Question

Throughout this text, it is assumed that demand functions are decreasing. Can you think of a product that has an increasing demand function? That is, can you think of a product that becomes more in demand as its price increases? Explain your reasoning, and sketch a graph of the function.

Short answer

A product with an increasing demand function could be luxury goods, like high-end designer handbags or watches. As the price of these goods increase, their demand also increases due to perceived exclusivity and quality, a phenomenon known as the 'Veblen effect'. The graph of this demand function would be an upward sloping curve.

Step-by-step solution

Understanding Demand Functions

Demand functions in economics are usually decreasing, meaning that as the price of a product goes up, the demand goes down. This makes sense as people are less willing or able to buy something when it costs more. However, the exercise asked us to provide an example of an increasing demand function where demand goes up as the price increases.

Identifying a Product with Increasing Demand

One possible example of a product with an increasing demand function could be luxury goods, such as high-end designer handbags or watches. Rarity, exclusivity, or perceived quality can all be reasons why some consumers might be more attracted to a product as its price increases.

Providing Reasoning

The reasoning behind this might be that for these types of luxury goods, a high price often represents exclusivity and quality. Thus, for some consumers, the higher the price, the more desirable the product becomes. This is known as the 'Veblen effect'.

Sketching the Graph

When plotting the demand function for such a product, price would be shown on the y-axis and quantity demanded on the x-axis. Since we have an increasing demand function, the demand curve will slope upwards. This means that as you move from left to right (increase the quantity demanded), the price also increases.

Key concepts

Demand Functions

In economics, a demand function describes the relationship between the price of a product and the amount of it that consumers are willing and able to purchase at that price. Typically, as the price of a product increases, the demand for it decreases. This phenomenon stems from the basic economic principle that people have limited budgets and tend to make rational decisions about their purchases.

Therefore, when prices go up, fewer people are inclined to buy, often opting for cheaper alternatives. Conversely, as prices go down, the product becomes more affordable, and demand increases. This general rule results in a downward-sloping demand curve when graphed, with price on the y-axis and quantity demanded on the x-axis.

Key features of demand functions include:

• Inverse Relationship: A typical demand function has an inverse relationship between price and quantity.
• Market Dynamics: Demand functions account for consumer preferences and influence pricing strategies.
• Exceptions: Some products do not follow the inverse demand rule, exemplified by luxury goods.

Luxury Goods

Luxury goods are unique in the realm of economics because they often defy the typical demand function. These are products that are not just about fulfilling a basic need but are often associated with status, prestige, and exclusivity. Examples include luxury cars, designer clothing, and expensive watches.

Unlike regular goods, luxury goods sometimes experience increasing demand as their prices rise. This is because higher prices may convey superior quality, exclusivity, or enhanced status to the consumer. People who purchase luxury goods may derive satisfaction not just from the functional aspect of the product but also from the prestige associated with it.

Characteristics of luxury goods:

• Status Symbol: Often seen as symbols of wealth and social status.
• Exclusive Appeal: A higher price can increase the perceived exclusivity of the product.
• Veblen Effect: A known phenomenon where higher prices can boost their desirability.

Veblen Effect

The Veblen effect is a fascinating economic concept which challenges traditional understandings of demand. Named after economist Thorstein Veblen, this effect occurs when the demand for a good increases as the price rises, contrary to the typical law of demand.

This effect is often observed in luxury goods, where consumers view higher prices as a signal of enhanced quality or greater desirability. Such products are considered Veblen goods. For example, a high-end handbag's price increase may lead to more sales, not fewer, because the buyer perceives the item as more prestigious or exclusive.

Key aspects of the Veblen effect include:

• Price and Perception: High prices enhance the perceived value of luxury goods.
• Social Status: Buying expensive items can reflect and perhaps inflate one's social status.
• Market Influence: This effect can lead to interesting market dynamics where price hikes might boost demand rather than suppress it.

Understanding the Veblen effect is crucial for businesses and marketers working with luxury products, as it informs pricing strategies and consumer engagement methodologies.