Demand
Definition: The quantity of goods and services that consumers are willing and able to buy at any price over a given period of time.
The Demand Curve: the relationship between the price level and quantity demanded. As is seen in the diagram below the demand curve is downward sloping, as the price level falls from £3 to £2 the quantity demanded increases from 26 to 38 (law of demand). There are two reasons for this:
- Income effect – as the price falls, a given income can afford more of the good.
- Substitution effect – as the price of a good falls, people substitute other goods for this one. For example if tea and coffee both cost £1, but then the price tea fell too £0.50, people would stop buying coffee and demand for tea would rise.
Movement – There can be movements along the demand curve, these are caused by changes in the price. A fall in the price causes a movement down (to the right) the demand curve and so a rise in quantity demanded. Where as a rise in the price causes a movement up the demand curve and so a fall in quantity demanded. For example, in the diagram above a fall in the price from £4 to £3 will cause a movement down the demand curve resulting in a rise in quantity demanded from 18 units to 26 units.
Shifts:
The demand curve can experience a shift. This is where the entire demand curve moves (shifts) right or left. A rightward shift is referred to as an outward shift. And a leftward shift is referred to as an inward shift.
Causes of shifts:
Customer preference – A rise in customer preference for your product will cause a rightward shift in the demand curve.
Price of complements – complements are goods that are bought in conjunction with each other, a good example is fish and chips. A fall in the price of chips would increase demand for fish because the overall cost has fallen (outward shift).
Price of substitutes – Substitutes are goods that satisfy the same need, an example is tea and coffee. In this case a fall in the price of coffee will cause a fall in the demand for tea because people will substitute tea for coffee (inward shift in demand for tea).
Number of potential buyers – A rise in the number of potential buyers (the larger the population) will shift the demand curve right.
Weather – When the weather is nice demand for certain products such as ice cream will rise.
Income – the larger a person's income the more goods they can buy and so demand rises – positive correlation (for normal goods).
Expectations – A report predicting a rise in the price of a good will cause a sudden rise in demand as consumers will want to buy the good while it’s cheaper.
Rightward shift – As the demand curve shifts right there is a rise in the price level and a rise in the quantity demanded. This can be seen in the diagram below, as the demand curve shifts outwards from D1 to D2, the price level rises from P1 to P2 and the quantity traded increases from Q1 to Q2.
Leftward shift – As the demand curve shifts left there is a fall in the price level and a fall in the quantity demanded. This can be seen in the diagram above, but this time imagine the reverse. The demand curve shifts inwards from D2 to D1, this causes the price level to fall from P2 to P1 and the quantity traded to fall from Q2 to Q1.
Supply
Definition: The quantity of goods and services supplied by producers at any price over a given period of time.
The relationship between the price level and the quantity supplied is known as the supply curve. And as is seen in the diagram below the supply curve slopes upwards, that is too say that as the price rises from £3 to £4, quantity supplied increases from 40 to 50 (known as the law of supply). Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue.
Supply and time
With supply there is an issue of time. Consider the supply of ice creams. If a heat wave occurs over the weekend then there will be a rise in demand for ice cream. Producers can respond to this by working machines etc more intensely. However if climate change occurs, there may well be an all year round demand for ice cream. Suppliers will now have to change their equipment and production facilities in order to meet the new long-term levels of demand, but changing production facilities is a timely activity.
Movements – as was the case with the demand curve, changes in the price level will cause a movement along the supply curve. A rise in the price level from £1 to £2 will cause a movement up the supply curve resulting in a rise in the quantity supplied from 11 units too 28 units.
Shifts
The supply curve can also be the subject of a shift. As will become clear anything that alters costs will result in the supply curve shifting.
Causes:
Number of sellers – the more sellers of a good there are ceteris parabus the greater the quantity of the good that will be supplied at each and every price level – a rightward shift.
Technology - Technological advances increase efficiency which ceteris parabus causes a rightward shift in the supply curve.
Cost of production – As the price of inputs rise profit margins will fall and so ceteris parabus producers will reduce the amount of a good that they supply (a leftward shift).
Government – tax/subsidy. A rise in tax rates causes a rise in costs leading to a leftward shift in the supply curve. On the other hand a subsidy reduces the cost of production and so the supply curve shifts right.
A rightward shift – The supply curve shifts right from S1 to S3, given a £10 price level, quantity supplied increases from 50 to 70. Causes: technological advance, fall in costs, more suppliers.
A leftward shift - The supply curve shifts left from S1 to S2, given a £10 price level, quantity supplied falls from 50 to 30. Causes: rise in costs, fewer suppliers.
Equilibrium
Definition: A condition achieved when demand = supply resulting in the determination of the market price and quantity to be traded. At this point there is no tendency to change, the allocation of goods is at its most efficient.
In the diagram above the demand curve intersects the supply curve producing an equilibrium price of £0.35 with 250 being the quantity traded.
Disequilibrium – when demand does not equal supply, when this occurs the market will adjust. There are two forms of disequilibrium, excess supply and excess demand.
Excess supply – If the price is set too high, excess supply will be created within the economy. In the diagram below the price is £0.40, at this price level supply exceeds demand – excess supply. In this case there are goods that aren’t being bought, demand is simply not high enough. In order to sell the excess supply the price will have to fall, as this happens there is a movement down the demand curve (demand rises) and down the supply curve (supply falls). This will continue until equilibrium prevails, when demand = supply at a price of £0.35.
Excess demand – Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it. In the diagram below the price is £0.25, at this point demand exceed supply, there is an excess demand of 200. In this case there will be large queues with not everyone getting the products they desire. Suppliers will recognise this and understand the opportunity to increase profits through raising prices. As the price rises demand falls and supply rises (movements), the economy will continue to move until equilibrium prevails at a price level of £0.35.
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