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Topic 2.2
Demand
This topic covers demand for goods and services by consumers, and the ways that demand changes to influence consumer and producer action. This topic also covers price elasticity of demand.
What is Demand?
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Demand is the willingness and ability of a consumer to buy a good or service at a given price and a given time period.
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There is only effective demand when the consumer wants to, and is able to buy the product. Demand can also be derived, meaning that it is the consequence of the demand for another product - e.g. the demand for baristas increases if the demand for coffee increases.
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On the right is a demand curve, which is downward sloping, due to the Law of Demand, which states that the quantity demanded (Qd) for a product varies inversely with the price - as price falls Qd increases as consumers have more disposable income to buy more of that product.
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Individual demand is demand by a single consumer, while market demand is the total sum of the individual demands
Changes to the Demand Curve
Movements along the demand curve
[Diagram Placeholder: Movements]
Shifts of the demand curve
[Diagram Placeholder: Shifts]
A change in price leads to a movement along the existing demand curve. When price rises, demand contracts, resulting in a lower quantity demanded and reduced revenue. When price falls, demand expands, increasing the quantity demanded and raising revenue. This relationship is explained by the Law of Demand.
Movements are only caused by changes in price.
A demand curve can only shift due to certain non-price factors (listed below). It will either result in a shift to the right in demand which is an increase in demand (from D1 to D3 on the above diagram) or a shift to the left which is a fall in demand (from D1 to D2).
Note: when drawing the first new demand curve, label it D2.
Shifts of the demand curve: non-price factors
A shift in the demand curve is always caused by a non-price factor, and they are listed below
Income - if income increases then consumers have more disposable income to spend on the product so demand shifts right
Marketing - marketing creates positive publicity which increases demand - if something happens that creates negative publicity then demand will shift left
Tastes and fashion changes - e.g. a new iPhone model would decrease the demand for the old model
Economic situation of countries - A good economic situation leads to higher income, and vice versa, which affects demand
Price expectations - If people think that prices are going to rise demand will increase so that they can save money before the price rise
Population - increase in size leads to right shift.
Substitutes - products that can be used interchangeably e.g. Pepsi and Coke - if the demand for one increases the demand for the other decreases
Complements - products that complement each other e.g. phones and chargers - if the demand for one increases the demand for the other does so too
More on Substitutes:
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Increased price of the first good (Pepsi) leads to more customers switching to the substitute good in order to save money.
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As a result, demand for Coca-Cola shifts to the right, creating a higher equilibrium price and quantity, which increases Coca-Cola’s revenue.
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At the same time, Pepsi experiences a contraction in demand, so its revenue decreases.
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Conversely, when demand for Pepsi shifts to the right, more customers choose Pepsi.
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This indicates that some consumers have switched from Coca-Cola to Pepsi, causing Coca-Cola’s demand to shift to the left.
Price Elasticity of Demand
PED is the responsiveness of quantity demanded to change following a change in price.
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Note: Due to the law of demand, PED values are always negative. This means that once you have your calculation, you need to add the negative sign.
Formula
Inelastic and Elastic Demand
Inelastic demand
Elastic demand
Inelastic demand is when the percentage change in quantity demanded is lower than the percentage change in price. Inelastic demand is always between 0 and -1.
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Essentially, when price changes by a lot, there is a small change in quantity
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Inelastic demand is generally better from a firm's perspective, because they can increase prices without losing much quantity demanded, so they can make more revenue
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This makes inelastic demand worse from a consumer's perspective
Inelastic
Perfectly Inelastic
Elastic
Elastic demand is when the percentage change in QD is greater than the percentage change in price. Elastic demand is always lower than -1.
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When price changes by a little, there is a large change in QD.
Perfectly Elastic
Determinants of PED - "SPLAT"
S
Substitutes
More substitutes means more competition so demand is elastic, as if price rises, people will switch to the substitutes
P
Proportion of Income
If a good's price takes up a large proportion of income (e.g. car) then demand is elastic because if prices rise then people will likely choose to not buy it
L
Luxury / Necessity
Something that it a necessity will have inelastic demand as it is needed so is prices rise people continue buying it (and vice versa for luxury goods)
A
Addictiveness
A good that is addictive will have inelastic demand: people will continue purchasing it even if the price is high
T
Time
Goods are more elastic over a time period, because consumers have time to find different options, and other substitutes enter the market
Evaluating the importance of PED to producers
Points
Evaluations
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Maximising Revenue - Allows them to know how to maximise revenue by increasing or decreasing price. If it is inelastic, increase prices as consumers will still buy it, but decrease if it is elastic. This means they can earn more revenue. This means they have more money to invest back into the business, this means that they can improve the productivity of the production process by buying new tech, for example. This is economically sustainable
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Price discrimination - Allows them to price discriminate. This means that they offer different prices for the same good/service to different consumers. This allows them to increase their revenue. This means that their profit will increase due to economies of scale, so the cost of producing one good/service decreases. This is economically sustainable
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Market share - they may choose to maximise market share rather than maximising revenue, through measures such as innovation, discounts or improving customer relations. This means that they can increase their presence in the industry. This means that they can compete more effectively - forward thinking firms
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Negative Publicity - Price discrimination could lead to negative publicity as consumers aren’t happy that they are being charged different prices for the same good. This will lead to a shift to the left of demand. This will lead to excess supply, leading to a decrease in prices. This will lead to less revenue.
Evaluating the importance of PED to consumers
Points
Evaluations
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Availability of substitutes - PED might be important because if they know it then they can work out the availability of substitutes. If PED is elastic then they know that there are substitutes in the market so they can look for them earlier to prepare for a price change.
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Budget Management - PED helps consumers understand how producers may change prices and how government taxes may affect the final price of goods. Governments tend to tax inelastic goods because demand does not fall much, which allows them to collect more tax revenue; this is why PED matters to consumers
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PED might not matter if prices are low because price is more important. Also, if there is high brand loyalty, then they will not want to switch to substitutes
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Impossible to Calculate - PED is impossible for consumers to calculate as they don't have the data so it does not matter to them as they cannot use it properly to make decisions
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Key Tip: Learn these tables by heart, as this is a frequently asked 6-mark essay question.