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2.1.1. The Interaction of Demand and Supply - Coggle Diagram
2.1.1. The Interaction of Demand and Supply
Theory of demand
The law of demand
Demand
is defined as the quantity of a good that consumers are willing and able to purchase in a given time period at every price level, ceteris paribus
The law of demand
states that when the price of a good rises, its quantity demanded will fall and vice-versa, ceteris paribus. There is an inverse relationship between price and quantity demanded
In other words, the law of demand states that demand curve dy/dx < 0
Law of Diminishing Marginal Utility (LDMU)
LMDU
states that beyond a certain point of consumption, as more and more units of a good or service are consumed, the additional utility a consumer derives from successive units decreases
Market demand curve
The
market demand curve
is the horizontal summation of all the individual buyer's demand curves for the good at each and every price
In other words, the value on the vertical axis (price) remains constant while the corresponding value on all the horizontal axis (quantity) are added together.
The larger the population, the greater the demand for good at each and every price
Movement along the demand curve
is dependent on
price determinants
=> change in
quantity demanded
A
change in own price
of the good will result in a change in its quantity demanded, ceteris paribus. This is illustrated by
movement along
the demand curve
Shift in the demand curve
is depended on
non-price determinants
=> change in
demand
A change in
factors other than the own price
of the good (non-price determinants) will result in a change in demand of the good, ceteris paribus. This is illustrated by a shift of the demand curve
Non-price determinants of demand
Tastes and preferences
Tastes and preferences are
influenced favourably/unfavourably by reasons such as advertising, changes in product quality and/or fashion trends/fads
, causing
increase/decrease
in demand
Level of income
(associated with economic growth)
Normal goods
As people's
incomes rise
, their
purchasing power increases
and their
demand will rise
Necessities:
an
increase in income
will lead to a
less than proportionate increase in demand for such goods
(income inelastic), ceteris paribus
Luxury goods:
and
increase in income
will lead to a
more than proportionate increase in demand
for luxury goods (income elastic), ceteris paribus
Inferior goods
As people are
richer
, they
spend less and reduce their demand for inferior goods
and
switch to better quality goods
Price of related goods
Price of substitute goods
Substitutes
are goods which are considered to be
alternatives
to each other and are said to be in
competitive demand
When goods are substitutes to each other, and
increase in price of one good will decrease quantity demanded of the good and thus increase the demand for the other
, ceteris paribus
Price of complementary goods
Complements
are defined as goods that
when consumed together, gives rise to a higher combined utility than if the goods were consumed individually
by the consumer. Complements are said to be in
joint demand
When goods are complements to each other,
an increase in price of one good will decrease quantity demanded of the good and thus decrease demand for the other good
, ceteris paribus
Demand for final good or service
Derived demand
describes the demand for goods which are
not demanded for its own sake
but is
used to facilitate the production of another
A
change in demand for a good will affect the derived demand for its factor of production
. When
demand for a good increases, the demand for the factor of production increases as well
, ceteris paribus
Ease of acquiring credit
Consumers often
borrow
to
finance the purchase of big-ticket items
.
Easier credit condition
(e.g. lower interest rates) would
encourage borrowing for consumption, causing increase in demand for good or service
, ceteris paribus
Government policies
Government policies can affect the demand for goods and services.
Population
A
rise in population size
leads to an
increase in the demand for all goods and services
(assuming per capita income, which is average income available for every person, remains unchanged)
Changes in
population structure
also affects demand patterns
Expectations of future prices
If the
price of a good is expected to increase
in the future, buyers may decide to
bring forward their purchase
and
buy more of the good before the price actually increases
, thereby
increasing the current demand
for the good, vice-versa, ceteris paribus
Such speculation often
exacerbates any price fluctuations and volatility
present in a market, and is
commonly witnessed in asset markets and commodity markets
Exchange rates
Exchange rates are defined as the
rate
at which a
country's currency can be exchanged for another currency
An
appreciation
/strengthening of
domestic currency
makes
imported substitutes relatively cheaper
, causing consumers to
switch from locally produced good to imported goods
, thus there is a
decrease in demand for locally produced goods
, vice-versa, ceteris paribus