Download Determinants of Demand

Demand
Economics
Objectives
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To understand what is meant by ‘demand’
To understand the concept of marginal
utility
To be able to draw demand curves
To understand what causes a movement
along a demand curve and a shift of a
demand curve
To understand what consumer surplus is
Demand: Buyers in the Market
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Demand:
• The quantity of a product that consumers are
willing and able to buy at a given price over a
given period of time
• Consider the demand for iPod Nano’s – what will
happen to the demand as the price decreases?
The Law of Demand
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‘As the price of a product falls the quantity
demanded will usually increase, ‘ceteris paribus’
Ceteris Paribus- Latin phrase meaning ‘all
other factors remain constant/ the same’. We
use it to isolate the impact of one factor.
Demand Curve
As price falls from P1 to P2
quantity demanded rises
from Q1 to Q2
Price
P1
P2
D1
0
Q1
Q2
Quantity
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Any changes in price will lead to a movement along the
demand curve (contraction or extension)
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Price changes have both income and substitution effects
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When the price of a good falls the rise in demand is due to
• Income Effect, a price fall means people see in an
increase in their ‘real income’, hence they can afford to
buy more
• Substitution Effect, when the price of a product falls
the product becomes more attractive relative to other
products whose prices are unchanged..
Downward-sloping demand curve
N.B.
The demand curve is normally drawn in textbooks as
a straight line suggesting a linear relationship
between price and demand, but in reality, the
demand curve will be non-linear
Demand: Marginal Utility Theory
The Law of Diminishing Marginal Utility
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The shape of the typical demand curve may also
be explained by the action of diminishing marginal
utility
Utility is the satisfaction gained from consuming a
good or service
As more of a good or service is bought, the total
utility derived increases.
Demand: Marginal Utility Theory
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The additional utility received from the last unit
consumed is known as the Marginal Utility
As more of a good is consumed it is generally
accepted that marginal utility diminishes.
Demand: Marginal Utility Theory
Example
Plot the Total Utility
on a graph
Plot the Marginal
utility on a
separate graph
Chocolate
Bars
Consumed
Total
Utility
1
10
Marginal
Utility
9
2
19
8
3
27
7
4
34
3
5
37
-2
6
35
Demand - Marginal Utility Theory
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Marginal Utility declines as the consumption
of a good increases
The MU curve is the same as the individual’s
demand curve if measured in money terms
Demand: Marginal Utility Theory
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Price measures sacrifice in the sense that it indicates
what other things might have been obtained with the
money
Since MU diminishes, consumers will be tempted to
buy more of a product only if it’s price is lowered
Thus as the price of a good falls more is demanded
Note:
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Consumers seek to maximise their total utility by
dividing their spending between products in such a way
that the MU per penny spent on each product is equal.
Consumer Surplus
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There are always some consumers willing to pay
more than the given price eg. Football matches
‘Benefit’ to the consumer
It is the difference between the total value
consumers place on all the units consumed and the
payments they need to make in order to actually
purchase that commodity
Consumer Surplus
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Diagram
Price
P1
Consumer Surplus
E
D
Q1
Quantity
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On another diagram illustrate the impact on
consumer surplus when there is a rise in the
price.
Change in Consumer Surplus
New consumer surplus
Price
P2
E2
Loss of consumer surplus
= P1P2E2E1
E1
P1
D
Q2
Q1
Quantity
Consumer Surplus
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A change in the price of a product affects the
amount of consumer surplus people receive
A rise in the price reduces consumer surplus and
a fall in price raises consumer surplus
When we analyse the impact of a change in price
we can explain the impact on the consumers
using the concept of consumer surplus to show
lost or gained benefit to consumers
Latent Demand
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Latent Demand
• Latent demand exists when there is willingness
to purchase a good, but where the consumer
lacks the real purchasing power to be able to
afford the product
• Latent demand is affected by persuasive
advertising – where the producer is seeking to
influence consumer tastes and preferences
• List 3 products that you have latent demand for
Effective Demand
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Effective Demand
• When a consumers' desire to buy a product is
backed up by an ability to pay for it
Joint Demand
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Joint Demand
The demand for a product X might be strongly linked to the
demand for a related product Y
You own a sports shop.
If the demand for tennis racquets rises (after watching
Wimbledon?) what will happen to the demand for tennis balls?
Goods which are in ‘joint’ demand are called compliments or
complimentary goods
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So if you decide to drop the price of golf clubs what will
happen to demand for golf clubs? What will happen to
demand for other products in your shop?
If the price of chicken in the UK fell, we would expect a
rise in demand for chicken, what other demand may be
affected as a result?
When the fall in price of good a causes a
rise in demand for good b, we say these
goods are substitutes they are in
competitive demand
Derived Demand
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When a product or factor (factor of
production) is demanded not for itself, but
for what it can produce.
Eg. Teachers are demanded by schools
because students/ parents demand
education.
A car manufacturer will demand rubber for
tyres because of the demand for cars.
Any other examples?
Derived demand
The housing market is a good example of the idea of
derived demand. When construction of new homes
rises, so too does the demand for materials used in
new properties as well as demand for labour
Shifts in the demand curve
Changes in the conditions of
demand
Shifts in the Demand Curve
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A change in price causes a movement along
the demand curve whereas a change in any
other factor that influence demand will cause
a shift of the whole curve (usually a parallel
shift).
Draw a diagram to show an increase in demand
for new cars
Factors that influence Demand
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Other than price, what factors do you think
would influence the demand for a new car?
Demand for New Cars
Consumer
Confidence
Interest Rates
Relative prices of
second-hand
vehicles
Cost of fuel
Road Charges /
Tax
Relative costs of
travelling on public
transport
Availability of
Credit
Costs of car
insurance and
servicing etc
TIMERS- factors that shift the demand
curve
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Taste- influenced by advertising, fashion etc
Income- influenced by economic growth and income tax
etc
Market size- change in population
Expectations- predictions about the future, consumer/
business confidence
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Related goods- complements and substitutes
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Seasons- including weather
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Note there are many many factors that affect demand
this is just a simple way to remember some of them!
Substitutes
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Recall: Substitutes are goods in competitive demand
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They are replacements for another product.
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Esso and Shell are competing brands of petrol in the UK
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A rise in the price of Esso petrol (other factors held
constant) should cause a substitution effect away from
Esso towards Shell (or other competing brands)
Fill out the following diagram to show the effect of a
rise in the price of Esso petrol and what impact this has
on the demand for Shell petrol
Changes in price of Substitutes
Price of
Texaco
petrol
Price of
Shell
petrol
D1
Output (Q)
D1
Output (Q)
Changes in price of Substitutes
Price of
Texaco
petrol
Price of
Shell
petrol
P2
P1
P1
Demand
Q2
Q1
Output (Q)
D1
Q1
Q2
D2
Output (Q)
Complements
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Recall: Complements are said to be in joint demand
Examples include: bread and butter, DVD players
and DVDs, iron ore and steel
A rise in the price of a complement to Good X
should cause a fall in the demand for y
Using 2 corresponding diagrams (as previously)
show what would happen to the demand for car
insurance when the price of cars increases.
Normal and Inferior Goods
A normal good will face an increase in
demand as income rises. Eg?
An inferior good faces a decrease in
demand as income rises. They are often
cheaper poorer quality substitutes for some
other good Eg?
Exceptions to the law of demand
Speculative Demand
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The demand for a product can be affected by
speculative demand. Here, potential buyers are
interested not just in the satisfaction they may get
from consuming the product, but also the potential
rise in market price leading to a capital gain or
profit
Giffen Good
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Unique type of inferior good- as the price increases
demand increases
Sir R Giffen (1837-1919) suggested there was a
tendency for the very poor to buy more of the basic
foodstuffs on which they depended when the price
rose, and less when the price fell
Eg. Bread- A rise in price would mean these
consumers have little extra money to spend on meat
(for eg.) so would abandon their demand for these
and instead buy more bread to fill up their stomachs.
Consequently a rise in the price of bread led to a rise
in the demand for bread
Most economists agree there are no real examples of
Giffen goods in developed economies. Some evidence
(Jenson and Miller, 2002) Giffen goods may exist in
the form of rice and noodles in some parts of China
Veblen Goods
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Thorstein Veblen- as the price rises demand
increases
Some products become more popular as the
price rises
Partly due to ‘conspicuous consumption’people get satisfaction from being seen by
other people to consume expensive goods
“Failure to consume in due quantity and quality
becomes a mark of inferiority and demerit”
Examples?
Price
At low prices a typical Veblen good will have a normal
demand curve, as rice rises eventually the good achieves
“snob value status” and further price rises lead to
increases in demand
“Snob Value Status”
D
Quantity