Factors affecting Demand

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Factors affecting Demand
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Demand

• for a commodity occurs when people have a
  desire for a commodity, coupled with the
  willingness and ability to purchase it.

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What factors can you think of that might affect
demand?

• Price of the commodity (PA)
• Level of income (Y)
• Price of substitute goods
• Price of complementary goods
• Consumer tastes (T)
• DA f(PA, Y, PB,,PN, T)

(PB,, PN)
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(a) How demand for a commodity varies with the
price of that commodity

• DA f(PA, other variable constant)

Quantity demanded (DA) ? Quantity demanded (DA) ?

• Price (PA) ? ?
• Price (PA) ? ?

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Consider the effect of a price change on the
demand of these goods

• A 50 reduction in the price of Shell petrol
  (other companies price remains unchanged)
• A 50 reduction in the price of milk

• The demand for Shell Petrol is likely to be price
  sensitive (Elastic)

• The demand for milk is likely not to be price
  sensitive (Inelastic)

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Price Elasticity of Demand EDp

• Petrol
• Assume Price falls from 10 to 8 ? increase in
  demand from 5 to 9 units
• change in demand (9-5)/5x100 4/5x10080
• change in price (8-10)/10x100
  -2/10x100-20
• EDp 80 / -20 -4

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Price Elasticity of Demand EDp

• Milk
• Assume Price falls from 10 to 4 ? increase in
  demand from 6 to 8 units

(8-6)/6x100 2/6x10033 (4-10)/10x100
-6/10x100-60 33 / -60 -0.55

• change in demand
• change in price
• EDp

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Price Elasticity of Demand EDp

• Demand curve for petrol

• Demand curve for milk

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Price Elasticity of Demand EDp

• EDp -1 Demand is unit-elastic
• An x price change ? x change in demand
• EDp 0 to -1 Demand is price-inelastic
• The change demand is smaller than change in
  price
• EDp -1 to -? Demand is price-elastic
• The change demand is greater than change in
  price

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Factors that determine the sensitivity of demand
to price?

• The presence of substitute goods
• If substitute, e.g. ESSO petrol price-elastic
• If no substitute, e.g. Powdered milk?
  price-inelastic
• Cost of good in relation to household income
• Low cost ? Price-inelastic

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Factors that determine the sensitivity of demand
to price?

• Essential / non-essential nature of good
• Essential goods (food, water, clothes, shelter)
  are price-inelastic
• Non-essential goods are price elastic
• Consumer habits
• Tobacco is price-inelastic, e.g. increasing tax
  on cigarettes does not reduce demand

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The significance of Price Elasticity of Demand on
agriculture

• Most agricultural products are price inelastic
  (EDp 0 to -1)
• Although some of the luxury products can be price
  elastic (EDp -1 to -?)

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Consider the demand for Potatoes
S1

• During a normal (weather) year, Q1 potatoes are
  sold at price P1, to give a revenue of P1Q1
  (shaded area).

D
Price
P1
E1
D1
Q1
Quantity
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Consider the demand for Potatoes

• What will happen during favourable weather?
• We will get increased yields and therefore supply
  will increase resulting in a small increase in Q
  demanded and large reduction in price.
• Revenue will be reduced.
• Note we get a shift along the demand curve!

S2
E2
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Implications

• Potatoes have a low price-elasticity.
• Favourable weather give high yields but low
  prices, resulting in reduced revenue.
• Poor weather gives low yields but is compensating
  by high prices, resulting in increased revenue.
• Policy response?
• Measures to reduce production, i.e. the Potato
  marketing board used to restrict area of potatoes
  grow divert potatoes to stock feed.

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(b) How demand varies with consumer income

• DA f(Y, other variable constant)
• If household get 10 increase in income, it will
  not increase its expenditure on all commodities
  equally.
• Income Elasticity of Demand (EDy)

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Income Elasticity of Demand EDy

• Following a 10 pay rise, you purchase
• 21 loaves of bread per month instead of 20 (5
  increase)
• 8 bottles of wine per month instead of 4 bottles
  (200 increase)
• 1 tubs of margarine per month instead of 2 tubs
  (50 reduction), i.e. you now also buy butter.
• EDy(Bread) 5 / 10 0.5 Normal good
• EDy(Wine) 200 / 10 20 Luxury good
• EDy(Marg) -50 / 10 -5 Inferior good

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Income Elasticity of Demand EDy

• A normal good
• Demand increases as income rises.
• A positive income elasticity of demand.
• An inferior good
• Demand falls as income rises
• A negative income elasticity of demand.
• An luxury good has an income elasticity gt1
• A necessity has an income elasticity lt1. Note all
  inferior goods are necessities.

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Income Elasticity of Demand EDy

• Demand curve for normal good

• Demand curve for luxury good

Small movement to right
Large movement to right
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Income Elasticity of Expenditure on good A

• Uses expenditure on a good, rather than a
  physical measure of change in demand (as used in
  EDy).

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Engels Law
Total spend

• The proportion of personal expenditure devoted to
  necessities decreases as income rises.

Luxuries
Expenditure ( / wk)
Food, clothing
Necessities
Income per wk
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Significance of EDy to rural areas

• Food products low EDy helps to explain why the
  agricultural industry is in decline
• Although the nations income is rising, a smaller
  portion is spent on food products.
• Therefore, although in absolute terms the farmer
  may be better off, he will be relatively worse
  off.
• To improve the situation, policies (such as the
  Welsh Food Strategy) aims to persuade farmers to
  produce and sell luxury products.

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The influence of changes in price of competitive
and complementary goods

• DA f(PB,,PN, other variables constant)

• Competitive goods Goods that are substitutes,
  e.g. butter and margarine.
• How would a price ? in butter affect the demand
  for marg?

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Cross Elasticity of Demand (EDx)

• The sensitivity of demand for margarine to the
  price of competitive goods is called Cross
  Elasticity of Demand.
• EDx of competitive goods is positive

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Complementary goods

• Complementary goods e.g. bread and butter.
• If the price of bread rises but that of butter is
  unaltered, the demand for both bread and butter
  will be lower.
• Cross elasticity of complementary goods are
  negative.

Effect on the Demand Curve of a Price Rise of a
complementary good
Price of butter
D1
D2
Quantity of butter
Reduced demand for butter (movement to left)
caused by a rise in the price of bread
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How demand is affected by tastes of consumers

• DA f(T, other variables constant)

Effect of changes in tastes on the Demand Curve
of a good

• An increase in demand caused by a change in
  consumer tastes towards the commodity will shift
  the demand curve for that commodity to the right
  so that more will be bought at any given price
  (D2).
• A change in tastes away from a commodity will
  shift the demand curve to the left (D3)

Price of Good A
D1
D2
D3
Quantity of Good A
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What factors might change consumer tastes?

• Personal experience (demand for pizzas increased
  as more people went on holiday to Italy)
• Advertising
• Food scares (BSE, Salmonella)

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Summary

• A demand curve shows the quantities of a
  commodity which consumers are willing and able to
  take from the market at a range of given prices.
• DA f(PA, Y, PB,,PN, T)
• A change in the price of a commodity, there is a
  shift along the demand curve.
• Changes in consumer income, price of a
  competitive or complementary good, changes in
  tastes result in a shift to the left or right of
  the whole demand curve.

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Further Reading

• Hill (1990). An introduction to economics for
  students of agriculture. Pergamon Press Oxford.
  Chapter 3
• Begg, Fisher and Dornbusch (2000). Economics.
  McGraw-Hill Maidenhead. Chapter 3 and 5