Suppose there are 25 people with a reservation price of $500, and the 26th person has a reservation price of $200.
What would the demand curve look like based on this information?
The Correct Answer and Explanation is:
Correct Answer:
The demand curve based on the given information would be a step-shaped (or staircase-like) demand curve, starting at a price of \$500 for quantities 1 through 25, and then dropping to \$200 at quantity 26.
Explanation:
A demand curve illustrates the relationship between the price of a good or service and the quantity demanded by consumers. Each individual’s reservation price is the maximum price they are willing to pay. If the market price is equal to or lower than their reservation price, the individual will buy the product; otherwise, they won’t.
In this scenario:
- There are 25 people each willing to pay \$500. This means at a price of \$500, up to 25 units of the product will be demanded.
- The 26th person has a reservation price of only \$200. This individual would only be willing to buy the product if the price drops to \$200 or lower.
This results in a step-shaped demand curve:
- From quantity 1 to 25, the demand curve is flat at \$500, indicating that all these buyers will purchase at that price.
- At quantity 26, the price suddenly drops to \$200, because only the 26th person is willing to buy at that lower price.
In graphical terms, the curve would look like a horizontal line at \$500 from 1 to 25 on the quantity axis, then drop vertically to \$200 at quantity 26. There would be no gradual slope since the prices are distinctly different and the number of buyers with each reservation price is fixed.
This is typical of a discrete demand curve, often seen in markets with a small number of buyers, where each buyer has a known reservation price. The shape reflects the individual steps of willingness to pay and is especially relevant in auctions or limited supply settings.