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Learn how price changes affect quantity demanded and how non-price factors shift the demand curve. Explore income and substitution effects, and understand changes in demand due to consumer income, tastes, related goods, and more.
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CHAPTER 4: DEMAND Lesson 2: FACTORS AFFECTING demand
A CHANGE IN THE QUANTITY DEMANDED • Let’s say the price of a product changes and all other factors remain the same. In that case, the demand curve doesn’t move, but the quantity demanded changes. But sometimes the entire demand curve shifts due to a factor other than price, such as an advertising campaign or a change in consumer income. Look at Figure 4.3 to see what happens when only the price changes and everything else remains constant. Point a on the demand curve shows that at $5, 24 burritos are sold. When the price falls to $3, the number of burritos purchased goes up to 40. This movement from point a to point b or from b to a is a change in quantity demanded—a change that is graphically represented as a movement along the demand curve.
A CHANGE IN THE QUANTITY DEMANDED Only Price Changes the Quantity Demanded: • A change in quantity demanded can be caused by only one event—a change in price. Lots of other things can affect the demand curve, but price is the only factor that can cause a movement along the demand curve, as we see in Figure 4.3.
A CHANGE IN THE QUANTITY DEMANDED The Income Effect: • When the price of a product drops, consumers pay less and, as a result, have some extra income to spend. For example, we can see from Figure 4.3 that consumers spent $120 to buy 24 burritos when the price was $5 per burrito. If the price drops to $3, they would spend only $72, or $3 times 24, on the same quantity, leaving them $48 “richer” because of the lower price. As a result, part of the increase from 24 to 40 units purchased comes about because consumers feel richer. • If the price had gone up, consumers would have felt a bit poorer and would have bought fewer burritos. This illustrates the income effect, the change in quantity demanded because of a change in price that alters consumers’ income.
A CHANGE IN THE QUANTITY DEMANDED The Substitution Effect: • When the price of a burrito drops from $5 to $3, burritos become less expensive than before, in comparison with other goods and services. As a result, consumers tend to replace a more costly item—say, pizza—with a less costly one—more burritos. The substitution effect is the change in quantity demanded because of a shift in relative prices. • Whenever a price change causes a change in quantity demanded, we see a movement along the demand curve, as illustrated in Figure 4.3. Regardless of whether the quantity demanded increases or decreases, the demand curve itself does not shift.
A CHANGE IN DEMAND • Sometimes other factors change while the price remains the same, this is known as a change in demand. As a result, the entire demand curve shifts to the right to show an increase in demand, or to the left to show a decrease in demand. This is different than a change in quantity demanded, which is a movement along the demand curve caused by a change in price. • Demand can change because of consumer income, consumer tastes, the price of related goods (such as substitutes or complements), future expectations, and the number of consumers.
A CHANGE IN DEMAND Consumer Income: • When people earn more, they are willing to buy different amounts at all possible prices. We can now add a third column to Panel A to show these increases. At a price of $9, for example, consumers are now willing to buy 16 burritos instead of 3. At a price of $7, consumers are now willing to buy 28 burritos instead of 12, a change shown by movement from point a to point a´. When the rest of the information in the schedule is transferred to the graph in Panel B, the demand curve will have increased, or shifted to the right. • A decrease in consumer income would have the opposite effect. Once these new quantities are plotted, the demand curve will have shifted to the left, showing a decrease in demand.
A CHANGE IN DEMAND Consumer Tastes: • Consumers often change their minds about which products to buy. Advertising, fashion trends, peer group pressure and even changes in the season can affect consumer choices. For example, when a product is successfully advertised, its popularity increases and people tend to buy more of it. As a result, the demand curve shifts to the right. • On the other hand, people will buy less of a product if they get tired of it, or if they have a reason to worry about whether it’s a good choice. This is exactly what happens when a rumor or unfavorable report about a product appears. When fewer people want the product, the demand curve shifts to the left, showing a decrease in demand.
A CHANGE IN DEMAND Substitutes: • A change in the price of related products can cause a change in demand. Some products are known as substitutes because they can be used in place of other products. For example, if people treat butter and margarine as substitutes, an increase in the price of butter will cause an increase in the demand for margarine. Likewise, an increase in the price of margarine would cause the demand for butter to increase. • In general, the demand for a product tends to increase if the price of its substitute goes up. The demand for a product tends to decrease if the price of its substitute goes down.
A CHANGE IN DEMAND Complements: • Other related goods are known as complements, because the use of one increases the use of the other. Personal computers and software are two complementary goods. When the price of computers decreases, consumers buy more computers and more software. If the price of computers spirals upward, consumers would buy fewer computers and less software. • In general, an increase in the price of a good usually leads to a decrease in the demand for its complement. A decrease in the price of a good tends to increase the demand for its complement.
A CHANGE IN DEMAND Expectations: • The way people think about the future can also affect demand. For example, suppose that a company announces a technological breakthrough in televisions. Even if these new products might not be available for a year, some consumers might hold off buying a TV today because of their expectations. The new expectations would cause fewer TVs to be purchased today and the demand curve would shift to the left. • Of course, expectations can also have the opposite effect. Imagine if the weather service forecasts a bad year for crops. People might stock up on some foods today, before these items actually became scarce. The willingness to buy more today because of expected shortages later on would cause an increase in current demand, shown by a shift of the demand curve to the right.
A CHANGE IN DEMAND Number of Consumers: • Generally, when more consumers enter the market, market demand increases, and the curve shifts to the right. Suppose that a building near a store that sells burritos needs repairs. A large group of workers comes to the neighborhood. Many of them buy burritos for lunch. We would add the number of burritos that they buy to those the store used to sell. When the construction workers leave, market demand might decrease, with the market demand curve shifting to the left.
