3.

THE DEMAND CURVE

 Demand… is the amount of a good that will be bought at a given prices over a period
of time.
 Effective demand …. Is the amount of a good that people are willing to buy at given
prices over a given period of time supported by the ability to pay [ that is, how
much people can afford to buy and would actually buy ]
 Demand schedule …. Is a table of the quantity demanded of a good at different
price levels.
 Demand curve … is a line drawn on a graph that shows the quantity demanded at
different price levels.
The demand curve slopes down from left to right; for most goods this is
always the shape of the demand curve. Figure A
The demand curve shows that price and quantity demanded have an
inverse relationship. This means ; when price goes up, the quantity demanded falls
and when price goes down, the quantity demanded rises.

Movement along the demand curve

Where there is a price change, there is a movement along the demand curve.
Figure B

A shift in the demand curve

A change in any other factor, e.g. income, will be shown by a shift in the demand
curve.
Shift in the demand curve shows movement to the left or right of the entire
demand curve when there is a change in any factor affecting demand except the
price.
 If the quantity demanded rises at every given price by a change in any other factor,
the demand curve will shift to the right.
 If the quantity demanded falls, the demand curve will shift to the left.
Figure C
4. FACTORS THAT MAY SHIFT THE DEMAND CURVE
Price is the main factor that affect the quantity demanded.
However, there are many other factors that may shift the demand curve. The more
important factors are as follows;

Advertising
 Businesses try to influence demand for their products through the
advertising and other forms of promotion.
 If goods are advertised more heavily, the quantity demanded is likely to
increase.
 So, an increase in advertising expenditure is likely to shift the demand
curve to the right.

Income
 Disposable income is income that is available to someone over a period of time to
spend; it includes state benefits but excludes direct taxes. [ Disposable income =
Income - Direct taxes ]
 Generally, when disposable income rises, demand for goods will also rise.
 Normal goods are goods for which demand will increase if income increases or
fall if income falls. Most goods in the economy are normal goods.
 Inferior goods are goods for which demand will decrease if income increases or
rise if income falls. [ e.g. supermarket own label brand, public transport ] A
minority of goods are inferior goods. When consumers’ incomes rise , their
spending may switch to a more expensive brand.

Fashion and Tastes

 Over a period of time, demand patterns change because there are changes in
consumer tastes and fashion.
 When products become fashionable, this leads to an increase in demand for them,
whereas those that become unfashionable ( such as last season’s cloth) have a
reduced level of demand.
 Fashions and tastes may be influenced by social changes.

Price of Substitutes
 Substitute goods are goods bought as an alternative to another but perform the
same function.
 The price of substitutes will affect demand.
 If the price of a substitute were lowered, demand for a product would fall and the
demand curve will shift to the left. Vice- versa
 If a good has a lot of close substitute, then the prices of these will affect demand
significantly.
Price of Complements
 Complementary goods are goods purchased together because they are consumed
together. E.g. car and car insurance are in joint demand.
 Demand for these product is likely to be affected by the price of complementary
good.
 A rise in the price of one will lead a fall in demand for both.
 If the price of milk were to rise, the demand for cornflakes may fall.

Demographic Changes
 As the world’s population grows, there will be an increase in demand for goods
and services.
 Demand will also be affected by the structure of the population as well as its size;
demography affects demand.
 The age distribution of population is the numbers of people who fall into
different age groups. This will have an effect on demand patterns. [ As the
population ages, there will be more demand for goods such as retirement
homes, specialist holidays and health care.]
 The gender distribution of population [ In some countries, there are more
women than men in older age groups so the demand for women’s clothes
increases.]
 The geographical distribution [ In most countries, more and more people
live in urban areas so the demand for goods in urban areas will be higher than
in rural areas.]
 Ethnic groups in population structure [ If these groups grow in size, there
will be an increase in demand for products used by them.]
5. THE SUPPLY CURVE
 Supply is the amount of a good that sellers ( producers ) are willing to offer for
sales at different prices in a given period of time.
 Supply curve is a line drawn on a graph which shows how much of a good sellers
are willing to supply at different prices. This means that the relationship between
price and quantity supplied can be shown on graph.
 The supply curve slopes up from left to right, which means is there is a
proportionate relationship between price and quantity supplied. This shows that ;
 when prices go up, supply will go up
 when prices go down, supply will go down. Figure 1
 The reason for this relationship is mainly because businesses are motivated by
profits. If prices are rising, existing business will be willing to supply increasing
amount of a good because they may make more profit. Or, more businesses will
join the market in the belief that they can also make a profit.

Movement along the supply curve

Where there is a price change, there is movement along the supply curve. If there
are changes in any other factor influencing supply, the effect on the supply curve is
different. Figure 2

A Shift in the supply curve

A change in any other factor, such as production cost, will be shown by a shift in
the supply curve.
A shift in the supply curve shows movement to the left or right of the entire
supply curve when there is any change in the condition of supply except the
price.

 If the quantity supplied rises at every given price by a change in any other factor,
supply curve will shift to the right.
 Inversely, if the quantity supplied falls, the supply curve will shift to the left.
Figure 3
6 FACTORS THAT MAY SHIFT THE SUPPLY CURVE
 Costs of production

 The quantity supplied of any product is influenced by the costs of production,

such as wages, raw materials, energy, rent and machinery.
 Assuming the price is fixed, if production costs rise, sellers are likely to reduce
supply. This is because their profits will be reduced.
 A rise in costs will cause the supply curve to shift to the left because of causing
the quantity supplied to fall.
 If costs fall, the quantity supplied would increase because production becomes
more profitable. The supply curve will shift to the right. This shows that more
is supplied at every price.
 The availability of resources will also affect supply. If there is a shortage in
some of the factors of production- e.g. land, labour, capital – this will cause it to
be difficult for producers to supply the market because their costs are likely to
raise.
 Productivity is a rate at which goods are produced, and the amount produced in
relation to the work, time, and money needed to produce them.

 Indirect Taxes

 Indirect taxes are taxes on spending, such as value added tax (VAT) and duties
on petrol and cigarettes.
 When they are imposed or increased, the quantity supplied decreases and the
supply curve will shift to the left. This is because indirect taxes represent a
cost to firms.
 If indirect taxes are reduced, the supply curve will shift to the right because
costs are lower.
 Governments use indirect taxes to raise revenue for the government
expenditure, to discourage the consumption of harmful products such as
cigarettes and alcohol, and to protect the environment.

 Subsidies
 Subsidy or grant is money that is paid by a government or organization to
make prices lower, reduce the cost of producing goods or providing a service,
usually to encourage production of a certain good.
 If the government grants a subsidy on a good, the effect is to increase its supply
because subsidies help to reduce production costs. The supply curve will shift
to the right.
 Changes in Technology

 Over a period of time, new technology becomes available that many businesses
use in their production processes.
 New technology is more efficient and can therefore reduce the costs of
production. Firms are likely to offer more for sale. There will be a shift in
supply curve to the right.

 Natural Factors

 The production of some goods is influenced by natural factors, such as the

weather, natural disasters, the presence of pests or diseases.
 This is true of many agricultural products.
 For example, good growing conditions can help to improve crop yields, which
will increase supply. This will shift the supply curve to the right.
 Poor growing conditions can cause severe shortages and the quantity supplied
may be cut. This will shift the supply curve to the left.
 7. MARKET EQUILIBRIUM

The two market forces are demand and supply which determine prices in a market.
Figure 1
 In any market, the price is set where the wishes of consumers are matched exactly
with those of producers. This price, called the equilibrium price, is where supply
and demand are equal.
 The equilibrium price is also known as the market clearing price. This is because
the amount supplied in the market is completely bought up by consumers. There
are no buyers left without goods and there are no sellers left without unsold stock.
The market is cleared.
At equilibrium price,
Quantity demanded = Quantity supplied = Equilibrium Quantity

 Total revenue …. Is the amount of money generated from the sale of output.
Total revenue = Price x Quantity
TR = P x Q
Example
Price $ 5 10 15 20 25 30 35 40 45

Quantity 0 20 30 40 50 60 70 80 90
supplied
Quantity 85 80 75 70 65 60 55 40 45
demanded

 Shifts in Demand … A change in demand will affect equilibrium price.

 If demand increases, the demand curve will shift to the right. The
equilibrium price will rise because supply and demand are now equal at a
different point. The amount sold goes up.
 If demand were to fall, the demand curve will shift to the left. The price
will fall. [ Figure 2 ]
  Shifts in Supply … A change in supply will affect equilibrium price.
 If supply increases, the supply curve will shift to the right. The equilibrium
price will fall because supply and demand are now equal at a different
point. The amount sold goes up.
 If supply were to fall, the opposite would happen. [ figure 3 ]

 Shifts in Supply and Demand

It is possible for both demand and supply to change at the same time in a market.
There are three conditions ;
 Change in demand is greater than change in supply
 Change in demand is less than change in supply
 Change in demand is equal to change in supply
As a result, the price and quantity sold will change. [ Figure 4 ]

Excess Demand and Excess Supply

 Figure [ 5 ]
 Excess Demand … If the price charged in the market is below the equilibrium
price, supply and demand will not be equal. At this lower price, quantity
demanded is greater than quantity supplied and there is excess demand. There is
shortage of goods in the market.

Amount of Excess Demand = Quantity demanded – Quantity supplied

= the amount of Shortage at that price

 Excess Supply … If the price charged is set above the equilibrium price, supply
and demand are not equal. At this higher price, quantity supplied is greater than
quantity demanded and there is excess supply. This occurs surplus of goods in the
market because goods would remain unsold.

Amount of Excess Supply = Quantity supplied – Quantity demanded

= the amount of Surplus at that price
= the amount of unsold stock
 Removing Excess Supply and Excess Demand

 If there is disequilibrium in the market, producers can restore equilibrium by

changing the price or adjusting supply.
 If there is excess demand in the market, producers could raise the price.
 Excess demand exists when the price is lower the equilibrium price.
 If producers raise the price to equilibrium price, the market would clear since both
the quantity supplied and quantity demanded would be equal at this equilibrium
price.
 Alternatively, producers could employ more resources and increase supply to
equal demand. If this action were taken, equilibrium would be restored at a price
that is lower than original equilibrium price.

 If there is excess supply in the market, producers could lower the price.
 Excess supply exists when the price is higher the equilibrium.
 If producers lower the price to equilibrium price, the excess supply would be
removed since both the quantity supplied and quantity demanded would be equal
at equilibrium price.
 Alternatively, producers could store the excess supply and release it onto the
market at a later date. However, this might not be practical because storing goods
costs money and some stocks such as fresh food, need to be consumed quickly.
8. PRICE ELASTICITY OF DEMAND

 Price elasticity of demand …. means the responsiveness of demand to change in

price.
 For some goods, a price change will result in a larger change in the quantity
demanded and for others a smaller change. It all depend on the type of good.
 In Figure 1, two different curves are shown with different slopes representing two
different products; A and B.
 The demand curve for product A is steep and the demand curve for product B is
flatter.
 At a price of P1 , the quantity demanded for both products is Q1 .
 When the price falls to P2 , the quantity demanded increases by different amounts
for each product. Demand for product A only increase slightly to Qa units. But for
product B, demand increases a lot more, to Qb units.
 Demand for product B is more responsive to the price change.

 For product A,
 The price change resulted in a small change in demand. The change in demand
was not as big as the change in price.
 The product A has inelastic demand or the demand is price inelastic for product A.
 Inelastic demand or price inelastic …. means that a change in price result in a
proportionately smaller change in the quantity demanded.

 For product B,
 The price change resulted in a significant change in the quantity demanded. The
change in demand was greater than the change in price.
 The product B has elastic demand or that demand is price elastic.
 Elastic demand or price elastic …. means that change in price results in a greater
change in the quantity demanded.
 Percentage change in quantity demanded
Price elasticity of demand PED =
Percentage change in price

Change in quantity
% change in quantity demanded =
Original quantity

Change in price
% change in price =
Original price

1. PED > 1, demand is said to be elastic, a change in price will result in a greater
change in quantity demanded.
2. PED < 1, demand is said to be inelastic, a change in price will result in a smaller
change in quantity demanded.
3. PED = 1 or -1 , demand is unitary elastic, the responsiveness of demand is
proportionately equal to the change in price.
4. PED = ∞, demand is perfectly elastic, an increase in price will result in zero
demand.
5. PED = 0, demand is perfectly in elastic, a change in price will result in no change
in the quantity demanded.

Factors affecting price elasticity of demand

 Availability of Substitutes
 Goods that have lots of close substitutes will tend to have elastic demand.
This is because consumers can switch easily from one product to another.
[ if the price of strawberry jam rises, consumers can switch to other types of
jams ]
 In contrast, if there are few or no real substitutes for a product, demand will
be inelastic.
 Degree of Necessity
 Essential goods will have inelastic demand. This is because if the prices of
essentials rise [ food, fuel], consumers cannot reduce the amounts they
purchase significantly – they are necessities.
 In contrast, goods that are not essential – luxury products [ boats, sports car
and holidays ] will have more elastic demand.
  If a product is habit forming, it may become a necessity and therefore it will
have inelastic demand.

 Proportion of Income Spent on a Product

 If consumers spend a large proportion of their income on a product,
demand will be more elastic.
 Such items are one-off or infrequent purchases and so consumers may be
prepared to wait a few months to see if the price drops. So, price changes
in high value items result in significant changes in the quantity demanded.
 In contrast, demand for products that cost very little in relation to income
are more price inelastic. Often these lower price items are more of a
necessity.

 Time
 In the short term, goods have inelastic demand because it can often take
time to consumers to find substitutes when the price rises.
 In the long term, demand is more elastic because consumers can search for
alternatives and are more prepared to switch.

The Relationship Between PED and Total Revenue

When there is a price change, there will be a change in the quantity demanded and
therefore a change in total revenue.
The value of price elasticity shows whether revenue will rise or fall following a price
change.

Price Elasticity Value of Elasticity Price Change Effect on TR

Inelastic <1 Decrease Fall

Inelastic <1 Increase Rise
Elastic >1 Decrease Rise
Elastic >1 Increase Fall
Price Elasticity and Businesses
 Price elasticity can provide useful information for businesses.
 It can help firms predict the effect of a price change on total revenue.
 When a firm changes its price, there will be a change in the quantity demanded
and therefore a change in total revenue.
 It help to know what effect a particular price change might have on total revenue
 If demand for a product is elastic, a price reduction will increase total
revenue. E.g. many rail companies charge much-reduced prices for ‘off-
peak’ period. By lowering the price, more travellers are attracted and
revenue rises. Demand during the ‘off-peak’ period must be price elastic.

Price Elasticity and The Government

Indirect Taxes
 Governments often value-added raise revenue by imposing indirect taxes such
as value-added tax ( VAT) and excise duty on products.
 It is important for government to select products that have inelastic demand.
This is because consumers will avoid heavily taxed products if demand for them
is elastic.
 Therefore, governments target goods that are either necessities or have few
substitutes.
 However, most governments do not target goods, such as food and water, which
are essential to human survival.
 Popular targets for governments when imposing taxes are cigarettes, alcohol,
and petrol. Demand for these products is very price inelastic. [ excise duty ]

Subsidies
 Governments might also consider PED when granting a subsidy to producers.
 The effect of a subsidy is to move the supply curve to the right ( to increase
supply) .
 If the subsidy is designed to help the poor by making the good cheaper, it is
important that demand is price inelastic.
 If the demand is not price inelastic, an increase in supply will only reduce the
price slightly.
 Since demand for many food products is inelastic, a subsidy to farmers will help
to keep food prices lower.
 9. PRICE ELASTICITY OF SUPPLY

Factors Influencing PES

Generally, PES is influenced by whether producers can increase supply easily, or
not.
If producers can increase the quantity supplied easily, supply will tend to be
elastic.
If there are barriers that prevent producers from increasing the quantity
supplied, supply will be more inelastic.

1. Factors of production

 If producers have easy access to the factors of production such as labour, raw
materials, energy, tools and machinery, they will be able to boost production if
necessary.
 Supply will also be more elastic if production factors are mobile. If
production factors such as labour and raw materials can be switched to other
uses easily, supply will be elastic.
 However, if specialized resources are needed for production, such as skilled
labour, such resources are less mobile [ it may take time to train workers in
new skills ] and supply will be more inelastic.

2. Availability of stocks

 Producers that can hold stocks of goods can respond quickly to price change so
supply will be elastic.
 However, when it is impossible or expensive to hold stocks, supply will be
inelastic.
 For some perishable goods, such as fruits and vegetables, supply will be inelastic
because they cannot be stored for very long.

3. Spare Capacity

 If producers have spare capacity, supply will be more elastic. With spare
capacity, producers have ability to produce more with their resources.
 In contrast, if firms are running full capacity, supply will be inelastic. This is
because output cannot be increased in short notice.
 Given more time, even firms running at full capacity can increase supply.
This is because they can build a bigger factory or buy more machine.
 4. Time

 The speed with which producers can react to price change in the market can
affect PES.
 Generally, all producers can adjust output if they are given time. As a result,
the more time producers have to react to price changes, the more elastic
supply will be.
 Where it is not possible to increase supply quickly due to production
limitation, supply will be inelastic.

PES for Manufactured and Primary Products

 A number of factors can influence the speed at which producers can react.
 Goods that can be produced quickly are likely to have elastic supply.
 Modern manufacturers can be quite flexible and can adjust production levels at
short notice. E.g. a car engine manufacturer could increase production by raising the
rate of output in the factory. This might involve using overtime and keeping the
factory open for longer. More raw materials and components will be required but this
should not be a problem.
 For many primary products, such as agricultural goods, are not able to react
quickly to price change. E.g. a strawberry producer cannot increase supply until
more strawberries can be grown. This might not be possible until next year. As a
result, supply is inelastic.
 The supply of other primary goods, such as gold and diamonds, is likely to be
inelastic. This is because there are few sources around the world. The production of
such goods is also expensive and time consuming. As a result, supply is not very
responsive to price change. It is likely to be very inelastic.
 10. INCOME ELASTICITY

Income elasticity of demand measures the responsiveness of demand to change in

income.
Income elasticity = Percentage change in quantity demanded / percentage change
of demand in income

The value of YED or IED shows whether demand is income elastic or

income inelastic.
This also shows the nature of goods in relation to how demand changes in
response to change in income.
 Necessities
 Necessities are basic goods that consumers need to buy. [ food ,electricity,
water, petrol ]
 Demand for these types of goods will be income inelastic.
 The value is between + 1 and – 1 .
 Luxury Goods
 Luxuries are goods that consumers like to buy if they can afford them.
 This spending is called discretionary expenditure – this means that it is
optional, non-essential spending or spending that is not automatic.
 Demand for these goods is income elastic. [ air travel, satellite TV, designer
clothing, many goods and services in the leisure and tourism industry,
imported goods ]
 The value is greater than 1 or less than -1.
 Normal Goods
 For normal goods, where an increase in income results in an increase in
quantity demanded, the value of income elasticity will be positive.
 Inferior Goods
 For inferior goods, where an increase in income results in a decrease in
quantity demanded, the value of income elasticity will be negative.
 This shows that the quantity demanded and income have an inverse
relationship.

Income Elasticity and Businesses

 Many firms will be interested in income elasticity. This is because changes in

income in the economy may affect demand for their products.
 If firms know the income elasticity of demand for their products, they can respond to
predicted changes in income. [ income increase , recession period ]