Understanding the Relationship Between Demand, Supply, and Price in Economics

D2 How much would you pay for a can of Coca Cola? Would you pay 50p? Would you pay 80p? Would you pay 1.00? Would you pay 1.20? What happens to demand as price goes up? RELATIONSHIP BETWEEN DEMAND, SUPPLYAND PRICE How much would you pay for a can of Tesco Cola? Is this different to Coca Cola? Why? RELATIONSHIP BETWEEN DEMAND, SUPPLY AND PRICE

RELATIONSHIPBETWEENDEMAND, SUPPLYANDPRICE In this topic you will learn about Influences on demand, e.g. affordability, competition, availability of substitutes, level of Gross Domestic Product (GDP), needs and aspirations of consumers Influences on supply, e.g. availability of raw materials and labour, logistics, ability to produce profitably, competition for raw materials, government support Elasticity: price elasticity of demand

DEMAND Demand is the amount society is willing and able to buy at a set price at a given point in time A normal good is one where, if price rises, demand will fall and vice versa i.e. there is a negative correlation The two variables price and demand move in the opposite direction to each other The relationship between price and quantity demanded can be shown using a demand curve Low prices see increased demand for gold. A demand curve is a graphical representation of the relationship between price and quantity demanded The demand curve shows the quantity demanded for a good, at any given price, over a period of time As price falls quantity demanded rises As price rises quantity demanded falls

THEDEMANDCURVE Price P D Q Quantity 0

THEDEMANDCURVE A change in price is shown by a movement along the demand curve. A change in price from P to P1is shown by a movement along the demand curve lowering quantity demanded from Q to Q1. Price P1 P D Q1 Q Quantity

THEDEMANDCURVE A change in price from 10 to 15 is shown by a movement along the demand curve with quantity demanded falling from 100 to 120 units. Price 15 10 D 100 120 Quantity

THEDEMANDCURVE Explanation of diagram: Show on the demand curve what would happen if price fell from P to P1. Price P D Q Quantity

INFLUENCESONDEMAND If a change in demand is caused by a change in price this is shown by a movement along the demand curve If the change in demand is caused by a change in any other factor this is caused by a shift in the demand curve What factors other than price will influence demand?

INFLUENCESONDEMAND - AFFORDABILITY Recap demand was defined as: The amount society is willing and able to buy at a set price at a given point in time Affordability is whether people are willing and able to buy a good or service at a given price We might all want certain goods e.g. a Ferrari or a house in Barbados but if we can t afford them then this does not influence demand

INFLUENCESONDEMAND - COMPETITION Competition Degree of competition If there are a lot of competitors demand will be spread more thinly Actions of competitors Competitors may lower their prices or increase spending on promotion to try and gain market share i.e. to shift demand from one firm to another

INFLUENCESONDEMAND - SUBSTITUTESAND COMPLEMENTARYGOODS Changes in the price of substitute and complementary goods will have a major impact on the quantity demanded of a product A substitute product acts as an alternative, therefore creating competition If the price of good A increases, the demand for good B will increase e.g. Coca-Cola and Pepsi Cola There is a positive correlation A complementary product is bought alongside a good or service If the price of good A increases, the demand for good B will decrease e.g. fish and chips There is a negative correlation Pizza and ice-cream wars. Explain what is happening in these 2 articles.

INPAIRS For each product give an example of a substitute product and a complementary product. Product Substitute Complement iPhone Jam Child s scooter Package holiday abroad Sunday Times

INFLUENCESONDEMANDLEVELOF GDP As GDP changes so does the level of consumer incomes As the income of consumers increases demand for some goods and services will increase Does this depend upon the nature of the good? Necessities It is less likely that demand for these will change in relation to income e.g. would you start buying more milk or less soap if your income changed? Luxuries If income increase customers may be able to afford more luxuries increasing demand , equally if incomes fall these may be the first items to cut e.g. not booking a holiday Inferior goods If incomes increase demand may decrease as customers switch to being able to afford a better quality product e.g. would you stop buying own brand Tesco beans and start buying Heinz When GDP is high there is a high level of economic activity. This means more people are employed and wages tend to rise.

INFLUENCESONDEMANDNEEDSAND ASPIRATIONSOFCONSUMERS People s tastes change over time and demand for fashionable products changes regularly As some products become more fashionable there is an increase in demand Just as quickly demand can disappear as tastes and fashion change What goods and services have seen an increase in demand in recent years as a result of changes in the needs and aspirations of consumers? Is Made in Britain back in fashion? Why has there been an increase in demand for organic food?

SUPPLY Supply is the amount of a good or service that producers are willing and able to sell at any given price Why will more firms be willing and able to supply a certain good when the price rises? Producers are those people that create and supply goods and services to a market A supply curve is a graphical representation of the relationship between price and quantity The supply curve shows the quantity supplied for a good or service, at any given price, over a period of time As price falls quantity supplied decreases As price rises quantity supplied increases

THE SUPPLY CURVE Price S P Q Quantity

THE SUPPLY CURVE S Price A fall in price from 15 to 10 is shown by a movement along the supply curve showing a fall in the quantity supplied from 100 to 80 units. 15 10 100 80 Quantity

THE SUPPLY CURVE Illustrate what would happen if price rose from P to P1. S Price Explanation of diagram: P Q Quantity

INFLUENCESONSUPPLY Availability of raw materials and labour Without raw materials and labour it will be impossible to produce goods and services Raw materials may need to be imported from abroad or affected by external factors such as the weather e.g. if dependent on crops Logistics The ability to bring together all of the factors of production i.e. land, labour, capital and enterprise The ability to match supply to demand to meet customer needs

INFLUENCESONSUPPLY How might changes to the minimum wage affect supply? Ability to produce profitably Costs of production are created by the 4 factors of production If the cost of producing a good or service increases it will become more expensive to supply the product This will lead to some firms reducing output The price of factor inputs can also be reduced making it cheaper to supply a product There will be an increase in supply Improvements in technology can help to reduce costs of production

INFLUENCESONSUPPLY Competition for raw materials Like all goods and services if there is competition this will increase demand and hence drive prices up May force some businesses out of the market as it is no longer profitable Government support Subsidies involve finance provided by the government to encourage suppliers to produce goods and services Subsidies will make it cheaper to produce a product Therefore, the quantity supplied of that product will increase The withdrawal of subsidies will make it more expensive to produce a product Therefore, the quantity supplied of that product will decrease Why will a cut in subsidies lead to a fall in the supply of onshore wind farms?

INTRODUCTIONOFNEWTECHNOLOGY Technological progress has meant that firms can produce in a more efficient and cost effective manner Improved large scale machinery allows them to spread fixed costs over greater output making the cost per unit produced cheaper As technology improves firms find it profitable to supply more products How could technological progress lead to lower fuel production costs?

TESTYOURSELF Define the following terms: Supply Explain how the subsidies might impact on the supply of a product. 1. Subsidies Explain two reasons why a firm might increase the production of a product. 2. What impact does: a) a fall in supply have on the price of a product? b) an increase in supply have on the price of a product? 3.

PRICEELASTICITYOFDEMAND (PED) Price elasticity of demand is a measure of how responsive demand is to a change in price There is an inverse relationship between price and demand As price goes up demand goes down As price goes down demand goes up But the question is by how much? Is the change in demand more than proportional to the change in demand or less than proportional? PED is price inelastic as the fall in demand is less than the fall in price. Price increases by 10% Demand falls by 5%

PRICEELASTICITYOFDEMAND (PED) Demand falls by 13% PED is price elastic as the fall in demand is greater than the fall in price. Price increases by 10% Price elastic demand means that a change in price will lead to a more than proportional change in demand i.e. demand is sensitive to price changes How price inelastic can a cheese sandwich really be? Price inelastic demand means that a change in price will lead to a less than proportional change in demand i.e. demand is not so sensitive to changes in price Can you think of products that are likely to be highly price elastic and some that are likely to be highly price inelastic?

PRICEELASTICITYOFDEMAND (PED) In business it is assumed that the PED will always be negative i.e. price and demand will always move in the opposite direction If PED is between 0 and -1 e.g. -0.7 then demand is price inelastic If PED is less than -1 e.g. -1.4 then demand is price elastic Why can premier league football clubs charge such high prices for tickets?

FACTORSINFLUENCING PED A number of factors affect the value of the PED coefficient including: The availability of substitutes the closer the substitutes and the more that are available the higher the price elasticity of demand The price of competitor goods if the price of goods in competition with a product increase this will affect demand and price elasticity of demand Time the longer the time period the higher the price elasticity of demand. Given more time other firms have the ability to produce similar products and customers have more chance of adapting their buying habits

FACTORSINFLUENCING PED Branding firms spend time and money building up their brand image. By creating brand loyalty firms know that their customers will be willing to pay more for the product and they can therefore raise prices as the PED is lower Income - if consumer incomes are higher then the issue of price becomes less important to the consumer and it is easier for firms to raise price as the PED is lower What factors will influence the PED for Coca Cola s Fairlife milk? Nature of the good a luxury good will be price elastic as demand will be more sensitive to changes in price a necessity good will be price inelastic as demand will be less sensitive to changes in price

THESIGNIFICANCEOF PED Business people want to know how a change in price will impact on revenue This will help determine whether changing price is a good or bad marketing decision Price elastic demand Price inelastic demand Raise selling price Sales revenue will decrease Sales revenue will increase Lower selling price Sales revenue will increase Sales revenue will decrease

PROBLEMSOFFORECASTINGPRICE ELASTICITYOFDEMAND The price elasticity of demand for a product is constantly changing in a dynamic world It is very difficult for firms to measure because: Difficulty in finding accurate information Price elasticity changes over different price ranges Price elasticity will change over the period of the economic cycle e.g. it will be affected in a recession Tastes and fashions are constantly changing Competitors don t stand still They are continually improving existing products, bringing out new products and trying to promote their products

DEMAND, SUPPLYANDPRICE Think about your two businesses What factors influence demand? Have these factors changed over time? What factors influence supply? Have these factors changed over time? What factors influence price elasticity of demand? Have these factors changed over time?

RELATIONSHIPBETWEENDEMAND, SUPPLYANDPRICE In this topic you have learnt about Influences on demand, e.g. affordability, competition, availability of substitutes, level of Gross Domestic Product (GDP), needs and aspirations of consumers Influences on supply, e.g. availability of raw materials and labour, logistics, ability to produce profitably, competition for raw materials, government support Elasticity: price elasticity of demand