Law of Demand and Supply with Non-Price Determinants

When drawing a graph, include the following: Title, axis, units, label, coordinate For a normal good, the Law of Demand states that there is a negative correlation between price (P) and the quantity demanded (QD). As price rises, consumer’s willingness and ability to pay will fall, ceteris paribus (all other factors constant). This is due to the fact that more expensive goods have a greater impact on consumers' income reduction when purchased, leaving them with less disposable income. This can be expressed as a simple linear demand function: QD= A-BP. Reference to elasticity*2 A is the quantity demanded if the price was zero while b is the gradient (slope) of the curve. The value of A and B is different for different consumers and for different goods. Non-price determinants of demand are factors affecting it: ● Income- Demand for normal goods (e.g. automobiles, cinema tickets and restaurant meals) increases as income increases, this shifts the demand curve to the right; and falls as income falls which shifts the demand curve to the left. This principle is dependent on the income for a particular population: the relatively poor, given in increases in incomes, may view bicycles for transportation as a normal good, while the richer population would not ● Price of related goods (substitute goods or complementary goods)- Substitute goods are goods that can easily replace the other due to their similarities. (Fizzy drinks- coke and carbonated water) An increase in the price of one good may lead consumers to switch consumption to the substitute, i.e. the price of one good and the demand for a substitute have a positive relationship. Therefore, the demand of a particular good will increase when its substitute goods increase in price, shifting the demand curve to the right; and the demand of the same good will decrease when its substitute goods decrease in price, which would shift the demand curve to the left. Complementary goods are goods that are typically purchased and consumed together. (DVD and DVD players, cameras and memory cards) An increase in the price of one good will appear to the consumer as an increase in the price of enjoying the combined experience of both goods, as a result, the demand for the other good will decrease. Therefore, the demand of a particular complementary good will increase when the price of the other decreases, shifting the demand curve to the right; and the demand of the same good will decrease when the price of the other increases, which would shift the demand curve to the left ● Taste and preferences- Goods become more or less popular because of fashion, current events and word-of-mouth recommendations between consumers. ● Expectations of future prices and incomes- If consumers believe that the price of a good is likely to increase, they will be inclined to purchase more immediately; if they expect prices to decline soon, it is likely to cause consumers to defer their purchases until the product is cheaper. This means that an expectation of higher future prices will cause consumers to buy more now, shifting the demand curve to the right; and an expectation of lower prices will shift the demand curve to the left. In an economic climate of high growth, surging business investment, relatively low unemployment and steadily rising wages, consumers tend to consume more as they believe that their future incomes will increase. Whereas a recession creates an atmosphere of pessimism, discouraging consumption and resulting in a lack of consumer confidence. ● Market size and number of potential buyers- All businesses hope to market their good to the greatest number of potential buyers as possible. New markets or large market sizes mean more potential buyers which increases potential demand and a shift to the right of the demand curve for their goods. Correspondingly, a decrease in the potential number of buyers shrinks demand. ● Changes in the price of a good or a service causes a movement along the demand curve: an expansion when the QD increases or a contraction when the QD decreases. When there is a change in the determinants (factors) of demand other than price, there is a horizontal shift of the demand curve. For a normal good, the Law of Supply states that there is a positive correlation between the quantity supplied (QS) and the price. As price rises, the producers are more willing and able to produce, ceteris paribus. This is because they are encouraged by the ludicrous profits which will cover up the costs of production more easily. This can be expressed as a simple linear supply function: QS= C+DP. C is the quantity supplied if price was zero while D is the gradient of the curve. The value of C and D is different for different suppliers and for different goods. Non-price determinants of supply are factors affecting it: Individual consumers have basic needs and wants, but our income is finite and scarce so we have to make choices as to what goods and services we spend our income on. Opportunity cost is the next best alternative foregone, therefore whenever we make a choice; it comes with an opportunity cost.