Download a) State the law of demand and distinguish between movements

(a) State the law of demand and distinguish between movements along the
demand curve and shifts of the demand curve.
(b) Explain with the help of diagrams the effect that an increase in the price of
petrol is likely to have on (i) the market for cars
(ii) the market for coal
(a) The law of demand states that as price increases, quantity demand decreases,
ceteris paribus, and over a given amount of time, based on rational behaviour.
A movement along the demand
curve is caused by a change in
price (shown in the diagram to
the right), whereas a shift of
the demand curve is caused by
factors which affect demand
such as advertising,
substitutes, complementary
goods, population
(demographics),
fashion/trends, incomes etc
(shown in the diagram below).
When consumers increase
the quantity demanded at
a given price, it is
referred to as an increase
in demand. This increased
demand can be
represented on a graph as
the curve being shifted to
the right. At each price
point, a greater quantity
is demanded, as from the
curve D1 to the new curve
D2. Examples of an
increase in demand are as
follows: successful
advertising will cause an
increase in demand and therefore there will be an increase in price. If the number
of substitutes fell, then demand would increase. If a good was in fashion, or a
‘trend’ at the time then demand would increase, causing an increase in price. Also,
if people were earning a higher income they would be more inclined to spend
money to purchase more luxury goods, therefore demand would increase.
If the demand decreases, then the opposite will happen - a shift to the left of the
curve. If the demand starts at D2, and decreases to D1, the price will decrease and
the quantity demanded will decrease. The quantity supplied at each price is the
same as before the demand shift (at both Q1 and Q2). The equilibrium quantity,
price and demand are different. At each point, a greater amount is demanded
(when there is a shift from D1 to D2).
(b) (i) An increase in the price of petrol is likely to result in a fall in demand for
cars because petrol and cars are considered complementary goods. Some buyers
may decide that cars are too expensive an item to maintain in the long term since
petrol prices are so high. So car suppliers may therefore decrease prices for cars in
order to create a larger demand for cars.
(ii) As petrol can be substituted for coal, the demand for these two goods will be
bound together by the fact that consumers can trade off one good for the other if
it becomes advantageous to do so. Thus an increase in the price of petrol (ceterais
pairbus) may result in an increase in demand for coal as coal can be a substitute
for petrol e.g. in heating or electricity. Consumers would probably react by buying
less petrol and replacing it with coal in this case. This can be shown on a demand
diagram.
Price
D
D1
P
D
Q
Q1
D1
Quantity
The demand curve for coal in the above diagram is D. A rise in price of petrol leads
to a rise in demand for coal. This means that at any given price a greater quantity
of coal will be demanded. The new demand curve D1 will therefore be to the right
of the original demand curve.
It is important to note that when speaking about substitute goods we are speaking
about two different kinds of goods. So the substitutability of one good for another
is always a matter of degree. A good is only a perfect substitute if it can be used in
exactly the same way, at exactly the same cost, and with exactly the same quality
of outcome. It is much more common for goods to be imperfect substitutes for one
another. In this case, for example, petrol and coal can both be used for the same
purpose (for heating and electricity), but there are significant differences between
the two. As a result the two can be substituted for one another, but there are
significant trade-offs involved in deciding to substitute one for the other.
However, there may be some cases, e.g. vehicles such as cars and aircrafts that
have petrol engines where no alternatives can be used besides petrol. This would
mean consumers would have no choice but to continue buying petrol despite the
increase in price.