Allocation of Resources – Demand
Objective
To understand what demand is, how to read and draw a demand diagram, the difference between movements along the curve and shifts of the curve, and the causes of extensions (right‑hand shifts) and contractions (left‑hand shifts) in demand.
Key Terms (AO1)
- Normal good – demand rises when income rises.
- Inferior good – demand falls when income rises.
- Substitute good – can be used in place of another good.
- Complementary good – used together with another good.
- Extension of demand – a right‑hand shift of the demand curve.
- Contraction of demand – a left‑hand shift of the demand curve.
- Ceteris paribus – “all other things being equal”.
Definition of Demand
- Individual demand: the relationship, ceteris paribus, between the price of a good and the quantity that one consumer is willing and able to buy.
- Market demand: the total quantity demanded in a market at each price. It is obtained by adding (horizontally) the individual demand curves of all consumers. In words: market demand = horizontal sum of all individual demands.
Demand Curve – Shape & Interpretation
A demand curve is drawn with price (P) on the vertical axis and quantity demanded (Q) on the horizontal axis. It slopes downwards from left to right, illustrating the law of demand: when price falls, the quantity demanded rises (ceteris paribus).
- Y‑intercept: the price at which quantity demanded would be zero.
- X‑intercept: the maximum quantity demanded if the price were zero.
- Any point on the curve shows the quantity demanded at that specific price.
Step‑by‑Step Checklist for Drawing a Demand Diagram
- Draw two perpendicular axes. Label the vertical axis P (price) and the horizontal axis Q (quantity).
- Mark a downward‑sloping straight line (or a smooth curve) from the upper‑left to the lower‑right.
- Label the line D₁ (the original demand curve).
- Indicate the Y‑intercept (price where Q = 0) and the X‑intercept (quantity where P = 0) if required.
- For a shift, draw a second curve parallel to the first:
- Right‑hand shift → label D₂ (extension).
- Left‑hand shift → label D₃ (contraction).
- Add arrows showing the direction of each shift and annotate the factor that causes it (e.g., “↑ income”).
- If you wish to show equilibrium, draw a supply curve S and mark the intersection points before and after the shift.
Movements Along the Demand Curve vs. Shifts of the Curve
- Movement along the curve: caused by a change in the price of the good itself. The result is a change in quantity demanded (a move from one point to another on the same curve).
- Shift of the curve: caused by a change in any determinant other than the price of the good. The whole curve moves right (extension) or left (contraction), indicating a change in demand at every price.
Quantitative Illustration (Demand Function)
Linear demand function:
QD = 200 – 5P + 2Y
- P = price of the good.
- Y = consumer income (in £ thousands).
- ∂QD/∂Y = +2 > 0 → the good is a normal good. An increase in income shifts the curve to the right.
Factors that Cause a Shift in Demand
Each factor below, when it changes ceteris paribus, will either extend (right‑hand shift) or contract (left‑hand shift) the demand curve.
- Consumer income
- Normal good: ↑ income → right‑hand shift.
- Inferior good: ↑ income → left‑hand shift.
- Tastes and preferences – e.g., health campaigns, fashion trends.
- Price of related goods
- Substitutes: ↑ price of substitute → right‑hand shift; ↓ price of substitute → left‑hand shift.
- Complements: ↓ price of complement → right‑hand shift; ↑ price of complement → left‑hand shift.
- Population or market size – growth → right‑hand shift; decline → left‑hand shift.
- Expectations of future prices or income
- Expect higher future price or income → current right‑hand shift.
- Expect lower future price or income → current left‑hand shift.
- Government policy
- Subsidies, tax cuts, lower import duties → effective price falls → right‑hand shift.
- Excise taxes, higher duties, removal of subsidies → effective price rises → left‑hand shift.
- Environmental / sustainability factors
- Green‑labeling or carbon‑footprint information → raises demand for “eco‑friendly” products (right‑hand shift).
- Regulations that restrict or ban a product (e.g., single‑use plastics) → left‑hand shift.
Summary Table
| Factor | Effect on Demand | Direction of Shift | Illustrative Example (local / sustainable) |
|---|
| Increase in consumer income (normal good) | Higher quantity demanded at each price | Right | Rising tourism income → more hotel‑room bookings in coastal Kenya |
| Decrease in consumer income (normal good) | Lower quantity demanded at each price | Left | Recession → fewer restaurant meals in the UK |
| Increase in income (inferior good) | Lower quantity demanded at each price | Left | Higher wages → reduced demand for cheap instant noodles |
| Positive change in tastes | Higher demand | Right | Health campaign promoting plant‑based diets → more soy milk bought |
| Price rise of a substitute | Consumers switch to the good | Right | Higher price of tea → coffee demand rises |
| Price fall of a substitute | Consumers switch away | Left | Cheaper smartphones → tablet demand falls |
| Price fall of a complement | More of the related good is bought | Right | Cheaper printers → demand for ink cartridges rises |
| Price rise of a complement | Less of the related good is bought | Left | Higher gasoline price → demand for large SUVs falls |
| Population growth / urbanisation | More buyers overall | Right | Urban growth in Lagos → higher demand for housing |
| Expectations of higher future prices | Current purchases increase | Right | Anticipated tax hike on cigarettes → current sales rise |
| Expectations of lower future prices | Current purchases decrease | Left | Rumour of a Black Friday sale → consumers wait |
| Government subsidy (e.g., renewable energy) | Effective price falls for consumers | Right | Solar‑panel subsidy → demand spikes |
| Government tax increase (e.g., excise duty) | Effective price rises for consumers | Left | Excise duty on alcohol → demand falls |
| Environmental labeling (green certification) | Higher demand for certified products | Right | Eco‑label on coffee beans → sales increase |
| Regulation restricting single‑use plastics | Lower demand for the restricted product | Left | Ban on plastic straws → demand falls |
Diagrammatic Representation
1. Draw the original demand curve D₁.
2. To show an extension, draw a second curve to the right, label it D₂, and add an arrow pointing right with a note such as “↑ income”.
3. To show a contraction, draw a third curve to the left, label it D₃, and add an arrow pointing left with a note such as “↑ price of complement”.
4. If required, include a supply curve S and mark the two equilibrium points (before and after the shift) to illustrate the impact on price and quantity.
Link to Assessment Objectives
- AO1 – Knowledge & Understanding: definitions, diagram interpretation, identification of determinants.
- AO2 – Application & Analysis: explain how a change in a determinant shifts the curve, using numerical or real‑world examples and appropriate terminology.
Exam Practice Question (AO1 & AO2)
Question: Explain how (a) a rise in consumer income and (b) a fall in the price of a complementary good would each affect the demand for a normal good. Use appropriate economic terminology and illustrate your answer with a diagram.
Answer Outline:
- Rise in income → for a normal good ∂QD/∂Y > 0. The demand curve shifts right (extension). Show this by moving from D₁ to D₂ on the diagram.
- Fall in the price of a complement → the total cost of using the two goods falls, making the normal good more attractive. The demand curve also shifts right, from D₁ to D₂.
- Both shifts increase the equilibrium price and quantity (ceteris paribus), which can be shown by the new intersection with the supply curve S.