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Dave Anderson: Hi, I'm Dave Anderson. In this video, I'll explain the demand curve, part of the ever-important model of supply and demand. The demand curve shows us the quantity of a good that consumers would buy at various prices. I want to show you a good way to understand how exactly the demand curve gets its shape and what makes it shift.

Let's talk about sweaters. What's the most you'd be willing to pay for your first wool sweater? Not what you'd like to pay, but the most you'd be willing and able to pay to have your first sweater.

Let's say you'd pay at most $90 for your first sweater if you had to. How much would you pay for a second one? $90? Probably not, because now you already have a sweater in your wardrobe. But still, it would be nice to have more for variety. So let's say you'd pay $80 for a second sweater.

As you get more and more sweaters, the usefulness of another one declines because your needs and wants are increasingly satisfied. So naturally, you'd be willing to pay less and less for one more sweater. If the price were $75, how many sweaters would you buy? Two, because the rest are worth less to you than the price. If instead the price of sweaters were $35, you'd buy three.

So this curve along the top of these bars indicates the quantity of sweaters you'd buy at each price-- that is, this is your demand curve. We go down from the intersection of the demand curve and the price line to the quantity axis to learn the quantity demanded at a particular price.

Markets generally have many consumers. Suppose for simplicity that you and I are the only consumers in a very small sweater market. We've seen your demand. Here's mine. The market demand is a combination of your demand and mine.

The quantity demanded at each price is found by adding the quantity you would demand to the quantity I would demand at each price. For example, at a price of $75, you would demand two and I would demand one, so the quantity demanded in the market is three. At a price of $35, you would demand three and I would demand three, so the quantity demanded is six.

We've been talking about demand curves for small quantities of a good, which, like your demand curve for socks, look like staircases. Most demand curves are drawn as smooth lines. This is more than a simplification. We can explain the smooth lines by looking at the demand curves for large groups of consumers. The demand curve for a family or town involves many units, so the bars representing each unit are narrower, and with enough units, the demand curve truly appears smooth. The straight demand curves we often use are simplifications of reality, because they imply that the most consumers are willing to pay for another unit drops by exactly the same amount for each unit, which is unlikely.

Knowing that the height of a demand curve represents consumers' willingness to pay for each unit makes it easy to understand not only the shape of the curve but what makes it shift. Demand increases if the most consumers would pay for each unit increases. You can think of an increase in demand as a shift upward and to the right. It's a shift upward because the most consumers would pay for each unit rises. It's a shift to the right because consumers would buy more at each price. Depending on the context, it might be easier to think about it as a rightward shift or an upward shift, but they're both an increase in demand.

What shifts the demand curve? One demand shifter is a change in income. For normal goods such as sweaters, an increase in income makes consumers willing to pay more for each unit and causes demand to increase. Note that the demand for inferior goods rises when income falls. For example, if your income fell, you might buy more sweaters made out of synthetic fibers such as rayon, which would make synthetic sweaters an inferior good for you.

Now suppose the price of substitutes such as jackets increases. The demand for sweaters would increase because some people would switch from jackets to sweaters. Complements are goods that are consumed together, like coffee and cream or sweaters and turtlenecks. If the price of a complement decreases, the demand for the good increases because it is now less expensive to buy the pair of goods that go well together.

Demand also increases when tastes change in favor of a good. During an especially cold winter, your tastes might change in favor of sweaters. You would be willing to pay more for them, and your demand would increase.

Suppose you expect prices to rise in the future. You'll want to buy more now. So when the price is expected to rise, demand increases. However, a change in the current price of a good does not shift the demand curve because it doesn't change the most you'd be willing to pay for another unit. Instead, a change in the current price causes a movement along the demand curve and a change in the quantity demanded.

We saw how the demand for two consumers is larger than the demand for one consumer. So an increase in the number of consumers in the market causes the demand curve to increase. The demand for a good decreases, meaning that the demand curve shifts downward and to the left, if the opposite of any of these changes occurs.

Remember that the height of the demand curve is determined by consumers' willingness to pay for each unit, and you'll have a firm grasp on the critical concept of demand.

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