The Allocation of Resources - Demand

This section focuses on understanding how changes in the determinants of demand lead to shifts in the demand curve. We will explore how to interpret diagrams illustrating these shifts and their impact on equilibrium price and quantity.

Factors Affecting Demand

Several factors can influence the quantity of a good or service that consumers are willing and able to purchase at a given price. These factors cause the entire demand curve to shift.

• Income:
  • Normal Goods: As income increases, demand increases. (Demand Curve Shifts Right)
  • Inferior Goods: As income increases, demand decreases. (Demand Curve Shifts Left)
• Prices of Related Goods:
  • Substitute Goods: If the price of a substitute good increases, demand for the original good increases. (Demand Curve Shifts Right)
  • Complementary Goods: If the price of a complementary good increases, demand for the original good decreases. (Demand Curve Shifts Left)
• Consumer Tastes and Preferences: Changes in consumer tastes (influenced by advertising, trends, etc.) can increase or decrease demand. (Demand Curve Shifts Right or Left)
• Expectations about Future Prices: If consumers expect prices to rise in the future, they may increase their current demand. (Demand Curve Shifts Right)
• Number of Buyers: A larger number of buyers will lead to higher overall demand. (Demand Curve Shifts Right)

Diagrams Illustrating Shifts in the Demand Curve

The demand curve shows the inverse relationship between price and quantity demanded. A shift to the right indicates an increase in demand, while a shift to the left indicates a decrease in demand. Let's examine some common scenarios.

1. Change in Income (Normal Goods)

When income increases, consumers can afford to buy more of most goods. This leads to a rightward shift in the demand curve.

	Price (P)	Quantity Demanded (Q)
Initial Equilibrium	$P_1$	$Q_1$
New Equilibrium (Increase in Income)	$P_2$	$Q_2$ ($Q_2 > Q_1$)

2. Change in Income (Inferior Goods)

For inferior goods, an increase in income leads to a decrease in demand, resulting in a leftward shift in the demand curve.

	Price (P)	Quantity Demanded (Q)
Initial Equilibrium	$P_1$	$Q_1$
New Equilibrium (Increase in Income, Inferior Good)	$P_2$	$Q_2$ ($Q_2 < Q_1$)

3. Change in the Price of a Substitute Good

If the price of a substitute good increases, consumers will switch to the original good, increasing its demand and shifting the demand curve to the right.

	Price (P)	Quantity Demanded (Q)
Initial Equilibrium	$P_1$	$Q_1$
New Equilibrium (Increase in Price of Substitute)	$P_2$	$Q_2$ ($Q_2 > Q_1$)

4. Change in the Price of a Complementary Good

If the price of a complementary good increases, consumers will buy less of the original good, decreasing its demand and shifting the demand curve to the left.

	Price (P)	Quantity Demanded (Q)
Initial Equilibrium	$P_1$	$Q_1$
New Equilibrium (Increase in Price of Complementary)	$P_2$	$Q_2$ ($Q_2 < Q_1$)

Impact on Equilibrium Price and Quantity

A shift in the demand curve always leads to a new equilibrium point. The new equilibrium price and quantity depend on the magnitude of the shift in the demand curve.

• Rightward Shift (Increase in Demand): Equilibrium price and quantity both increase.
• Leftward Shift (Decrease in Demand): Equilibrium price and quantity both decrease.

Summary

Understanding how changes in the determinants of demand affect the demand curve is crucial for analyzing market dynamics. By recognizing these shifts and their impact on equilibrium, we can better predict how markets will respond to various economic events.