Factors Affecting Demand

Site: Saylor Academy
Course: ECON101: Principles of Microeconomics
Book: Factors Affecting Demand
Printed by: Guest user
Date: Thursday, October 28, 2021, 12:24 AM

Description

Read this to learn about how factors that affect demand, such as income and change in tastes, are graphed as shifts of the demand curve. Make sure to answer the "Try It" questions.

Learning Objectives

  • Describe which factors cause a shift in the demand curve and explain why the shift occurs
  • Define and give examples of substitutes and complements
  • Draw a demand curve and graphically represent changes in demand

We know that a change in prices affects the quantity demanded. Price, however, is not the only thing that influences demand. For example, how is demand for vegetarian food affected if, say, health concerns cause more consumers to avoid eating meat?


Source: Lumen Learning, https://courses.lumenlearning.com/wmopen-microeconomics/chapter/factors-affecting-demand/
Creative Commons License This work is licensed under a Creative Commons Attribution 4.0 License.

The Effect of Income on Demand

Let's use income as an example of how factors other than price affect demand. Figure 1 shows the initial demand for automobiles as D0. At point Q, for example, if the price is $20,000 per car, the quantity of cars demanded is 18 million. D0 also shows how the quantity of cars demanded would change as a result of a higher or lower price. For example, if the price of a car rose to $22,000, the quantity demanded would decrease to 17 million, at point R.

Figure 1. Shifts in Demand: A Car Example.

The original demand curve D0, like every demand curve, is based on the ceteris paribus assumption that no other economically relevant factors change. Now imagine that the economy expands in a way that raises the incomes of many people, making cars more affordable. How will this affect demand? How can we show this graphically?

Return to Figure 1. The price of cars is still $20,000, but with higher incomes, the quantity demanded has now increased to 20 million cars, shown at point S. As a result of the higher income levels, the demand curve shifts to the right to the new demand curve D1, indicating an increase in demand. Table 1, below, shows clearly that this increased demand would occur at every price, not just the original one.

Table 1. Price and Demand Shifts: A Car Example
Price Decrease to D2 Original Quantity Demanded D0 Increase to D1
$16,000 17.6 million 22.0 million 24.0 million
$18,000 16.0 million 20.0 million 22.0 million
$20,000 14.4 million 18.0 million 20.0 million
$22,000 13.6 million 17.0 million 19.0 million
$24,000 13.2 million 16.5 million 18.5 million
$26,000 12.8 million 16.0 million 18.0 million

Now, imagine that the economy slows down so that many people lose their jobs or work fewer hours, reducing their incomes. In this case, the decrease in income would lead to a lower quantity of cars demanded at every given price, and the original demand curve D0 would shift left to D2. The shift from D0 to D2 represents such a decrease in demand: At any given price level, the quantity demanded is now lower. In this example, a price of $20,000 means 18 million cars sold along the original demand curve, but only 14.4 million sold after demand fell.

Figure 2. A New Shopping Trip. When this man got a raise, he shopped at an expensive organic grocery store instead of buying generic groceries. The generic groceries are an example of an inferior good.

When a demand curve shifts, it does not mean that the quantity demanded by every individual buyer changes by the same amount. In this example, not everyone would have higher or lower income and not everyone would buy or not buy an additional car. Instead, a shift in a demand curve captures a pattern for the market as a whole: Increased demand means that at every given price, the quantity demanded is higher, so that the demand curve shifts to the right from D0 to D1. And, decreased demand means that at every given price, the quantity demanded is lower, so that the demand curve shifts to the left from D0 to D2.

We just argued that higher income causes greater demand at every price. This is true for most goods and services. For some – luxury cars, vacations in Europe, and fine jewelry – the effect of a rise in income can be especially pronounced. A product whose demand rises when income rises, and vice versa, is called a normal good. A few exceptions to this pattern do exist, however. As incomes rise, many people will buy fewer generic-brand groceries and more name-brand groceries. They are less likely to buy used cars and more likely to buy new cars. They will be less likely to rent an apartment and more likely to own a home, and so on. A product whose demand falls when income rises, and vice versa, is called an inferior good. In other words, when income increases, the demand curve shifts to the left.

Try It

Question 1

Alexis owns a small business selling power tools. This past month she has noticed that the quantity demanded for high-end electric drills has decreased by 25%. Which of the following demand curve shifting events is a possible explanation for this change?

    • Customers' incomes have decreased.
    • The price of electric drills has increased.
    • Customers' incomes have increased.

Question 2

Over the past century the quantity of potatoes purchased by Irish consumers has fallen significantly, while incomes have grown exponentially. Meanwhile potatoes are still the cheapest source of calories available to the consumer. From this information it would be correct to assume that potatoes are a(n) ________ good.

    • essential
    • normal
    • inferior

Answer to Try It

1.

    • Customers' incomes have decreased.
      This is correct. Falling incomes would lead to a leftward shift of the demand curve causing less quantity demanded at any given price.
    • The price of electric drills has increased.
      While this would explain the decrease in quantity demanded, it will not have occurred because of a shift in the demand curve, rather movement along the existing curve.
    • Customers' incomes have increased.
      While his event would shift the demand curve, it would cause an increase in quantity demanded at any given price level. Jane Doe has observed a decrease.

2.

    • essential
      Incorrect. Whether a good is 'essential' or not has no bearing on the evidence presented.
    • normal
      Incorrect. we would expect to see demand increase as incomes rose if potatoes are a normal good.
    • inferior
      Correct. An inverse relationship between demand and incomes is the hallmark of an inferior good.

Watch It

A change in price does not shift the demand curve. It only shows a difference in the quantity demanded. The demand curve will move left or right when there is an underlying change in demand at all prices.

Other Factors That Shift Demand Curves

Income is not the only factor that causes a shift in demand. Other things that change demand include tastes and preferences, the composition or size of the population, the prices of related goods, and even expectations. A change in any one of the underlying factors that determine what quantity people are willing to buy at a given price will cause a shift in demand. Graphically, the new demand curve lies either to the right (an increase) or to the left (a decrease) of the original demand curve. Let's look at these factors.

Changing Tastes or Preferences


Figure 3. Changing Tastes. This man eats a chicken foot. Changes in society's preferences for chicken have led to changes in demand for certain foods.

From 1980 to 2012, the per-person consumption of chicken by Americans rose from 33 pounds per year to 81 pounds per year, and consumption of beef fell from 77 pounds per year to 57 pounds per year, according to the U.S. Department of Agriculture (USDA). Changes like these are largely due to shifts in taste, which change the quantity of a good demanded at every price: That is, they shift the demand curve for that good ­– rightward for chicken and leftward for beef.

Changes in the Composition of the Population

The proportion of elderly citizens in the United States population is rising. It rose from 9.8 percent in 1970 to 12.6 percent in 2000 and will be a projected (by the U.S. Census Bureau) 20 percent of the population by 2030. A society with relatively more children, like the United States in the 1960s, will have greater demand for goods and services like tricycles and day care facilities. A society with relatively more elderly persons, as the United States is projected to have by 2030, has a higher demand for nursing homes and hearing aids. Similarly, changes in the size of the population can affect the demand for housing and many other goods. Each of these changes in demand will be shown as a shift in the demand curve.

Changes in the Prices of Related Goods

The demand for a product can also be affected by changes in the prices of related goods such as substitutes or complements. A substitute is a good or service that can be used in place of another good or service. As electronic books become more available, you would expect to see a decrease in demand for traditional printed books. A lower price for a substitute decreases demand for the other product. For example, in recent years as the price of tablet computers has fallen, the quantity demanded has increased (because of the law of demand). Since people are purchasing tablets, there has been a decrease in demand for laptops, which can be shown graphically as a leftward shift in the demand curve for laptops. A higher price for a substitute good has the reverse effect.

Figure 4. Office Supplies.  A drop in the price of pens and pencils may lead to higher demand for complement office supplies.

Other goods are complements for each other, meaning that the goods are often used together, because consumption of one good tends to enhance consumption of the other. Examples include breakfast cereal and milk; notebooks and pens or pencils, golf balls and golf clubs; gasoline and sport utility vehicles; and the five-way combination of bacon, lettuce, tomato, mayonnaise, and bread. If the price of golf clubs rises, since the quantity of golf clubs demanded falls (because of the law of demand), demand for a complement good like golf balls decreases, too. Similarly, a higher price for skis would shift the demand curve for a complement good like ski resort trips to the left, while a lower price for a complement has the reverse effect.

Changes in Expectations About Future Prices

While it is clear that the price of a good affects the quantity demanded, it is also true that expectations about the future price (or expectations about tastes and preferences, income, and so on) can affect demand. For example, if people hear that a hurricane is coming, they may rush to the store to buy flashlight batteries and bottled water. If people learn that the price of a good like coffee is likely to rise in the future, they may head for the store to stock up on coffee now. These changes in demand are shown as shifts in the curve. Therefore, a shift in demand happens when a change in some economic factor (other than the current price) causes a different quantity to be demanded at every price.

Try It

Question 1

Natalie runs a fast food stand selling hot dogs and soft drinks. A decrease in the price of which good below is likely to negatively impact her bottom line?

    • t-shirts
    • mustard
    • hamburgers

Question 2

Over the past 10 years consumer incomes have grown by 15%, while the price of automobiles has increased by over 20%. Tires and automobiles are complement goods. What would be a reasonable expectation regarding the demand for tires today compared to 10 years ago?

    • The demand for tires will shift to the right because of the income effect.
    • It is impossible to know with the given information.
    • The demand for tires will shift to the left because the price of the complement good-automobiles- has increased.

Answer to Try It

1.

    • t-shirts
      The demand for tires will shift to the left because the price of the complement good-automobiles- has increased.
    • mustard
      This is incorrect. Mustard and hot dogs are likely to be complements, so if the price of mustard falls this will likely shift the demand curve for hot dogs to the right, increasing her sales.
    • hamburgers
      Correct. Hamburgers and hot dog are likely to be substitutes, so if the price of hamburgers falls this will likely shift the demand curve for hot dogs to the left, decreasing her sales of hot dogs.

2.

    • The demand for tires will shift to the right because of the income effect.
      While the income effect is likely to increase demand for automobiles and therefore tires, the effect of a price increase for the complement good automobiles must also be considered.
    • It is impossible to know with the given information.
      Correct. The income effect will increase demand for tires, while the increase in the price of automobiles will decrease demand. It is impossible to know at the present time which effect is stronger.
    • The demand for tires will shift to the left because the price of the complement good-automobiles- has increased.
      While increasing the price of a complement good would decrease demand for tires, the impact of income on tires and automobiles must also be considered.

Exercise: Shift In Demand Due To Income Increase

A shift in demand means that at any price (and at every price), the quantity demanded will be different than it was before. Following is a graphic illustration of a shift in demand due to an income increase.

Step 1. Draw the graph of a demand curve for a normal good like pizza. Pick a price (like P0). Identify the corresponding Q0. An example is shown in Figure 5.


Figure 5. Demand Curve. A demand curve can be used to identify how much consumers would buy at any given price.

Step 2. Suppose income increases. As a result of the change, are consumers going to buy more or less pizza? The answer is more. Draw a dotted horizontal line from the chosen price, through the original quantity demanded, to the new point with the new Q1. Draw a dotted vertical line down to the horizontal axis and label the new Q1. An example is provided in Figure 6.


Figure 6. Demand Curve with Income Increase. With an increase in income, consumers will purchase larger quantities, pushing demand to the right.

Step 3. Now, shift the curve through the new point. You will see that an increase in income causes an upward (or rightward) shift in the demand curve, so that at any price, the quantities demanded will be higher, as shown in Figure 7.


Figure 7. Demand Curve Shifted Right. With an increase in income, consumers will purchase larger quantities, pushing demand to the right, and causing the demand curve to shift right.

Figure 8. Remember that changes in price change the point of quantity demanded on the demand curve, but changes in other factors (such as taste, population, income, expectations, and prices of other goods) will cause the entire demand curve to shift.

Summary: What Factors Shift Demand?

Six factors that can shift demand curves are summarized in Figure 9, below. The direction of the arrows indicates whether the demand curve shifts represent an increase in demand or a decrease in demand. Notice that a change in the price of the good or service itself is not listed among the factors that can shift a demand curve. A change in the price of a good or service causes a movement along a specific demand curve, and it typically leads to some change in the quantity demanded, but it does not shift the demand curve.

Figure 9. Factors That Shift Demand Curves (a) A list of factors that can cause an increase in demand from D0 to D1. (b) The same factors, if their direction is reversed, can cause a decrease in demand from D0 to D1.

Try It

Question 1

You are a consultant analyzing the American car market for the new Toyota Prius. Your chief competitor Tesla has recently dropped the list price of their vehicles by 20%. When illustrating shifts of the demand curve it is customary to draw arrows to show the direction of change. Which directions should the arrows be drawn in the graph below? Which curve represents old demand and which curve the new demand?


    • The arrows should be drawn pointing leftwards, The curve on the right represents the old demand and the curve on the left new demand.
    • The arrows should be drawn pointing rightwards. The curve on the right represents the new demand and the curve on the left old demand.
    • The arrows should be drawn pointing leftwards. The curve on the right represents the new demand and the curve on the left old demand.

Question 2

You are in charge of data analytics for Home Depot's South Florida division. Recently you have observed a change in the market for power generators illustrated below. Which explanation best corresponds with the observed data?


    • A hurricane is expected to arrive next week.
    • The price of a competitor's generators has fallen.
    • The price home depot generators has dropped 20%

Answer to Try It

1.

    • The arrows should be drawn pointing leftwards, The curve on the right represents the old demand and the curve on the left new demand.
      Correct. If the price of a substitute good decreases we would expect demand to increase for that good, thereby lowering demand and shifting the curve to the left for the substitute.
    • The arrows should be drawn pointing rightwards. The curve on the right represents the new demand and the curve on the left old demand.
      This is incorrect. If the price of a substitute good decreases we would expect demand to shift leftwards.
    • The arrows should be drawn pointing leftwards. The curve on the right represents the new demand and the curve on the left old demand.
      This is incorrect. While the arrows may be pointing in the correct direction, the curve on the left should represent new demand and the curve on the right old demand.

2.

    • A hurricane is expected to arrive next week.
      Correct! Expectations of an impeding storm are likely to increase short-run demand, which is consistent with what we observe in the demand curves here.
    • The price of a competitor's generators has fallen.
      This is incorrect. A drop in the price of substitute goods will cause a leftward shift of the demand curve.
    • The price home depot generators has dropped 20%
      This is incorrect. A price change would cause a movement along the demand curve, not a shift in demand.

Try It

These questions allow you to get as much practice as you need, as you can click the link at the top of the first question ("Try another version of these questions") to get a new set of questions. Practice until you feel comfortable doing the questions and then move on.

Note that you will use the information provided in the first question for all of the questions on this page.

Glossary

complements:
goods or services that are used together because the use of one enhances the use of the other

substitutes:
goods or services that can be used in place of one another

inferior good:
good or service whose demand decreases when a consumer's income increases and demand increases when income decreases

normal good:
good or service whose demand increases when a consumer's income increases and demand decreases when income decreases