The Role of Price

Economists give prices a special place in this analysis. The DEMAND CURVE is defined as the relationship between the price of the good and the amount or quantity the consumer is willing and able to purchase in a specified time period, given constant levels of the other determinants--tastes, income, prices of related goods, expectations, and number of buyers. In the diagram, the line labeled "D" shows a plot of that demand curve, say for blue jean prices and number of pairs demanded. Prices are P (in $) and quantity is Q (in number of product units) on this diagram. At a price of $75 (vertical axis), two pairs are demanded (Q on horizontal axis). As the price P on vertical axis is lowered from $75 to $50, the quantity demanded Q is increased from two pairs to three pairs of blue jeans. Although this price-quantity demanded relationship is obvious to Bob and any other struggling consumer, several formal reasons can be given. Two important explanations are the (1) income effect--as the price per pair is smaller, Bob can buy more pairs with his fixed income without giving up buying other goods, and (2) the substitution effect--that there are other goods that he regards as substitutes for L-501s and when L-501s become more expensive he might switch to wearing other clothes, such as baggy shorts. Diminishing marginal utility might also come into play--as Bob buys more and more pairs of blue jeans, his increase in satisfaction with having yet another new pair falls, so the price he is willing to give up also falls. After a few new pairs, the thrill is gone (or at least it's declining)! Economists give prices a special place in this analysis. The DEMAND CURVE is defined as the relationship between the price of the good and the amount or quantity the consumer is willing and able to purchase in a specified time period, given constant levels of the other determinants--tastes, income, prices of related goods, expectations, and number of buyers. In the diagram, the line labeled "D" shows a plot of that demand curve, say for blue jean prices and number of pairs demanded. Prices are P (in $) and quantity is Q (in number of product units) on this diagram. At a price of $75 (vertical axis), two pairs are demanded (Q on horizontal axis). As the price P on vertical axis is lowered from $75 to $50, the quantity demanded Q is increased from two pairs to three pairs of blue jeans. Although this price-quantity demanded relationship is obvious to Bob and any other struggling consumer, several formal reasons can be given. Two important explanations are the (1) income effect--as the price per pair is smaller, Bob can buy more pairs with his fixed income without giving up buying other goods, and (2) the substitution effect--that there are other goods that he regards as substitutes for L-501s and when L-501s become more expensive he might switch to wearing other clothes, such as baggy shorts. Diminishing marginal utility might also come into play--as Bob buys more and more pairs of blue jeans, his increase in satisfaction with having yet another new pair falls, so the price he is willing to give up also falls. After a few new pairs, the thrill is gone (or at least it's declining)!