THE ALLOCATION OF RESOURCES (4&5)

DEMAND
LEARNING OBJECTIVES
1. Define demand;
2. Draw and interpret appropriate demand diagrams;
3. Explain movements along demand curves;
4. Explain the link between individual and market demand;
5. Explain the causes of shifts in a demand curve.
Demand refers to both the willingness and the ability of customers to pay a given price to buy a
good or service. This is sometimes referred to as effective demand to distinguish genuine
demand from a desire to buy something.
Law of demand
There is an inverse relationship between the price of a good or service and the quantity
demanded. This rule is known as the law of demand. There are two reasons for this
relationship:
1. As the price of a good or service falls, the customer’s real income rises — that is, with
the same amount of income, the customer is able to buy more products at lower prices.
2. As the price of a good or service falls, a higher number of customers are able to pay, so
they are more likely to buy the product.
Determinants of Demand
Although price is regarded as the key determinant of the level of demand for a good or service,
it is not the only factor that affects the quantity demanded. Other determinants of demand can be
remembered by the acronym HIS AGE:
1. Habits, fashions and tastes
2. Income.
3. Substitutes and complements — substitutes are goods or services that can be used instead
of each other, such as Coca-Cola or Pepsi and tea or coffee. If the price of one product falls,
then it is likely the demand for its substitute will also fall. Complements are products that
are jointly demanded, such as tennis balls and tennis racquets or cinema movies and
popcorn. If the price of one product increases, then the demand for its complement is likely
to fall.
4. Advertising
5. Government policies
6. Economy

Student Activity
Attempt Activity (Cambridge IGCSE and O Level Economics Second Edition, Page 28)
PRICE AND DEMAND
Diagrammatically, the demand curve is shown as a downward-sloping curve to indicate the
inverse relationship between price and quantity demanded.

MOVEMENTS ALONG A DEMAND CURVE

A change in the price of a good or service causes a movement along the demand curve. A price
rise will cause a contraction in demand for the product — that is, the quantity demanded falls.
By contrast, a reduction in price will cause an extension in the quantity demanded.

Student Activity
On an appropriate diagram of a demand curve illustrate the concept of contraction and extension
INDIVIDUAL DEMAND AND MARKET DEMAND
The market demand refers to the aggregation of all individual demand for a product. It is
found by adding up all individual demand at each price level. For instance, suppose that a
bookshop charges $20 for its books and the demand from JOAN totals 3 per week while
EDWRD purchased 1book at that price per week. The market demand for books at $10 per
book is therefore 4 books per week.

CONDITIONS OF DEMAND
While a movement in demand is caused by price changes only, a change in all other (non-
price) factors that affect demand, such as income, will cause a shift in demand.
An increase in demand (rather than an increase in the quantity demanded) is represented by
a rightward shift in the demand curve from D to D1. For example, BMW recorded higher than
expected profits in 2017 due to increasing demand for its cars in Europe, the USA and Asia.
Hence, the demand for BMW’s cars was higher at all price levels. when the demand curve shifts
from D to D1 at a price of P the quantity demanded increases from Q to Q1.
A decrease in demand (rather than a fall in the quantity demanded) is shown by shifting
the demand curve to the left, from D to D2, resulting in less quantity demanded at all price
levels. At the price of P, demand falls from Q to Q2. For example, financial problems and rising
unemployment in the economy will decrease the demand for cars.

Student Activity
On an appropriate diagram of a demand curve illustrate an increase in demand and a decrease in demand
 SUPPLY
LEARNING OBJECTIVES
1. Define supply;
2. Draw and interpret an appropriate supply diagram;
3. Explain movements along the supply curve;
4. Explain the link between individual and market supply;
5. Explain the causes of shifts in supply.
Supply is the ability and willingness of firms to provide goods and services at given price
levels. Firms will have more incentives to supply their products at higher prices — the higher
the price, the greater supply tends to be; this is popularly referred to as the law of supply.
There are two reasons for this positive relationship between price and supply:
1. Existing firms can earn higher profits if they supply more.
2. New firms are able to join the market if the higher price allows them to cover their
production costs.

Determinants of supply
Although price is regarded as the key determinant of the level of supply of a good or service, it
is not the only factor that affects the quantity supplied. Non-price factors that affect the level of
supply of a product can be remembered by the acronym TWO TIPS:
1. Time — the shorter the time period in question, the less time suppliers have to increase their
output, so the lower the supply tends to be.
2. Weather — favourable weather conditions will shift the supply of agricultural output to the
right.
3. Opportunity cost — price acts as a signal to producers to allocate their resources to the
provision of goods and services with a greater level of profits. For example, if the market
price of corn falls while the price of apples increases, then farmers are likely to reduce their
supply of corn (due to the higher opportunity cost) and raise their supply of apples.
4. Taxes — taxes imposed on the supplier of a product add to the costs of production.
Therefore, the imposition of taxes on a product reduces its supply, shifting the supply curve
to the left.
5. Innovations — technological advances such as automation and wireless internet
technologies mean that there can be greater levels of output at every price level. Hence,
innovations will tend to shift the supply curve to the right.
6. Production costs — if the cost of raw materials and other factors of production falls, then the
supply curve will shift to the right, ceteris paribus.
7. Subsidies — subsidies are a type of financial assistance from the government to help
encourage output by reducing the costs of production for firms. Subsidies are usually given
 to reduce the costs of supplying goods and services that are beneficial to society as a whole,
such as education, training and healthcare.

PRICE AND SUPPLY

The law of supply states that there is a positive relationship between price and the quantity
supplied of a product. Hence, a supply curve is drawn as upward sloping from left to right.

MOVEMENTS ALONG A SUPPLY CURVE

A movement along a supply curve occurs only if the price of the product changes. A change in
price alone causes a change in the quantity supplied. There is an extension in supply if price
increases. A contraction in supply occurs if the price of the product falls.

Student Activity
On an appropriate diagram of a supply curve illustrate the concept of contraction and extension

INDIVIDUAL SUPPLY AND MARKET SUPPLY

The market supply curve is the aggregation of all supply at each price level. Suppose that at
a price of $20 per unit ROBERT is willing and able to supply 3 books and his rival GREGORY
supplies 4 books, per time period. At this price, the total market supply is 7 books. Hence, the
market supply is found by adding up all individual supply at each price level.

CONDITIONS OF SUPPLY
A change in any of the non-price factors that affect the supply of a good or service will
cause a shift in the supply curve. A rightward shift of the supply curve from S to S1 is
described as an increase in supply (rather than an increase in the quantity supplied). By contrast,
a leftward shift of the supply curve from S to S2, results in a decrease in supply (rather than a
fall in the quantity supplied). For example, Japan’s tsunami in March 2011, the country’s worst
natural disaster, reduced the supply of major manufacturers such as Sony, Panasonic, Toyota
and Honda.

Student Activity
On an appropriate diagram of a supply curve illustrate an increase in supply and a decrease in supply