determinants of demand
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Demand's determinantsTRANSCRIPT
Determinants of Market Demand
IGCSE Economics
Key Issues
How the price mechanism works
Law of demand
Determinants (Factors that influence) of demand
Joint demand, effective demand
The demand curve and shifts in demand curve
Functions of Prices
The Price Mechanism • Prices provide the main method through which
scarce resources are allocated between competing uses in virtually all modern economies
The Signalling Function • Prices signal what is available, conveying
information to producers and consumers alike
• If prices signal wrong or misleading information, then markets may perform inefficiently or break down completely
Functions of Prices
The Incentive Function • Prices create incentives for agents to behave in
ways consistent with their self-interest. For example, the rising price of a good may: • Result in a firm expanding production of that good
in its pursuit of profit-maximisation • Result in a consumer contracting demand as she
tries to maximise her overall ‘utility’ with her limited income
Demand: Buyers in the Market
Demand: • The quantity of a product consumers are willing
and able to buy at different prices in a specified time period
• Normally there is an inverse relationship between the price of good X and the quantity demanded of good X
Demand: Buyers in the Market
Factors that affect demand • Consumer tastes and preferences
• Income available to the consumer
• Prices of other goods and services • Substitute goods • Complementary goods
• Consumer population – Age distribution and size
• Advertising
Demand for New Cars
The Price of New Cars
Interest Rates
Relative prices of second-hand
vehicles
Cost of fuel
Road Charges / Tax
Consumer Confidence
Relative costs of travelling on public
transport
Availability of Credit
Costs of car insurance and servicing etc
Effective Demand
Effective Demand • When a consumers' desire to buy a product is
backed up by an ability to pay for it
• They must have sufficient real purchasing power
• Consider the market for pay-per-view boxing events – the companies promoting these events must price carefully so that they tap into the largest possible market
Effective demand
Demand is only effective if backed up with an ability to pay for the product
Latent Demand
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
Latent demand
Derived Demand (Joint Demand)
The demand for a product X might be strongly linked to the demand for a related product Y – giving rise to the idea of a derived demand
For example, the demand for coal is derived in part on the demand for fossil fuels to burn in the process of generating energy
Demand for steel is strongly linked to the demand for new vehicles and many other manufactured products
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
Demand for steel
The construction of a new steel roof
Global demand for steel is strongly linked to the world economic cycle
Complementary Demand
As the demand for mobile phone handsets increases, so too does demand for phone calls
Mobile phone companies often sell handsets at very low prices because they can recoup revenues from the calls made by subscribers to their network
The Demand Curve
Quantity Demanded
Demand
P1
Q1 Q3 Q2
P2
P3
Price
A contraction of demand
Quantity Demanded
Demand
P1
Q1 Q3 Q2
P2
P3
A contraction of demand due to a higher price
Price
An expansion of demand
Quantity Demanded
Demand
P1
Q1 Q3 Q2
P2
P3
An expansion of demand due to a lower price
Price
Falling Prices and Demand
Many goods and services are cheaper now in both money and real terms than they were a few years ago • Flights/holidays overseas
• Audio-visual equipment – TV’s, DVD Players
• Laptop computers
• New car prices
When prices are falling, we see a rise in the quantity demanded as consumers respond to the change in price
Price trends for selected items
Downward-sloping demand curve
For normal goods, more is demanded as price falls Firstly at lower prices, consumers can afford to
purchase more with their income Secondly, a fall in price makes one good relatively
cheaper than a substitute Thirdly, a fall in price means that the consumer derives
more benefit per pound spent on the product than they did before
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
Shifts in the demand curve
Changes in the conditions of demand
Shifts in Demand
Quantity Demanded
D1
P1
Q1 Q2 Q3
D2 D3
Increase in Demand Decrease in
Demand Price
An outward shift in demand
A rise in the real incomes of consumers
An increase in the price of a substitute good (i.e. a competing product)
A fall in the price of a complementary good
A change in consumers’ preferences towards the good
An increase in the size of the total population
A fall in interest rates
A rise in consumer confidence
Social changes which affect total demand for a product
Substitutes
Substitutes are goods in competitive demand • They are replacements for another product
• For example, 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
Complements
Complements are said to be in joint demand • Examples include: fish and chips, 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 X
Normal and Inferior Goods
For normal products, more is demanded as income rises, and less as income falls
There are exceptions called inferior products
They are often cheaper poorer quality substitutes for some other good
With a higher income a consumer can switch from the cheaper substitute to preferred alternative
As a result, less of the inferior product is demanded at higher levels of income
Income Elasticity of Demand
For some products there is a strong link between income and demand • New cars
• Expensive furniture
• Overseas holidays
Changes in price of Substitutes
P1
Q1 Q2
Demand
Output (Q)
Price of Texaco petrol
P1
Q1 Q2
D1
Output (Q)
Price of Shell petrol
P2
D2
Changes in tastes and preferences
Market demand in nearly every market is often affected by changes in consumer preferences
One person’s preferences can affect those of others
This is a very powerful force in digital markets e.g. iTunes, demand for DVDs
But it is also powerful when influencing the demand for meals at restaurants, hotels in holiday destinations et al
Advertising and marketing are explicitly designed to influence consumer tastes and preferences
What factors are influencing market demand for smoothies?
Exceptions to the law of demand
Ostentatious consumption
Some goods are luxurious items where satisfaction comes from knowing both the price of the good and being able to flaunt consumption of it to other people!
Speculative Demand
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