factors affecting Demand and Supply

In economics, Demand refers to the quantity of a goods or services that consumers are willing and able to buy at a given price in a given time period. The law of demand stipulates that there is an inverse relationship between the price of a good and the quantity demanded, that is to say, if the price of, say, good X rises, it will decrease the quantity demanded of good X and the price of the good falls, this will bring an expansion of the quantity demanded.

The diagram below clearly explains the above statement:

A movement along a demand curve only occurs when there is a change in the price of the good in question. Some textbooks call these movements’ extensions and contractions. In the diagram below (Fig 1.1), when the price of CDs falls (from P1 to P2) there is a rise in demand (from Q1 to Q2), ceteris paribus. The movement along the curve is from point A to point B.

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When the price rises (from P1 to P3) there is a fall in demand (from Q1 to Q3), ceteris paribus.

The movement along the curve is from point A to point C.
Note that we must say 'ceteris paribus'. If one of the other determinants of demand changes as well, then the curve would shift.

A shift in the demand curve occurs if one of the 'other' (i.e. non-price) determinants of demand change. This means that for a given price level the quantity demanded will change. This is illustrated in the diagram below:

Fig 1.2

Note that the price has not changed (P1) and yet demand has increased (in the case of the shift to D2) to Q2. This could be due to a rise in real incomes (assuming the good is normal - see the required section in the 'Elasticities' topic), a rise in the price of a substitute good, a fall in the price of a complement, etc. (see 'determinants of demand' above). In the case of the shift to D3, demand has fallen even though the price has
remained constant.

It is fairly obvious so far that the price of a good is a pretty strong determinant of its demand, but there are many other things that will affect demand too. First of all, the disposable income is one of the factors causing a shift in the demand curve. The effect that income has on the amount of a product that consumers are willing and able to buy depends on the type of good we're talking about. For most goods, there is a positive (direct) relationship between a consumer's income and the amount of the good that one is willing and able to buy. In other words, for these goods when income rises the demand for the product will increase; when income falls, the demand for the product will decrease. The above is the case for normal goods. However, when there is an inverse relationship between one's income and the demand for that good, it is categorised as inferior good.

Another factor which is a determinant of demand is the price of related goods. As with income, the effect that the price of related good has on the amount that one is willing and able to buy depends on the type of good we're talking about. Think about two goods that are typically consumed together, for example, tea and milk (complements). If the price of milk goes up, the Law of Demand tells us that people will be willing/able to buy less milk. But if we want less milk, we will also want to use tea and therefore, an increase in the price of milk means we want to purchase less tea. We can thus summarize this by saying that when two goods are complements, there is an inverse relationship between the price of one good and the demand for the other good.

A person’s taste and preference is also one slightly obscure but very important determinant of demand. It could be noted that if a good becomes fashionable, this will boost up the demand. For example, if a celebrity endorses a new product (like Pepsi), this might increase the demand for the product. On the other hand, if a campaign crops up, stating that the product is nefarious to health, this would decrease the demand of the product.

An increase in the population of a country will be another determinant of demand of a product. More people will mean more demand for, say, bread. Nonetheless, it should be noted that a change in the structure of the population, (an ageing population), this will increase the demand for some goods but reduce the demand for others. For example, the quantity of medical shoes will increase in an ageing population.

Advertising is also likely to have a great impact on the demand of a product. Many of you probably doubt the effectiveness of some of the appalling adverts on the TV. We may assume that companies would not spend fortunes on advertising if they did not expect to see a significant rise in demand for the product in question. This can be clearly shown when supermarkets advertise their price drop-downs, through flyers, TV adverts, radio et al.

Some people always think of securing a better future. In so doing, if they expect the price of a good to rise in the future, they will more likely to demand for more of the product. For example, if we hear that Apple, the electronic giant, will soon introduce a new iPod that has more memory and longer battery life, people may decide to wait to buy an iPod until the new product comes out. This will surely decrease the demand for the current iPod as they will prefer the new ones.

On the other hand, just like with demand, where it only became effective if it was backed up with the ability to pay, supply is defined as the willingness and ability of producers to supply goods and services on to a market at a given price in a given period of time. In theory, at higher prices a larger quantity will generally be supplied than at lower prices, ceteris paribus, and at lower prices a smaller quantity will generally be supplied than at higher prices, ceteris paribus.

Diagram

A movement along a supply curve only occurs when the price changes, ceteris paribus. In other words, the price changes but the other non-price determinants remain constant. The diagram below shows that a price rise will cause an extension up the supply curve, from point A to point B, whilst a price fall will cause a contraction back down the supply curve, from point A to point C.

Supply curves shift, at all prices, if there is a change in one or more of the determinants of supply. If something happens that decreases a firm's costs regardless of the price level (e.g. improved technology or a subsidy from the government), then the firm's supply curve shifts to the right. The diagram below demonstrates these shifts:

Note that the price remains unchanged at P1; the shifts in the supply curve are caused by various changes in the determinants of supply.

As with the demand curve, there are many things that affect supply as well as the price of the good in question.

The most important factor determining the supply of a commodity is its price. As a general rule, price of a commodity and its supply are directly related. It means, as price increases, the quantity supplied of the given commodity also rises and vice-versa. It happens because at higher prices, there are greater chances of making profit. It induces the firm to offer more for sale in the market.

The price of other factors of other goods is one of the determinants of the supply. Increase in the prices of other goods makes them more profitable in comparison to the given commodity. For example if it is more profitable to produce LCD TVs then producers will produce more LCD TVs as compared to PLASMA TVs. Thus the supply curve for PLASMA TVs will shift inwards i.e. there will be a fall in supply. Another factor to determine supply is through Technology. Technological changes influence the supply of a commodity. Advanced and improved technology reduces the cost of production, which raises the profit margin. It induces the seller to increase the supply. However, technological degradation or complex and out-dated technology will increase the cost of production and it will lead to decrease in supply.

Govt., through taxation policies, is also a determinant of supply. Increase in taxes raises the cost of production and, thus, reduces the supply, due to lower profit margin. On the other hand, tax concessions and subsidies increase the supply as they make it more profitable for the firms to supply goods.