Demand and Supply

Demand

• the buying intentions of consumers

• demand operates on consumer sovereignty. this means that the consumers, through demand, determine what will be produced and how much of it will be produced. This also means consumers set the price in the economy, not producers.

The law of demand

• as the price of a good rises, people will buy less of it, ceteris parabis

• there is an inverse relationship between the prices and quantity demanded

• there are no exceptions to the law of demand, because it will always be negative as long as the ceteris parabis holds

• A consumer will always prefer to pay a lower price for the same good than a higher price

income effect

• if the price of a good rises, consumers will buy less of it because their real income has decreased. If the price of a good decreases, they will buy more.

• real income: the quantity of foods you can buy with a fixed amount of money

• when real income falls, people are poorer and therefore will purchase less and vice versa.

substitution effect

• if the price of one good rises, consumers will see if they can swap it for a cheaper good

• an increase of price will cause consumers to switch to relatively cheaper substitutions

changes in demand: price

• an increase in price will cause a decrease in quantity demanded

• a decrease in price will cause an increase in quantity demanded

• a change in price results in a change in quantity demanded directly. A change in price cannot shift the curve.

changes in demand: non price factors

• when a non price factor changes, it results in a new demand curve

• a shift of the curve to the right is called an increase in demand

• a shift of the curve to the left is called a decrease in demand

non price factors: levels of disposable income

• your level of income determines your budget - what you can and cannot afford

• consumers will normally purchase more of a good when their income increases.

• normal good: a good where demand increases as income increases. Most goods and services are normal goods

• inferior good: when demand decreases as income rises. e.g. home brand products

non price factors: price of related goods

• on most occasions, consumers can choose between a number of goods and services which satisfy the same want

• substitutes: goods that satisfy the same wants; consumers can choose between them

• complements: goods that are consumed alongside other goods

non price factors: tastes and preferences

• the tastes and preferences of consumers are an important determinant of consumer demand

• the advertising industry plays an important role in affecting consumers’ preferences and spending habits

non price factors: expectations of consumers / expected future prices

• if people expect conditions to change in the future, they may make decisions now rather than postpone them.

• for example, if the price of petrol is expected to rise in the future, then consumers will have an incentive to increase their purchases now to beat the price rise. This is rational behaviour and will result in an increase of demand temporarily

non price factors: demographic factors

• the size and age composition of the population can have an important bearing on the pattern of demand

• a growing population increases the market size for all goods and services whereas a change in age profile will affect specific goods and services

• for example, as the Australian population ages, the demand for child care facilities will decrease relative to the demand for retirement facilities.