No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Three: Demand 67 implicit opportunity cost when we assess the impact of changes in price. They also avoid possible errors in our calculus due to monetary distortions, since relative prices eliminate a money price. Now we’re ready to discuss the concept of demand in a more in-depth way. Recall from chapter 2 that marginal utility decreases as you increase the quantity consumed of a given good. This is a natural result from our assumption that acting man will use any good or service against his most urgent need. Any subsequent good or service is applied against the next most urgent need, and so forth. For instance, a woman riding by horseback across the desert may stumble across an oasis. Her first action will likely be to get a drink of water. The next action might be to allow her horse to drink from the water. Then she might decide to take a bath to clean up. Ultimately, she might decide to take a swim in the water. Each use of the water will be applied against a less urgent need than the one before. As her marginal utility of each additional unit of water diminishes, so does her quantity demanded: ceteris paribus . Because marginal utility decreases as the quantity consumed increases, the opportunity cost of additional consumption (as represented by the price) must also fall for consumers to demand more. In economics we state this as the law of demand : as the price of any good goes down, the quantity demanded goes up; and as price goes up, the quantity demanded goes down. It is convenient to think of price as an expression of the opportunity cost, since in a market economy we could take the same money spent on one good and spend it on its next best alternative. Figure 3.1 shows the downward sloping demand curve. Note that the X-axis (horizontal) is quantity demanded, and the vertical or Y-axis is price. You can thank the economist Alfred Marshall for standardizing an unconventional diagram; normally the independent variable (price) is on the horizontal axis with the dependent variable (quantity) on the vertical. Marshall is credited (or blamed!) for this unique way of displaying S&D (although earlier writers preceded him on this point). This P-Q diagram law of demand: as the price of any good falls, the quantity demanded rises; and as price rises, the quantity demanded falls, ceteris paribus P ($) Q (#) D Figure 3.1, Notional Demand Curve. The demand curve always slopes downward, to reflect the decreasing marginal utility provided by additional units of a good or service. The vertical axis is the price and the horizontal axis is the quantity of a good or service. For acting man to want more and more of a given item, the price must go down. The arrows are intended to show that you can travel either direction on the curve as price changes.