This article defines a market and demand. It shows The Demand Curve and explains the inverse relationship between price and demand by showing the effects of price changes on demand.
Also, it visualizes shifts in The Demand Curve both inwards and outwards. In addition, it analyses the factors which cause an increase or decrease in demand, and applies them to real world examples.
What is a market?
A market is the place or situation where buyers and sellers meet to exchange products – goods and service. This exchange occurs because buyers demand certain goods and sellers supply them.
What is demand?
Demand refers to the quantity of goods or services that people are willing and able to buy over a period of time on a market at a given price.
Let’s suppose that you did some preliminary research into the local New York economy and discovered that 15 million bottles of Pepsi Cola were bought for USD$2. You could use that to express demand in the local economy. In economic terms ‘the annual demand for Pepsi Cola at USD$2 in New York, USA is 15 million units’.
When concerned with the level of demand in an economy, the effects of a price change is important.
The Demand Curve
Let’s take a look how the demand for Pepsi Cola changes depending on the price.
The price of Pepsi Cola (in USD$):
USD$1
USD$2
USD$3
USD$4
USD$5
Demand for Pepsi Cola (in units):
100,000,000
80,000,000
60,000,000
40,000,000
20,000,000
In principle, when the price of a good is low, it means that more people are interested in buying that product. Alternatively, when the price of a good is high, it means that less people are interested in buying that product with many people simply being unable to afford it at a higher price.
This inverse relationship produces the downward sloping Demand Curve as seen above on the chart representing a typical Demand Curve.
SCENARIO 1: Movement along The Demand Curve outwards
When the price changes on The Price & Quantity Graph, the change is described as a ‘movement along the curve’.
If people can afford a good, they are ‘able’ to buy a good. And, if they can accept the price of a good, they are ‘willing’ to buy. It is necessary for a consumer to be willing and able to buy, if they are to be considered to ‘demand’ a good.
As the price of Pepsi Cola decreases (↓), the quantity of Pepsi Cola demanded increases (↑). Demand for products increases, if a product becomes cheaper.
This ‘movement along the curve’ happens because more people will have the interest and ability to purchase the good or service.
SCENARIO 2: Movement along The Demand Curve inwards
When the price changes on The Price & Quantity Graph, the change is described as a ‘movement along the curve’.
If people cannot afford a good, they are ‘not able’ to buy a good. And, if they cannot accept the price of a good, they are ‘not willing’ to buy. It is necessary for a consumer to be willing and able to buy, if they are to be considered to ‘demand’ a good.
As the price of Pepsi Cola increases (↑), the quantity of Pepsi Cola demanded decreases (↓). Demand for products decreases, if a product becomes more expensive.
This ‘movement along the curve’ happens because less people will have the interest and ability to purchase the product or service.
Shifts of The Demand Curve
A shift in The Demand Curve refers to the situation when the whole curve moves to the left or to the right.
A shift of the curve often happens for reasons other than price changes. An outward shift means that a product will be in higher demand at the same price. Alternatively, an inward shift of the curve represents a fall in demand at the same price.
SCENARIO 1: Shift of The Demand Curve to the right
A shift to the right, or an outward shift of The Demand Curve, is when a greater quantity of Pepsi Cola is demanded at any given price.
SCENARIO 2: Shift of The Demand Curve to the left
Conversely, a shift to the left, or an inward shift of The Demand Curve, is when a lower quantity of Pepsi Cola is demanded at any given price.
What causes a shift of The Demand Curve?
These ‘shifts’ of The Demand Curve are caused by various economic factors listed over the page.
1. Changes in income. If income rises, then demand for most goods also rises. In Economics, these are called ‘normal goods’. For example, as income grows, car ownership becomes more important and possible. However as income rises, some products decrease in demand. In Economics, these are called ‘inferior goods’. This could be the result of buying better quality goods instead of their cheaper alternatives. For example, buying Heineken beer instead of Snow beer.
2. Price of other substitute goods and complementary goods. The changing price of competition (substitution goods) and goods which are used together (complementary goods) are also factors that can affect the demand of a product.
A: SUBSTITUTE GOODS: Changes in demand can occur due to changes in the price of substitute products. A substitute is a brand or product that gives the consumer the same benefits as another, and can therefore be used in its place. For example, the price of pork increased in China during 2008, so the demand for beef and other meats increased. Here, the increasing price of pork would cause a movement along the curve in the market for pork becuase the price has changed. However in the market for beef, there will be a shift to the right as more people demand beef because pork is more expensive.
B: COMPLEMENTARY GOODS: Demand for a product can alter, if the price of a complementary product changes. A complementary product is used with another, and the purchase of one encouraging consumer to buy another. For example, a hat and a scarf, a bike and a helmet, a shirt and a tie or a movie and popcorn, DVD discs and DVD players, etc. Therefore, if the price of entry into a cinema increases, then demand for popcorn would decrease. Another example, if the price of bikes decreases, more people will buy bikes. In this case, consumers are more likely to buy safety helmets too.
3. Advertising. One major impact on demand is advertising in all types of media (TV, radio, the Internet, newspapers, magazines, etc.). An effective advertising campaign that truly captivates the target audience will receive a rise in demand. This is why Volkswagen could bring life and success to the Skoda brand name. Skoda was a very unpopular brand in Europe before Volkswagen purchased the company. Successful advertising has also led to the creation of global brands such as McDonald’s, Coca Cola and Nike. Successful advertising will cause a demand shift to the right as more people will demand the product at a certain price.
4. Availability of cheap credit. Credit is time allowed for payment for goods or services obtained on trust.The easier it is to borrow, the more goods and services consumers will buy. Credit cards and bank loans increase consumer spending by giving people more spending power. Of course, the level of ‘interest’ for borrowings is a factor too. The higher the interest rates, the more extra money you must pay back, therefore the less you are likely to borrow. An increase in the availability of credit will cause an increase in demand leading to an outward shift of The Demand Curve, and vice versa.
5. Expectations of future price changes. If consumers believe that the price of a product is going to decrease, they will wait for a while for the price to change. For example, in the UK, it is becoming more common for those people who are anticipating the January sales (a time of lower prices) to buy less during the Christmas shopping period. This will lead to a demand shift to the left. The reverse is true, buying a house in China is becoming more and more expensive. This encourages people to want to buy now, causing The Demand Curve for housing to shift to the right. This idea can also be applied to include expected changes in TAX rates for different products. If you know that petrol TAX will increase, you will try to keep the tank of your car full. Another example can be confidence about unemployment and the level of job security. If the economy is performing poorly and people are losing jobs, then, demand for luxuries will decrease as people save more for difficult times ahead.
6. Changes in population. Population changes can affect demand in many ways. A ‘baby boom’ causes demand to increase for food, but also for random baby products. On the other hand, an ageing population causes increase in demand for healthcare, drugs, elderly holidays and other related products. However, it will also see the reduction in demand throughout youth markets.
7. Market failures. Governments seeking to correct or avoid market failure (inefficient economies) can introduce laws to alter demand of products:
• Firstly, by banning smoking in enclosed public areas. For example, the UK government has reduced demand for cigarettes and other smoking products because people have less opportunities to smoke anywhere they want.
• Secondly, many governments have made it compulsory to attend school until a certain age (in the UK from 4 to 16). This increases the demand for education and complementary products such as uniforms, books, pens, after-school activities, etc.
8. Fashion and other factors. Tastes change all the time – from year to year and from generation to generation. Changes in technology and seasonal changes are also factors that affect demand regardless of price cusing shifts of The Demand Curve to the left and to the right. Examples of these include increased demand when Apple introduces a new product or consumers demand more ice-cream during the summer months.
Summary
Demand for products refers to how many products will be demanded at any given price level. As you can see, there are many ways which the demand for a product or service can be affected including price, income and other products in the market.
When demand changes because of price, it causes a ‘movement along the curve’ on The Price & Quantity Graph. When demand changes because of other factors, it causes ‘shifts’ of The Demand Curve to the right or to the left.
