to a play means you do not buy something else because you have less money for a fancy meal or you get less utility from a movie, the meal and movie are substitutes for the play. An implication of this is that, as you increase the price of a play, you are less likely to go to a play, but more likely to have a fancy meal or go see a movie. The increase in the price of the play shifts out the demand curve for the meal and the movie, as shown by the move from A to B in the “Shift in Demand Curve” figure above.
In some cases you get the opposite result. Take coffee and donuts. They go well together. If you buy a donut, you want a coffee to wash it down with. The two goods are complements. Not quite like left and right shoes, but you value a donut more when you have a coffee and vice versa. When you have two goods that are complements, an increase in the price of one good (say, donuts) not only decreases your demand for that good (donuts), a shift along the demand curve, but it typically shifts in your demand for the complement (coffee), a shift from B to A (rather than A to B) in the “Shift in Demand Curve” figure above.
Query: Knowing nothing else about two goods, you would think they are likely to be substitutes, mainly because you have a budget constraint. But suppose you had two goods that are complements, i.e., consuming one good increases the value to you of consuming the other. Is it theoretically possible that an increase in the price of one good will still shift out your demand for the other good? Hint: Your logic here is going to be relevant when we discuss income effects and substitution effects.
Query: Assume that you cannot borrow and that you always spend all your income, i.e., assume you don’t save. I assert that not all goods that you consume can be complements. Can you explain why?
If you want more explanation of a demand curve, I encourage you to watch the demand curve video at Marginal Revolution University: https://mru.org/courses/principles-economics-microeconomics/demand-curve-shifts-definition.