Determinants of demand

     Many factors can affect demand for a specificproduct or service. Among these factors are changes in population, changes in income, changes in people’s tastes and preferences, the availability and price of substitutes, and the price of complementary goods.

      Changes in Population   When population increases, opportunities to buy and sell increase. Naturally, the demand for most products then increases. This means that the demand curve for, say, flat-screen televisions, shifts to the right. At each price, more flatscreen televisions will be demanded simply because the consumer population increases.

     In contrast, if population decreases, overall demand for products also decreases. At each price, fewer flatscreen televisions will be demanded. When this happens, the demand curve shifts to the left.

     Changes in Income The demand for most goods and services depends on income. Your demand for DVDs would certainly decrease if your income dropped

in half and you expected it to stay there. You would buy fewer DVDs at all  possible prices.

    Changes in Tastes and Preferences   One of the key factors that determine demand is people’s tastes and preferences. Tastes and preferences refer to what

people like and prefer to choose. When a product becomes a fad, more of the products are demanded and sold at every possible price. The demand curve then

shifts to the right.

     Substitutes As you’ve learned, substitutes are goods used in place of one another. The availability and price of substitutes also affect demand. For example,

people often think of butter and margarine as substitutes. Suppose that the price of butter remains the same and the price of margarine falls. People will then buy more margarine and less butter at all prices of butter.

    Complementary Goods Complements are products that are generally bought and sold together. Digital cameras and flash memory, for example, are complementary goods. When two goods are complementary, the decrease in the price of one will increase the demand for it as well as its complementary good. If the price of digital cameras drops, for example, people will probably buy more of them. They will also probably buy more flash memory to use with the cameras. Therefore, a decrease in the price of digital cameras leads to an increase in the demand for flash memory. As a result, the demand curve for flash memory will shift to the right. The opposite would happen if the price of digital cameras  increased. In this case, the demand for the complement, flash memory, would decrease, and the demand curve would shift to the left.

 

PRICE ELASTICITY OF DEMAND

    The law of demand is straightforward: The higher the price charged, the lower the quantity demanded—and vice versa. If you sold DVDs, how could you use this information? You know that if you lower prices, consumers will buy more DVDs. By how much should you lower the price, however? You cannot really answer this question unless you know how responsive consumers will be to a decrease in the price of DVDs. Economists call this price responsiveness elasticity. The measure

of the price elasticity of demandis how much consumers respond to a given change in price.

     Elastic Demand For some goods, a rise or fall in price greatly affects the amount people are willing to buy. The demand for these goods is considered elastic —consumers can be flexible about buying or not buying these items. For example, specific brands of coffee probably have a very elastic demand. Consumers consider the many competing brands of coffee to be almost the same. A small rise in the price of one brand will probably cause many consumers to purchase the cheaper substitute brands instead.

   Another example of goods that are generally considered to have elastic demand are luxury items. Luxury items are things people might want but do not really need to survive. Expensive cars, high-end electronic items, and exotic vacations are all examples of luxury items. Some foods, especially expensive foods such as steak and lobster, are also considered luxury items. Because people do not need these things to survive, the demand for them is usually elastic.

    Inelastic Demand If a price change does not result in a substantial change in the quantity demanded, then demand for that particular good is considered inelastic. This means that consumers are usually not flexible with these items and will purchase some of the items no matter what they cost. In general, goods that are considered necessities, such as staple foods, spices like salt and pepper, and certain types of medicine, normally have inelastic demand.

 

The Supply Curve

     Remember that economists show the relationship between price and quantity demanded by using a demand schedule and a demand curve. Similarly, we can use special tables and graphs to illustrate the law of supply visually. Note that the bottom (horizontal) axis shows the quantity supplied, and the side (vertical) axis shows the price per good. The supply curve slopes upward from left to right.

   You can compare the supply curve to the demand curve.  In doing so, you will see that the two curves are similar. The main difference between them is that in looking at the supply curve, you can see that the relationship between price and quantity supplied is direct—or moving in the same direction. In the case of the demand curve, the opposite is true—the relationship between price and quantity demanded is inverse. Because of this key point, the slopes of the two curves will always be different.

Equilibrium Price

        In the real world, demand and supply operate together. As the price of a good goes down, the quantity demanded rises and the quantity supplied falls. As the price goes up, the quantity demanded falls and the quantity supplied rises.

     Is there a price at which the quantity demanded and the quantity supplied meet? Yes. This level is called the equilibrium price. At this price, the quantity supplied by sellers is the same as the quantity demanded by buyers. One way to visualize equilibrium price is to put the supply and demand curves on one graph.   Where the two curves intersect is the equilibrium price.

   What happens when there is an increase in the demand for a good? This will cause the entire demand curve to shift outward to the right. What about changes in supply?  Assume that there is a major breakthrough in the technology of producing goods. The supply curve also  shifts outward to the right. The new equilibrium price will fall, and both the quantity supplied and the quantity demandedwill increase.

      In countries with mainly free-enterprise systems prices serve as signals to producers and consumers. Rising prices signal producers to produce more and consumers to purchase less. Falling prices signal producers to produce less and consumers to purchase more.

  A shortageoccurs when, at the current price, the quantity demanded is greater than the quantity supplied. If the market is left alone—without government regulations or other restrictions—shortages put pressure on prices to rise. At a higher price, consumers reduce their purchases, whereas suppliers increase the quantity they supply.

    At prices above the equilibrium price, suppliers produce more than consumers want to purchase in the marketplace. Suppliers end up with surpluses—large, undesired inventories of goods—and this and other forces put pressure on the price to drop to the equilibrium price. If the price falls, suppliers have less incentive to supply as much as before, whereas consumers begin to purchase a greater quantity. The decrease in price toward the equilibrium price, therefore, eliminates the surplus.

Types of Monopolies

    Pure monopolies can be separated into four categories depending on why the monopoly exists. The four types of monopolies are natural, geographic, technological, and government.

    First, we have natural monopolies, where the government grants exclusive rights to companies that provide things like utilities, bus service, and cable TV. The justification for natural monopolies is that a larger firm can often use its factors of production more efficiently. The large size, or scale, of most natural monopolies gives them economies of scale—by which they can produce large amounts of their good or service at a relatively low cost.

    A geographic monopoly is another kind of monopoly. A country store in a rural setting is an example of this. Because the setting of the business is isolated and the potential for profits is so small, other businesses choose not to enter the market.

   If you invent something, you are capable of having a technological monopoly over your invention. A government patentgives you the exclusive right to manufacture, rent, or sell your invention for a specified number of years—usually 20. Similarly, a United States copyrightprotects art, literature, song lyrics, and

other creative works for the life of the author plus 70 years.

   Finally, we have government monopolies. A government monopoly is similar to a natural monopoly, except the monopoly is held by the government itself. The construction and maintenance of roads and bridges, for example, are the responsibility of local, state, and national governments, who contract this work out to companies. In the United States, the postal service is a common example of a government monopoly.