| Chapter 3 Outline | ||
| I. DEMAND AND SUPPLY ANALYSIS | ||
| A. General Definitions and Comments | ||
| 1. The law of demand states that consumers will purchase more of a good at lower prices and less of a good at higher prices. | ||
| 2. The law of supply states that producers will sell less of a good at lower prices and more of a good at higher prices. | ||
| 3. Equilibrium exits when there is no reason for a situation to change. | ||
| a. When equilibrium exits, the quantity people plan to buy is equal to the quantity that producers plan to sell. | ||
| b. The laws of demand and supply cause the market to move to equilibrium. | ||
| B. Other Demand Factors | ||
| 1. Changes in demand factors other than price of the good will result in achange in demand. | ||
| a. An increase in demand is depicted as a rightward shift of the demand curve. | ||
| b. An increase in demand means that consumers plan to purchase more of the good at each possible price. | ||
| c. A decrease in demand is depicted as a leftward shift of the demand curve | ||
| d. A decrease in demand means that consumers plan to purchase less of the good at each possible price. | ||
| 2. The price of related goods is one of the other factors affecting demand. | ||
| a. Related goods are classified as either substitutes or complements. | ||
| 1. Substitutes are goods that satisfy a similar need or desire. | ||
| a. An increase in the price of a good will increase demand for its substitute, while a decrease in the price of a good will decrease demand for its substitute. | ||
| 2. Complements are goods that are used jointly. | ||
| a. An increase in the price of a good will decrease demand for its complement while a decrease in the price of a good will increase demand for its complement. | ||
| 3. Income is another factor that can affect demand. | ||
| a. If a good is a normal good, increases in income will result in an increase in demand while decreases in income will decrease demand. | ||
| b. If a good is an inferior good, increases in income will result in a decreasein demand while decreases in income will increase demand. | ||
| C. Other Supply Factors | ||
| 1. Changes in other supply factors will result in a change in supply. | ||
| a. An increase in supply is depicted as a rightward shift of the supply curve. | ||
| b. An increase in supply means that producers plan to sell more of the good at each possible price. | ||
| c. A decrease in supply is depicted as a leftward shift of the supply curve. | ||
| d. A decrease in supply means that producers plan to sell less of the good at each possible price. | ||
| 2. Other factors affecting supply include technology, the prices of inputs, and the prices of alternative goods that could be produced. | ||
| a. An advance in technology, a decrease in the prices of inputs, or a decrease in the prices of alternative goods that could be produced will result in an increase in supply. | ||
| b. A deterioration of technology, an increase in the prices of inputs, or an increase in the prices of alternative goods that could be produced will result in a decrease in supply. |
Consumer demand and income
Consumer income (Y) is a key determinant of consumer demand (Qd). The relationship between income and demand can be both direct and inverse.
Normal goods
In the case of normal goods, income and demand are directly related, meaning that an increase in income will cause demand to rise and a decrease in income causes demand to fall. For example, for most people, consumer durables, technology products and leisure services are normal goods.
Inferior goods
In the case of inferior goods income and demand are inversely related, which means that an increase in income leads to a decrease in demand and a decrease in income leads to an increase in demand. For example, necessities like bread and rice are often inferior goods.
It should be noted that ‘normal’ and ‘inferior’ are purely relative concepts. Any good or service could be an inferior one under certain circumstances. Even luxury goods can become inferior over time. Video players were once luxuries, but as incomes rose consumers switched to DVDs. Of course, DVD’s have been replaced by digital downloads, on-demand TV, and streaming services like Netflix.
Engel curves
Engel Curves, named after 19th Century German statistician Ernst Engel, illustrate the relationship between consumer demand and household income.
Engel curves for normal goods slope upwards – the flatter the slope the more luxurious the good, and the greater the income elasticity. In contrast, Engel curves for inferior goods have a negative slope.
Demand for the three goods, shown here, all respond very differently to the same change in income, Y to Y1. Demand for the normal good increases from Q to Q1, demand for the luxury good rises much more, to Q2, and demand for the inferior good falls from Q to Q3.
See also:
Indifference curves and normal goods