Why Is the Demand Curve Also a Willingness to Pay Curve?
The demand curve in economics is a visual display of the relationship between the price of a product and the quantity demanded by consumers. A deeper examination of the demand curve reveals that it is a measure of consumers' willingness to pay for a product or service. The key to understanding the demand curve as a "willingness to pay" curve lies in another economic concept known as consumer surplus.
Consumer surplus is a measure of the difference between what consumers are willing to pay for the products they want minus what they actually pay. If a buyer is willing to pay as much as $20 for a good but actually pays only $15 for it, that person's consumer surplus is $5. Economist Greg Mankiw notes that individual buyers place different value on a product, with some consumers willing to pay more than others. Consumer surplus, derived in part from willingness to pay, is the benefit buyers receive from participating in market transactions.
Mankiw points out that willingness to pay is closely related to the demand curve. The demand curve for most products illustrates lower levels of demand as prices rise. This means as the price increases, more consumers leave the market for the product in question because they are not willing to pay the higher price. Conversely, as the price of a good declines, more buyers enter the market because they are willing to pay the lower prices.
At any quantity demanded, the corresponding price depicted on the demand curve shows the willingness to pay of what Mankiw calls the "marginal buyer." The marginal buyer is the consumer who will leave the market for a product first if the price was any higher. Mankiw concludes that the area below the demand curve and above the price measures the level of consumer surplus.
Most economists derive the demand curve for a good from a table that shows price and quantity data, displaying the relationship between price and quantity demanded. Mankiw notes that demand schedule for a product is derived from consumers' willingness to pay.