AS Micro: Determinants of Demand

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Demand is the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period

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  • Demand is defined as the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period. Each of us has an individual demand for particular goods and services. Demand at each market price reflects the degree of value consumers place on item and their expected satisfaction gained from purchase and consumption.
  • Market demand is simply the sum of the individual demand for a product from each consumer in the market. If more people enter the market, then demand at each price level will rise.
  • Demand in economics must be effective. Only when a consumers' desire to buy a product is backed up by an ability to pay for it do we speak of demand. For example, many people would be willing to buy a luxury sports car, but their demand would not be effective if they did not have the financial means to do so. They must have sufficient 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.
  • A demand curve shows the relationship between the price of an item and the quantity demanded over a period of time. For normal goods, more of a product will be demanded as the market price falls.
  • At higher prices, consumers generally willing to purchase less than at lower prices
  • At lower prices there is a financial incentive to demand more of a good or service
  • Changes in any of the factors other than price causes the demand curve to shift
    Changes in the price of the good itself cause a movement along the demand curve
  • Substitutes are goods in competitive demand and act as replacements for another product.
    For example, a fall in the monthly rental charges of cable companies or Vodafone mobile phones might cause a decrease in the demand for British Telecom services. Consumers will tend over time to switch to the cheaper brand or service provider. When it is easy and cheap to switch, then consumer demand will be sensitive to price changes
  • AS Micro: Determinants of Demand

    1. 1. tutor2ututor2u™™ Determinants of Market Demand AS Economics
    2. 2. tutor2ututor2u™™ Key Issues  Functions of the price mechanism  Law of demand  Determinants of demand  Joint demand, effective demand  The demand curve and shifts in demand curve
    3. 3. tutor2ututor2u™™ 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
    4. 4. tutor2ututor2u™™ Functions of Prices  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
    5. 5. tutor2ututor2u™™ 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
    6. 6. tutor2ututor2u™™ 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
    7. 7. tutor2ututor2u™™ 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 • Interest rates • Consumer population
    8. 8. tutor2ututor2u™™ 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
    9. 9. tutor2ututor2u™™ 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
    10. 10. tutor2ututor2u™™ Effective demand Demand is only effective if backed up with an ability to pay for the product
    11. 11. tutor2ututor2u™™ 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
    12. 12. tutor2ututor2u™™ Latent demand
    13. 13. tutor2ututor2u™™ 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
    14. 14. tutor2ututor2u™™ 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
    15. 15. tutor2ututor2u™™ Demand for steel  The construction of a new steel roof  Global demand for steel is strongly linked to the world economic cycle
    16. 16. tutor2ututor2u™™ 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
    17. 17. tutor2ututor2u™™ The Demand Curve Quantity Demanded Demand P1 Q1 Q3Q2 P2 P3 Price
    18. 18. tutor2ututor2u™™ A contraction of demand Quantity Demanded Demand P1 Q1 Q3Q2 P2 P3 A contraction of demand due to a higher price Price
    19. 19. tutor2ututor2u™™ An expansion of demand Quantity Demanded Demand P1 Q1 Q3Q2 P2 P3 An expansion of demand due to a lower price Price
    20. 20. tutor2ututor2u™™ Falling Prices and Demand  Many goods and services are cheaper now in both money and real terms than they were a few years ago • Short-break holidays overseas • Prices of new audio-visual equipment • Personal computers • New car prices  When prices are falling, we see a rise in the quantity demanded as consumers respond to the change in price
    21. 21. tutor2ututor2u™™ 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
    22. 22. tutor2ututor2u™™ Shifts in the demand curve Changes in the conditions of demand
    23. 23. tutor2ututor2u™™ Shifts in Demand Quantity Demanded D1 P1 Q1 Q2Q3 D2 D3 Increase in Demand Decrease in DemandPrice
    24. 24. tutor2ututor2u™™ 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
    25. 25. tutor2ututor2u™™ 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
    26. 26. tutor2ututor2u™™ 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
    27. 27. tutor2ututor2u™™ 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
    28. 28. tutor2ututor2u™™ Income Elasticity of Demand  For some products there is a strong link between income and demand • New cars • Expensive furniture • Cruise tours  What of the demand for package holidays?
    29. 29. tutor2ututor2u™™ Changes in price of Substitutes P1 Q1Q2 Demand Output (Q) Price of Texaco petrol P1 Q1 Q2 D1 Output (Q) Price of Shell petrol P2 D2
    30. 30. tutor2ututor2u™™ 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
    31. 31. tutor2ututor2u™™ What affects demand for smoothies?
    32. 32. tutor2ututor2u™™ 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!
    33. 33. tutor2ututor2u™™ Exceptions to the law of demand  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
    34. 34. tutor2ututor2u™™ Get help from fellow students, teachers and tutor2u on Twitter: #econ1 @tutor2u_ec on

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