Economics Stack Exchange Archive

What determines the shape of the demand curve?

Obviously one economic goal of marketing is to shift the demand curve for your product outwards, but I’m wondering whether it’s feasible to evaluate and manipulate the shape of the demand curve. For example, a steeper curve means you can make more money by charging more, assuming everything else stays constant. A curve that is nonlinear has two particular price points (the points farthest from the line with slope -1) where profits are maximized and minimized.

So to that end: What determines the shape of the demand curve? Is it purely tastes and preferences, or are there other factors a company may be able to control or influence?

Answer 29

One option firms have is to somehow differentiate their product from other similar products. Under perfect competition, the demand curve represents demand for perfectly substitutable products from many firms. For example, many agricultural products are perfect substitutes (I don’t care if my corn came from farm A or farm B). In markets for undifferentiated products, there little incentive for firms to engage in marketing activities because other firms will capture much of the benefit (this is why we don’t see ads for, say, wheat).

However, some firms endeavor to create a separate market for their product, usually by branding. Advertising and other marketing activities can be used to create this separate market and to influence demand in that market. For example, there was once a market for MP3 players, and each firm’s MP3 player was more-or-less a perfect substitute for players from other firms. Apple succeeded in differentiating their MP3 player, the iPod, sufficiently to create a separate market. In this market, Apple could capture the benefits of advertising, and they could also exercise some monopoly powers (as they were the only source of iPods).

In short, firms will only endeavor to influence demand if they can differentiate their product from others, so the real questions firms ask often relate to how they might convince consumers that their product is really different from products of other firms.

Answer 113

Literally speaking, the demand curve for a single person is the quantity demanded by that person for each price in a range of prices. You can figure out your own demand curve by doing the following exercise.

Let's say somebody opens a pizza shop in your neighborhood, and they auction off a bunch of pizzas every night.

You are hungry and you're craving pizza, so you would gladly pay $10 for one pizza. You're not hungry enough to eat 2 pizzas yourself, so you wouldn't pay another $10 to get a second pizza. But if the second pizza was only $8 more, then you would go ahead and get one for your roommates to make up for playing loud music the night before.

As you think about how much each additional pizza is worth to you, you realize that each additional pizza has less and less appeal. There's only so much you can eat yourself, share with roommates, or refrigerate to eat later. So your willingness to pay more to buy more diminishes as the number of pizzas goes up.

Before going to the auction, you write down your preferences on a sheet of paper and bring it with you:

Number Of Pizzas    Willing To Pay
1st                 $10 
2nd                 $8  
3rd                 $6  
4th                 $2 
5th                 $1
6th                 $0.50    
7th                 $0.50       
8th                 $0.50

Now you can go to the auction and know exactly what your maximum bid is for each pizza. I.e. you'll bid up to $10 on a pizza until you win your first pizza. Then you will bid up to $8 until you win a second pizza. And so on…

What if the pizza restaurant does not auction off pizzas, but instead sets a fixed price for pizzas? Now how would you decide how many pizzas to buy?

You can figure this out quickly by looking at your notes for the auction. If the price of pizza is $7, then you will definitely buy at least 1 pizza (because the first pizza is worth $10 to you) and you will definitely want a 2nd pizza (because the second pizza is worth $8 at the auction) but you will not buy a 3rd (because the third pizza is only worth $6 to you).

The table above is called a demand schedule. If we were to depict those series visually, we would call it a demand curve:

demand curve example

The aggregate demand curve for multiple people is easy to find if you know the demand curves for each individual. You add up the quantity demanded for each person at each price. I don't know how to write the fancy equations, so here goes:

D(p) = sum(di(p))

Where D is the aggregate demand function, di is the i'th consumer's demand function, and p is price.

This is what shapes the demand curve.

The problem with this definition of demand is that it doesn't incorporate time as a variable or substitution effects -- other goods that similar but not identical to the good in question. This is why you never see a business owner in the real world whipping up a demand schedule and then charting the results. Most prices are either set "by feel" and experimented with, or companies may try to get a rough idea of demand by surveying consumers or conducting focus groups.

Is it purely tastes and preferences, or are there other factors a company may be able to control or influence?

Yes, in this simple model, it's just each individual's preference. A company may be able to control or influence an individual's preference, for example marketing something as "manly" so that male customers are more likely to buy it.

Answer 20

Demand curves are simply determined by preferences and the budget constraint. That said, you need to be careful, because preferences aren’t always exogenous to the determination of price and quantity.

A luxury good is one example. It could be possible for the firm to raise prices and find itself on the upward sloping part of the demand curve.

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