The Theory of Demand

go back

Markets

• Where Buyers and Sellers meet in order to exchange money for goods
  • They do not always meet in person
• Goods can be bought by consumers and sold by suppliers in online markets, e.g., Amazon
• Amount of money a consumer pays the supplier in exchange for a good/service is called the price*
• There are markets for the factors of production
• Labour is needed by producers to make goods
• The producers are the buyers of labour and individual people are the sellers of their own labour

Product Markets

• Product markets deal with the buying/selling of goods and services
• Consumers represent the demand side of the market, while producers/firms represent the supply side
• Firms produce goods and services and sell them to households (consumers)

Factor Markets

• Deal in the buying and selling for factors of production or resources
  • E.g., labour market
• In a factor market, households sell their resources to firms
• Households represent the supply side of the market
• Firms represent the demand side

Markets can also be classified according to the intensity of competition in the market

Competitive Markets

• Large number of buyers and sellers
• Firms are price takers (no power over price), must take price established by market
• Very similar (homogenous) products
• Easy entry into market (no barriers to entry or exit)
• Price is determined by the interaction between buyers and sellers
• No individual buyer or seller can influence the market price
  • No market power

Imperfect Market

• Not competitive
• A.k.a. non-competitive market
• Small number of firms
• Product differentiation
• Firms are price setters, can set their own price
  • They have market power
• Entry into market is restricted (barriers to entry), makes it harder to have competition
• E.g. Mobile Phones, Water Corporation
• Monopoly, Oligopoly
  • Monopoly: One seller or producer is the sole supplier of a good/service in a market
  • Oligopoly: Small number of firms, none of which can keep the others from having significant influence. I.e., a few sellers/producers are the sole suppliers of a good/service in a market
• Firms try to make their products look “different” in their consumer’s eyes

Demand

• Amount of a good/service consumers are willing and able to buy in a given period of time at a given price, ceteris paribus
  • Ceteris paribus: other things remaining constant
• A.k.a. effective demand
• Law of Demand: Quantity demanded of a product is inversely related to its price, in a given period of time, ceteris paribus
• Individual Demand:**** Demand for a good or service by an individual consumer
• Market Demand: Sum of the individual demand for a good or service by all of the consumers in the market

Non-Price Factors affecting Ability and Willingness to buy

• Shifts demand curves left/right

1. Demographic Changes, e.g. size/composition of population
2. Changes in expectations about future price changes
3. Changes in Consumer’s Money income
4. Changes in Price/Demand of related goods
5. Changes in consumer tastes and preferences

Changes in Price/Demand of Related Goods

Substitutes

• Alternative product that can replace another because it satisfies the same want
• A.k.a. competitive demand
• If the price of one good changes, the demand for the substitute good will change in the same direction

Complements*

• Complementary products must be used at the same time with another to satisfy the same human wants
• A.k.a. joint demand
• Separate products, but are consumed at the same time
• If the price of one good changes, the demand for the complementary good will change in the opposite direction

Goods in Derived Demand*

• When a good is in derived demand, it is demanded for its contribution to the manufacture of another product
• Usually raw materials, e.g. wood
• For 2 goods in derived demand, a change in demand for the final good causes a similar change in demand for the resource used to produce it

Changes in Consumer’s Money Income

Normal Goods*

• A good is a normal good when demand for it increases in response to an increase in consumer income
• Demand for the good varies directly with income
• Most goods are normal goods
  • Luxury goods, necessities
• Increase in income leads to a rightward shift in the demand curve, and vice versa
• Purchasing power increases with income, therefore demand increases

*Inferior goods

• Goods where the demand falls as consumer income increases and vice versa
  • E.g., cheaper alternatives, like flying with JetStar instead of Singapore Airlines
• Demand for the good varies inversely with income
• As income increases, consumers switch to more expensive alternatives, so the demand for the inferior good falls
• Relative to wants
• Increase in income leads to a leftward shift in the demand curve, and vice versa
• When income changes, demand will change in the opposite direction

Changes in Consumer Tastes and Preferences

• The more desirable a good is to consumers, the higher the demand, and vice versa
• Tastes and preferences are affected by advertisements, pop star appeal, age, peers, etc
  • Advertisement campaigns

Demographic Changes

• Changes in size/composition of population
• E.g., Age, if you are old, you will buy less athletic goods

Changes in Expectations about Future Price Changes

• If the price is expected to increase, demand will increase, so they have more purchasing power before the increase in price
  • Demand curve shifts to the right
• Vice versa

Upward-Sloping Demand Curve

• Ostentatious goods
  • E.g., Luxury items, cars, watches
• Price is directly related to quantity demanded
• Higher price is perceived as higher quality, resulting in more being bought