Demand Curve

The Demand Curve in Perfect Competition

The demand curve in perfect competition is flat or a straight horizontal line parallel to the horizontal axis.

Why is this so?

This is because in perfect competition, as buyers have perfect information, they know who is selling the same product for a lower price. As a result, if one seller is selling the product for too high a price, the consumers will simply not buy from that seller. Rather, they will buy from a seller who sells the same product for cheaper. Therefore, all firms must sell their product at the same price in perfect competition, which leads to a horizontal demand curve.

Since the product is being sold at the same price, the consumers buy as much as they can afford to buy or until the firm runs out of product. Figure 2 below shows the demand curve in perfect competition.

Fig. 2 - Demand curve in perfect competition

Shift in the Demand Curve

Some factors can cause a shift in the demand curve. These factors are referred to by economists as the determinants of demand. The determinants of demand are factors that cause a shift in the demand curve of a good.

There is a rightward shift in the demand curve when demand increases. Conversely, there is a leftward shift in the demand curve when demand decreases at every price level.

Figure 3 illustrates an increase in demand, whereas Figure 4 illustrates a decrease in demand.

Fig. 3 - Rightward shift in the demand curve

Figure 3 above depicts a demand curve shift to the right from D1 to D2 due to an increase in demand.

Fig. 4 - Leftward shift in the demand curve

As sketched in Figure 4 above, the demand curve shifts to the left from D1 to D2 due to a decrease in demand.

The main determinants of demand are income, the price of related goods, tastes, expectations, and the number of buyers. Let's explain these briefly.

1. Income - After the income of consumers increases, they tend to cut down the consumption of inferior goods and increase their consumption of normal goods. This means that an increase in income as a determinant of demand causes a reduction in the demand for inferior goods and an increase in the demand for normal goods.
2. Prices of related goods - Some goods are substitutes, which means that consumers can either buy one or the other. Therefore, in the case of perfect substitutes, an increase in the price of one product will result in an increase in the demand for its substitute.
3. Taste - Taste is one of the determinants of demand because the tastes of people determine their demand for a given product. For instance, if people develop a taste for leather clothes, then there will be an increase in demand for leather clothes.
4. Expectations - The expectations of consumers can also result in an increase or decrease in demand. For instance, if consumers hear rumors about a planned increase in the price of a given product, then the consumers will buy more of the product in anticipation of the planned price increase.
5. The number of buyers - The number of buyers also increases demand by simply increasing the number of people buying a given product. Here, since the price doesn't change, and there are simply more people buying the product, demand increases, and the demand curve shifts to the right.

Types of the Demand Curve

There are two main types of demand curves. These include the individual demand curve and the market demand curve. As the names suggest, the individual demand curve represents demand for a single consumer, whereas the market demand curve represents demand for all the consumers in the market.

Market demand is a summation of all individual demand curves. This is illustrated in Figure 5 below.

Fig. 5 - Individual and market demand curves

As illustrated in Figure 5, D₁ represents the individual demand curves, whereas D₂ represents the market demand curve. The two individual curves are summed up to make the market demand curve.

Demand Curve with Example

Now, let's look at an example of the demand curve by showing the effect of multiple buyers on demand.

Inverse Demand Curve

The inverse demand curve shows the price as a function of the quantity demanded.

Normally, the demand curve shows how the quantity demanded changes as a result of changes in price. However, in the case of the inverse demand curve, price changes as a result of changes in quantity demanded.

Let's express the two mathematically:

For demand:

\(Q=f(P)\)

For inverse demand:

\(P=f^{-1}(Q)\)

To find the inverse demand function, we simply need to make P the subject of the demand function. Let's take a look at an example below!

The inverse demand curve and the demand curve are essentially the same, hence are illustrated in the same way.

Figure 7 shows the inverse demand curve.

Fig. 7 - Inverse demand curve