Factors influencing decisions    What is a market? Demand Supply Equilibrium Excess demand   Excess supply   Shifts of demand  Shifts of supply Convergence to equilibrium  Economicstutor..com.au

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1 Introductory concepts 2  Market mechanism  3 Elasticities  4 Market structures 5  Market failures  6  Macro economic activity/eco growth  7 Inflation 8  Employment & unemployment  9  External Stability  10  Income distribution 11.Factors affecting economy  12  Fiscal/Budgetary policy  13  Monetary Policy   14 Aggregate Supply Policies  15 The Policy Mix

The demand for a good or service represents the willingness and ability of buyers or consumers to purchase goods and services.  The total demand for a product will depend on a number of factors, with the most obvious factor being the price of the product.  A rational consumer will seek to purchase products at the lowest price possible because it maximises the ‘value’ or ‘satisfaction’ (in economics we sometimes refer to this as utility)  he or she gets from purchasing and consuming the product.

Almost without exception, when the price of a product falls, the total demand for the product will rise in response.  This occurs for two main reasons:

  1. Existing consumers may increase the amount they purchase given that their income ‘will go further’ and be able to afford a greater volume of that particular product. In  economics we sometimes refer to this as the income effect.

  1. Other consumers may turn away from a rival product and buy the existing product because it becomes ‘relatively’ cheaper. This means that a fall in price will tend to result in consumers substituting into the product.  In economics we sometimes refer to this as the substitution effect.

For example, if the price of oranges falls from $4  to only $2 per kilogram it is likely to cause some customers to purchase two kilograms instead of one kilogram and it will no doubt lead some consumers to substitute away from mandarines (a substitute) and towards oranges because mandarines are relatively more expensive (i.e. the relative price of mandarines has increased).  This relationship between the price of the product and the total quantity demanded in the market place is often referred to as the Law of Demand.   This states that as the price of a product increases, the total quantity demanded decreases and as the price decreases the total quantity demanded increases. There is an inverse relationship between quantity demanded and price.

It is important to remember that the demand curve only captures the relationship between a change in price and the quantity demanded of a product.  This is highlighted in the two demand curves to the right. As the price rises, it results in a reduction in demand ‘along the demand curve’ which we refer to as a contraction of demand. In contrast, as the price falls, it results in an increase in demand ‘along the demand curve’ which we refer to as an expansion of demand.  If demand for a product changes for any OTHER reason, it will shift the whole demand curve. See shifts of demand.  

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