3.1 The determinants of demand

Define market

A volunary meeting of buyers and sellers with exchange taking place

Define demand

The quantity of a good or service that consumers are willing and able to buy at given prices in a given period of time

Define supply

The quantity of a good or service that producers are willing and able to sell at given prices in a given period of time

Define competitive markets

Markets in which the large number of buyers and sellers possess good market information and can easily enter or leave the market

Define ruling market price

The price at which planned demand equals planned supply

Why do competitive markets occur?

Competitive markets occur when there are a large number of buyers and sellers all passively accepting the ruling market price, which is set, not by individual decisions, but by the interaction of all those taking part in the market. Highle competitive markets lack entry and exit barriers. This means that new buyers and sellers can easily enter the market without incurring costs. In the same way, buyers and sellers can leave the market if they wish to. Competitive markets also exhibit a high degree of transparency - buyers and sellers can quickly find out what everyone else in the market is doing.

Define effective demand

The desire for a good or service backed up by an ability to pay.

What is the relationship between price and quantity demanded?

Households and firms operate simultaneously in two sets of markets. The first of these contains the goods markets, in which members of households demand and buy consumer goods and services produced and supplied by firms. But for household demand in the goods market to be an effective demand - that is, demand backed up by an ability to pay - households must first sell their labour, or possibly the services of any capital or land they own, in the markets for factors of production. Households' roles are therefore reversed in goods markets and factor markets.

What does a demand curve show?

(page 46) A demand curve shows the relationship between the price of a good or service and the quantity of the good or service demanded at different prices. If the price starts off high, for example at P1, household demand is Q1. But if the price falls to P2, quantity demanded increases to Q2.

Demand for a good varies according to the time period being considered. For example, the weekly demand is different from daily, monthly and annual demand. For this reason, the horizontal axis is labelled 'quantity demanded per period of time'. It is normal practice to use the label 'quantity' on the horizontal axis of a demand curve diagram however.

Define market demand

The quantity of a good or service that all the consumers in a market are willing and able to buy at different prices

Define individual demand

The quantity of a good or service that a particular consumers or individual is willing and able to buy at different market prices

Relationship between individual and market demand

Market demand is just the sum if the demand of all the consumers in the market.

How do demand curves shift and move?

Students often confuse a movement along the demand curve and a shift of a demand curve. A movement along a demand curve takes place only when the good's price changes. Provided the demand curve slopes downward, a fall in price results in more of a good being demanded. This is sometimes called an extension in demand. Likewise, a contraction in demand occurs when a rise in price leads to less being demanded.

When we draw a demand diagram, we assume that all other variable that may also influence demand are held unchanged or constant. This is the ceteris paribus assumption, which means 'other things being equal'. Among the variable whose values are held constant or unchanged when we draw a demand curve are disposable income and tastes or fashion. Collectively, the variables (other than the good's own price) whose values determine planned are often called the conditions of demand. A change in a condition of demand shits the demand curve to a new position.

Define conditions of demand

A determinant of demand, other than the good's own price, that fixes the position of the demand curve.

What are the main conditions of demand?

- Prices of substitute goods or goods in competing demand

- The price of goods in joint demand or complementary goods

- Personal income

- Tastes and preferences

- Population size (influences market size)

What is an increase is demand?

A rightward shift of the demand curve

What is a decrease in demand?

A leftward shift of the demand curve

What might cause a rightward shift in the demand curve?

- An increase in the price of a substitute good or a good in competing demand

- A fall in the price of a complementary good or a good in joint demand

- An increase in personal disposable income

- A successful advertising campaign making people think more favourably about the good

- An increase in population size

Define a normal good

A good for which demand increases as income rises and demand decreases as income falls

Define an inferior good

A good for which demand decreases as income rises and demand increases as income falls

How do normal and inferior good affect the demand curve?

When disposable income increases, a demand curve shifts rightward, but only if the good is a normal good, for which demand increases as income increases. However, some goods are examples of inferior good, for which demand decreases as income increases, and an increase in income shifts the demand curve leftward.

To take an example, private car transport and bus travel are not just substitutes for each other. As people's incomes rise, demand for cars generally increases, while, at the same time, demand for bus travel usually falls. If people respond in this way to changes in income then private transport is a normal good, but certain forms of public transport are inferior goods. For an individual, whether a good is a normal or inferior depends on personal income, tastes and possibly age. For young people, junk food is usually a normal good, but later in life this may become an inferior good.

Providing a good is normal good, an increase in income shifts the good's demand curve to the right. However, if the good is inferior for most people, its demand curve shifts to the left when income increases.