The Law of Demand - How You Choose to Buy

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Betsy, how often would you go for coffee if a
cup cost four dollars?
Probably once a day, I mean, I really like coffee.
And how about if the price goes up to eight
dollars a day?
Oo?
Well, eight dollars is a little bit too expensive for
me to buy a cup every day. Maybe I'll go
out once a week for a treat, you know, on
Fridays or something.
And what if coffee is cheaper, say only two dollars.
Aca, Oh, that's easy. I'll get a coffee every morning
one in the afternoon too, and I'll probably take some
work to the coffee shop in the afternoon.
Okay, So cheaper coffee means more coffee for Betsy exactly.
In fact, this is known as the law of demand,
the idea that we want more of something when the
price is lower, and.
When the price goes up, we buy less. It applies
to almost everyone and to almost everything that they buy.
Demand is our focus for this episode of Think Like
an Economist. I'm Betsy Stevenson.
And I'm Justin Wolfus, and we'll be teaching you the
tools that you need to think like an economist. It's
a journey that will transform your life and help you
make the best decisions tailored to you. Journalist and former
economics student NaSTA and Tabercoli far joins us as we
dive in.
Hey, Justin, Hey Betsy, you've just mentioned demand. I think
this is one of the main concerts we think of
when we hear the word economics, the other being supply.
Yep, and we're going to focus on supply in the
next episode. For now, our focus is on demand, which
is simply the set of decisions you make when you're
a buyer.
We've already discovered the law of demand that the lower
the price of something, the more of it you'll buy.
It's a big idea in economics. One idea is this
big economists often want to graph it and give it
a name, like the demand curve. We're not going to
draw the graph now, but realize that it's easy enough
to draw a graph that summarizes the idea that I'll
buy more coffee when the price of coffee is low.
There's an underlying logic to Betty's coffee choices, and indeed
all buying or demand decisions. So if you want to
understand where the law of demand comes from, will need
to apply the four core principles of economics.
Let me see if I can remember these. There's the
marginal principle, which reminds us to break down how many
questions into just considering whether we should choose one more
or the marginal change, the cost benefit principle. This is
about the full pros and cons of each choice, including
remembering the opportunity cost principle, which reminds you to ask,
or what you know, what would you be choosing instead?
And finally, we have the interdependence principle, which is about
how our best choice depends on other factors.
So let's apply these principles to an important buying decision.
Like deciding how many times to head to the cafe
each week to buy a coffee?
Perhaps, yeah, sure, let's do it. This is how many questions,
how many coffees should you buy each week? The marginal
principle reminds you to ask instead, should I buy one more? So, Betty,
should you buy one more cup of coffee?
I'm going to need to apply the cost benefit principle
to give you an answer. It says I should buy
the extra cup of coffee if the benefit of that
coffee exceeds the cost. The benefit of one more cup,
which we call the marginal benefit right now, is really
high for me. Why did you say that I didn't
get much sleep last night? I really could use the caffeine.
And if I don't go out to the cafe to
get a delicious handmade coffee, I'll have to grab one
from the staff lounge. But the coffee and the staff
lounge is almost undrinkably bad.
It's true. Notice that Betty's comparing buying that coffee to
her next best alternative, which is drinking a sad, bad
cup of coffee from the staff lounge. She's using the
opportunity cost principle, which says you should always ask or
what comparing her current choice with her next best alternative.
So I use the opportunity cost principle even when analyzing
the benefit of something like a cup of coffee.
Yes. The point is that you should always ask or what,
and compare your choice to your next best alternative.
So, Betty, if you were going to buy only one
cup of coffee each week, how much is it worth
to you? What's the most you'd be willing to pay?
You know, I'm not really that spendye, but there are time,
maybe once a week, when I really need a place
to meet and I want a good coffee. So in
these cases, I'd pay up to eight dollars to have
a cup of coffee inside a coffee shop.
So that's the marginal benefit of your first cup each week,
which depends on how much you value that first cup
of coffee.
So are you going to buy the coffee or not?
Well, that also depends on the marginal cost. The marginal
cost of a cup of coffee is simply the price
of that cup. So if the price is less than
eight dollars, then yes, you bet, I'm definitely gonna buy
at least that first cup of coffee each week.
Are you going to buy more than one cup.
Well, it depends. It depends on the marginal benefit of
that second cup and the price a break at a
cafe with a cup of coffee, so relaxing. The marginal
benefit of the relaxation that comes with the second cup
is worth about five dollars to me.
So five bucks is the marginal benefit of your second
cup of coffee.
Yep. So if the price of coffee is five dollars
or less, I'll go ahead and buy two cups of
co a week. But if it's more than five dollars,
I won't.
Okay, So the marginal benefit of that second cup is lower,
and because of this, you'll only buy more coffee if
the price is lower.
Pretty much, go into a cafe also substitutes for making
coffee at home, which takes my time and requires that
I buy beans. If the price of coffee fell even
further to four dollars, I'd buy my morning cup every
day at the cafe just to avoid having to make
it at home.
So if the price falls further, the quantity you'll demand
will rise even more.
Yep, it's that love demand again.
Now let's focus on the logic that's driving Betsy's buying decisions.
It's all about whether the marginal benefit of each cup
of coffee outweighs the price you'll have to pay.
The key idea here is something we call the rational
rule for buyers. I only want to buy something if
the marginal benefit is greater than the price.
Okay, I see now, So the lower the price, the
more likely it is that the marginal benefit of one
more coffee as well.
That's the logic behind the law of demand, and we
can now see even more deeply the demand is all
about marginal benefits. Your marginal benefits determine how many cups
of coffee you'll buy at each price. It's an idea
that applies to anything we buy. Your marginal benefits determine
whether it's worth buying one more, and one more after that,
and so on.
So, like we said at the start, when the price
of something goes down, you're likely to buy more of.
It, Yes, and it goes further. If the praise goes down,
some new people may enter the market. Now, as you're
not a coffee drinker, but what if coffee only costs
a dollar a cup?
Yeah, I'd buy a cup, and just.
Like that another coffee customer. So if the price goes down,
I'll buy more, justin and many other folks will buy more,
and at some point new folks like you, Naz enter
the market and start buying coffee too.
Add it all up and we say that the law
of demand doesn't just hold for each of us, it
also holds when you look across the whole market, including
all coffee drinkers. The lower the price of coffee, the
more they'll collectively buy.
And how about the interdependence principle, because that's not come
up yet.
Well, we're going to dig into that more shortly. But
you can start to think about it by considering what
happens to your demand for tea If the price of
coffee falls so low that you actually buy a cup.
You're right, I might end up buying less tea. Letsy,
justin not to sound rude, but I mean, is any
of this realistic? I personally studied economics, and even I
never think about stuff I'm going to buy in this way.
I mean, I'm just too busy.
For all of this. Yeah, I know what I mean.
I can imagine.
Nas. You might not be consciously thinking like an economist
using spreadsheets to evaluate your marginal benefits and costs, but
you might come to similar conclusions just by experimenting a bit.
You know, if you buy a bit more coffee this
week or a bit less. You sort of see whether
your life is better or worse. If buying more makes
your life better, you'll stick with it. And if it
did make your life better, that's because the marginal benefit
outweighed the price of an extra cup. Experiment in this way,
and you'll end up acting as if you're following the
rational rule for buyers.
Look, none of us are walking spreadsheets. I agree, that's silly.
The point here is the idea that when you're making
buying decisions, you should think of the margin. Do I
want one more cup of coffee? And your answer should
really depend on comparing the marginal benefit with the price,
and don't forget to take account of your next best alternative.
Okay, so if the price of something goes down, we're
likely to buy more of it. I feel like there
are other things which will change my demand or how
much of something I want to buy.
Yes, And this is where the interdependence principle really comes in,
because the interdependence principle is about how my best choice
depends on other factors, things other than the price of coffee.
So, Nas, you already said that even though you prefer tea,
if the price of coffee is low enough, you might
buy coffee instead. It follows when the price of alternatives
to coffee, such as tea or maybe even a red bull, changes,
it can affect how much coffee you might buy. Hey, nas,
can you think of other factors? Accept the price that'll
change how much coffee you're willing to buy at a
nice cafe.
So honestly, the first thing I can think of is
how much money I'm making. If I'm short on money,
I'll go to cafes less. If I'm earning more money,
then I'll make more trips to the cafe.
Absolutely. Ingram is one of the main things that affects
our demand.
With a lot of products will buy more if we're
earning more. We call these normal goods. But what's interesting
is that there are some products we may buy less
of if we're making more money, and we call these
inferior goods.
Instant coffee is an example of an inferior good. By
the way, this has nothing to do with quality, even
if you think instant coffee is not quite as good.
When we say inferior good, it's really just the kind
of thing you're gonna buy less of when you earn
more money because there are other more expensive substitutes you
might buy instead, like switching from instant coffee to go
into Starbucks.
Beyond that, your preferences will also impact how much of
something you're willing to buy is. Studies suggest that coffee
could be bad for your health. Some people may switch
to other drinks like herbal tea.
There also products which compliment coffee, such as little cakes
and pastries yum. If these become cheaper, you might be
more willing to buy a cup of coffee to drink
with that new bargain treat.
Another fact that it'll change your demand is expectations. This
is related to what we think the price will be
in the future.
And how do expectations fit in what am I expecting exactly?
I'm a bit unclear on this.
People wait for things to go on sale all the time.
That's what we mean when we're talking about expectations. What
do you think is going to happen to the price.
The more likely you think it is that something's going
to go on sale, the more likely you are to
wait and see if you can get a lower price.
For example, if you were thinking of heading for a
mid afternoon coffee and you expect the cafe to drop
their prices after four pm, you might just wait to
buy your cup of coffee at that tuaber time.
And finally, sometimes how much you want to use something
depends on everyone else. Have you ever shown up at
your favorite cafe and left because the line was just
too long?
Definitely?
Yeah. So we call this the congestion effect, when you
want to buy something less because other people are buying it.
In this case, the busy cafe means that making a
purchase is more of a hassle, effectively costing you more,
so you'll be less likely to buy a coffee.
You know, I feel like there are times I may
want to use more of something if other people are
into it too. So an example is messaging apps. I
never used to use something like Telegram, but now loads
of my friends are using it, so they've sort of
convinced me to use it too. I mean, there's no
other way of reaching them otherwise.
Yes, this is actually called a network effect. It's the
opposite of a congestion effect. It's where you want to
buy something more if other people are also using it. Like,
you might be more willing to go buy a cup
of coffee if you think you'll run into friends at
the coffee shop, or like you want to use that
messaging app more because all your friends are using it.
When we're thinking about the total demand for coffee across
the whole market, there's one more factor to consider, how
many people there are. The more people there are, the
more potential coffee drinkers there are, and so the greater
the quantity demand will be at any price.
That's also why we have to think about demographics, because
different groups of people have different demand for different types
of goods. So for instance, if we had a big
baby boom and there were a lot of new babies,
we'd see a lot of demand for diapers.
So, Betsy justin, we've just been through demand. Lets summarize.
Demand is all about buying decisions, and the law of
demand tells us that the lower the price, the greater
the quantity that people will buy.
And if you want to make smart buying decisions, my
advice is to follow the logic behind the rational rule
for buyers, which says to buy one more item as
long as the marginal benefit exceeds the price.
And if you're running a business, realize that price isn't
the only thing that affects the quantity of your goods
that people will buy. It also depends on their income,
on the price of substitute or complementary goods, on preferences,
on congestion and network effects, and on how many buyers
there are.
Is there anything you want our listeners to think about
over the next few.
Days, you'll actually be out in the real world making
buying decisions. Use that as your laboratory for better understanding demand.
So that means thinking about whether you're guided by your
marginal benefits? Are there other factors that affect your demand decisions?
Could you make better choices if you thought a bit
harder about the rational rule for buyers?
This is really handy. I'm going to try this all
over the next few days. I'm off to make a
cup of tea. Betsy and Justin thanks for teaching me
how to think like an economist.
Now as I'm off to get a cup of coffee.
It's a pleasure ass and get out there and buy
some things. Demand Demand Demand.
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