Determinants of Demand

1
Determinants of Demand

• Revision presentation on the demand curve and
  causes of shifts in the demand curve

2
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
• 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

3
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
• 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

4
The Factors Affecting the Demand for New Cars
The Price of New Cars
Consumer Confidence
Interest Rates
Relative costs of travelling on public transport
Relative prices of second-hand vehicles
Availability of Credit
Cost of fuel
Costs of car insurance and servicing etc
Road Charges / Tax
5
Effective Demand and Latent 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
• 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

6
Derived 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

7
Falling Prices and Expanding Demand

• Many goods and services are cheaper now in both
  money and real terms than they were a few years
  ago. In many cases, this has contributed to a
  large expansion in the total quantity demand
• Short-break holidays overseas
• Prices of new audio-visual equipment
• Personal computers
• New car prices
• Many items of clothing in mainstream clothing
  retail markets
• When prices are falling, we see a rise in the
  quantity demanded as consumers respond to the
  change in price

8
The Law of Demand and the Demand Curve
Price
The demand curve shows how quantity demanded
responds to a change in the goods own
price There is an inverse relationship between
price and quantity demanded
P1
Demand (D)
Quantity Demanded (Qd)
9
The Law of Demand and the Demand Curve
Price
A contraction of demand
P2
P1
Demand (D)
Quantity Demanded (Qd)
10
The Law of Demand and the Demand Curve
Price
P2
P1
An expansion of demand
P3
Demand (D)
Quantity Demanded (Qd)
11
Explaining the 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 encouraging
  consumers to switch their demand in favour of the
  lower priced product
• Thirdly, a fall in price means that the consumer
  derives more benefit (satisfaction or utility)
  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

12
Shifts in the demand curve
13
Shifts in Demand
14
An Outward Shift of Demand
Price
An outward shift of the demand curve shows that
more of the product is being demanded at each
price. It also shows that the seller (supplier)
could sell the same quantity at a higher price
P1
Demand (D)
D2
Quantity Demanded (Qd)
15
Causes of 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 (e.g. if the product is
  often bought using loan finance)
• A rise in consumer confidence (important for big
  ticket items of spending)
• Social changes which affect total demand for a
  product

16
An Inward Shift of Demand
Price
An inward shift of demand means that less is
bought at each price level. There has been a
reduction in the quantity that consumers are
willing and able to see at each and every price
P1
D3
Demand (D)
Quantity Demanded (Qd)
17
Substitutes and Complements

• 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 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

18
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. Examples include
  black-and-white television sets, cigarettes,
  white bread and several other basic foods.
• 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

19
Changes in the Price of Substitutes
Price of Texaco petrol
Price of Shell petrol
P2
P1
P1
D2
Demand
D1
Q1
Q2
Q1
Output (Q)
Q2
Output (Q)
20
Changes in the Price of Complements
Price of DVD Players
Price of Pre-recorded DVDs
P1
P2
P1
D2
Demand
D1
Q1
Q1
Q1
Output (Q)
Output (Q)
21
Factors Affecting Market Demand for Beef

• These are factors other than the price of beef
  itself
• Fall in consumer incomes (real purchasing power)
• An increase in the price of chicken ( a
  substitute)
• A government tax on hamburger producers
• A successful advertising campaign
• Rise in the price of Yorkshire Puddings
• A fall in the price of lamb
• A fear of recession and rising unemployment