Microeconomics Theme 1: Supply and Demand

Formula for Revenue

Price * Quantity

Factors which cause a shift in demand

Population
Advertising
City Speculators
Income (disposable)
Fashion/trends/tastes
Interest rates
Complementary goods (price of)
Substitute goods (price of)

Relation between population and demand

The larger the population, the more demand there is for most goods

Relation between advertising and demand

• Advertising is designed to change our preferences

  • Effective advertising and marketing will make products more attractive and increase demand

Relation between city speculators and demand

If speculators feel a commodity will increase in value, they will buy more of it which increases demand. However, this is only relevant to asset markets e.g. Bitcoin, property, stocks

Relation between change in real disposable income and demand

Effective demand is affected by our willingness and ability to purchase a good or service. There are always some things that we can’t afford; the economic problem demands that we make choices

Real Disposable Income

The amount of money an individual or household has available to spend or save after accounting for taxes and adjusting for inflation

Normal goods

A good where demand increases when income increases e.g. luxury goods

Inferior goods

A good where demand decreases when income increases e.g. canned goods, Tesco value sausages

Relation between change in taste and preferences and demand

Over time, consumer tastes and preferences change according to fashions. Fashion makes products more desirable, which means more people will start buying and demand for the product will increase

Relation between interest rates and demand

A fall in interest rates will make it cheaper to borrow, so demand for loans and thus consumption of a good may increase. An increase in credit lent out by banks will cause an increase in purchasing power for consumers. This is usually applicable for ‘big ticket’ items e.g. home, car, sofa

Relation between change in price and availability of other products and demand

The demand for one product, at each and every price, will be affected by the price of a different but related product, complements or substitutes.

Complementary goods

Two goods that are consumed together e.g. toothbrush and toothpaste

Substitute goods

Two goods that are used instead of one another

Demand

The quantity of goods that consumers are willing and able to each price

Law of Demand

Assuming ceteris paribus, if the price of the good rises, the quantity demanded of that good decreases.
If the price of the good falls, the quantity demanded of that good increases.

Effective Demand

When demand is backed up by an ability to pay e.g. sports top

Latent Demand

When a consumer want is not backed up by an ability to pay e.g. Ferarri

Derived Demand

When the demand is not for the product itself but for what it provides e.g. Uber, Demand for Labour

Complementary Demand

When the demand for one product increases the demand for another that is used in conjunction (e.g. lamb & mint sauce)

Utility

The satisfaction derived from consuming a good

Marginal Utility

Extra satisfaction from consuming a good

Diminishing marginal utility

When a consumer consumes additional units of a good, the extra utility they derive will decrease

The Law of Diminishing Marginal Utility

For every additional unit of a good consumed, consumers are likely to pay less as the utility gained from its consumption falls

Substitution effect

When the price falls, the good becomes cheaper relative to its substitutes. Some consumers will switch their purchases from the more expensive substitutes

Income effect

When the price of a good falls, a consumer’s real income may increase. The purchasing power of a consumer’s nominal income has increased, so more can be bought

Supply

The quantity that producers are willing and able to supply at each price

Law of Supply

Assuming ceteris paribus, if the price of a good rises, the quantity supplied of that good increases. If the price of a good falls, the quantity supplied of that good decreases.

Reasons why the supply curve is upward sloping

• Profit incentive

  • Firms incentive to increase profit. As price increases, firms are encouraged to increase the quantity supplied

• Production costs

  • As firms’ output increases in the short run, production costs increase. In order to cover costs, firms need to charge higher prices

• New entrants

  • Higher prices create incentive for new firms to enter the market, increasing quantity supplied

Factors which cause a shift in supply (PINTS WC)

Productivity
Indirect tax
New entrants
Technology
Subsidies
Weather/War
Costs of production