Year 10 Personal and Global Economics

Supply and Demand

The role of prices
In the market the four key economic questions are answered by the price mechanism- the interaction of buyers
and sellers. In the market economy, the consumer is king (consumer sovereignty).
Consumers signal their tastes and preferences by casting their dollar votes when they buy goods and services.
The consumer will therefore determine what will be produced and how much.

The how question is answered by producers. Producers are guided by the principle of self-interest. Producers
must operate profitably so firms have to operate efficiently and minimise costs. Producers will compare the costs
of inputs and there is an incentive to become more efficient and lower costs.

Price determines the for whom question as well. The rewards of production reflect the price which the market is
willing to pay for resources. Wages and salaries are the reward for labour; the owners of capital receive
dividends; owners of natural resources receive rent and the owners of entrepreneurial skills receive profits.

DEMAND
Demand refers to the buying intentions of consumers. The quantity demanded of a good or service is the quantity
that consumers are willing and able to purchase at a particular price at a particular point in time.
Demand is not the same thing as want. Mr Johnson wants a Ferrari but he is not willing or able to buy one (at this
point in time).

The Law of Demand states that as price increases for a product the quantity demanded of the product will
decrease (ceteris paribus). The law of demand shows a negative relationship between prices and quantity
demanded.
Why?
1) The income effect- when the price of a good rises, consumers are not willing to buy as much of a good
because their ‘real’ income or purchasing power has decreased. Dillon earns $40 a week, gardening
around the house. He usually buys 4 pizzas a week at $10 each. If the price of pizzas increases to $20 he
can now only afford 2 pizzas and so his demand has fallen.
2) The substitution effect- when the price of one good rises, other goods become more attractive because
they are relatively cheaper. As price increases, consumers will switch to cheaper substitutions. Instead of
now buying 2 pizzas for $20, Dillon will instead buy 3 plates of meatballs at $12.50 a plate.

Notice that the substitution and income effects work together to reinforce the law of demand. Are there
exceptions? No! The law of demand holds for all goods and services- as long as ceteris paribus holds.

The law of demand varies in strength between different types of goods depending on how strong the income and
substitution effects are. Eg. Law of demand for petrol will be very weak, because there are few substitutes (in the
short term). The law of demand for orange juice will be much stronger, people can switch to apple and guava
juice.

Non-price factors affecting demand

Price is an important but not the only determinant of demand. There are numerous non price factors including:
 Income of consumers- consumers will normally purchase more of a good when their income increases. (The
exception would be inferior goods such as ‘Home Brand’ biscuits as opposed to normal goods)
 The price of related goods- consumers can choose between a number of substitutes which satisfy wants. For
example there are many different types of fast food. Many goods are also consumed with other goods, these
are called complements. For example biscuits complement coffee.
 If the price of pizza rises then the demand for a complement such as garlic bread will fall but the demand for a
substitute like McDonalds will rise.
 Tastes and preferences- advertising attempts to affect consumers’ preferences through persuasion and
information. Preferences change over time as goods become obsolete – eg. Demand for CD’s has fallen as
sales of online music has increased.
 Expectations of consumers- if people expect conditions to change in the future, they make decisions now
rather than postpone them. For example if consumers expect petrol prices to rise on Friday then demand for
petrol will increase on Wednesday and Thursday.
 Demographic factors [population] – the size and age of the population and its make-up can influence
demand on numerous products. Eg. As the population ages then demand for dentures will rise and demand
for skateboards fall.

Movements along and shifts in the demand curve.

Price changes of the good will lead to a movement along the curve. We use the terms contraction in demand and
expansion in demand for price changes.

Non-price factors- any change other than price will lead to an overall change in the demand – which will mean a
shift in the demand curve. We use the terms increase and decrease in demand when the curve shifts.

Demand expansion – Demand contraction- Demand increase – non Demand decrease – non
price falls price rises price factor shifts right price factor shifts left

SUPPLY
Supply is the quantity that producers are willing and able to produce at a particular price at a particular point in
time. The Law of Supply states that as the price of a good increases, then the quantity producers are willing to
supply also increase. It is therefore a positive relationship between price and quantity.
What is the reason for the Law of Supply? Rational, self- interested producers would prefer to sell their output at
a high price than at a low price because of the desire for profit.
Non-price factors affecting supply
 Cost of production- If the price of L,L,C,E increases, this means production costs are increasing, so at a given
price the firms will reduce their output. This will lead to a decrease in supply – a shift to the left.
 Technology- if technology improves then more output can be produced from the same quantity of resources.
This means the costs of production will fall and supply will increase.
 [factors of production] Price of other goods that can be produced- suppliers monitor the price of the other
types of goods they can produce. If the farmer thinks they can make more profit from oats then he/she will
switch production away from wheat. Car manufactures can increase the supply of small cars and decrease the
supply of large cars if they think small cars are more popular.
 Number of sellers – New sellers entering the market will increase competition and therefore reduced prices.
Current sellers may also leave the market decreasing supply and increasing prices.
 Expectations of future prices- what suppliers feel about future conditions will affect current production. If
producers think they will get a higher price in the future, then they will decrease their current supply.
Investment decisions on capital and machinery will be based on predicted prices. Expectations on profits also
affect supply.

Changes in Supply
Changes in the price will lead to movements along the curve. We call these expansions (right) and contraction
(left). Similarly, to demand, non-price factor changes in supply will lead to an increase (rightward shift) or a
decrease (leftward shift) of the supply curve.

DRAW diagrams
Supply expansion – Supply contraction- Supply increase- non Supply decrease – non
price rises price falls price factor shifts right price factor shifts left
 Activities
Changes in demand and supply
D/S Change Diagram
An increase in demand- if cheese makers decided to
advertise the benefits of cheese eating, this would
lead to an increase in demand (a shift to the right).
The increased demand for cheese would cause the
price to __________and producers would respond
by producing ________ cheese.

A decrease in demand – If it is proven that cheese

causes people to gain weight this would lead to a
decrease in demand (shift to the left). Price
would____________ and quantity would
___________.

An increase in supply – a new milking machine is

developed that gets more milk from cows. This
leads to an increase in supply (shift to the right).
Price would ________ and quantity supplied would
__________.

A decrease in supply – foot and mouth diseases kills

many cows which would decrease the supply of
cheese (shift left). Price would _____________ and
quantity would ______________.

In groups or individually, draw diagrams for the following scenarios

1. The effect on the market for raspberries of the ending of the growing season
2. The effect on the market for hotel rooms in Australia after a rise in consumer confidence
3. The effect on the market for alcohol of an increase in the government excise tax on sellers
4. The effect on the market for plastic swimming pools during a heatwave
5. The effect on the market for health care of a rise in the birth rate
6. The effect on the market for solar panels of an increase in the government subsidy to sellers
7. The effect on the market for caged eggs of a successful advertising campaign by the RSPCA
8. The effect on the market for coal of a slowdown in global economic growth
9. The effect on the market for synthetic fibres (like polyester used in clothing) due to a fall in oil prices
10. The effect on the market for alcohol of an increase in the government excise tax on sellers
11. The effect on the market for Microsoft Office due to an increase in price of laptop falls
12. The effect on the market for grapes following a media report suggesting they improve brain function
13. The effect on the market for MP3 players following the advancement in technology in phones and music apps
such as Spotify