Econ basics for noobs : Supply and Demand (Part II)

This article is part of a series called Econ basics for noobs. This is the second part and here is the link to the first part which talks about the supply part of the demand and supply topic.

Till now we have discussed the following things:

  1. What is supply
  2. The Law of supply
  3. The shifts in the graph of supply
  4. The factors that cause the shifts in the graph of supply

In this article I will talk about what demand is and what factors affect demand. Well, demand is the desire of the consumer to have a good or service in exchange for a price they are willing to pay. Remember the time you go to a grocery store and almost always choose a Balaji over a Lays because you feel that you prefer to eat chips instead of nitrogen. Well a lot of consumers like you are here increasing the demand for Balaji because it is comparatively cheaper. Since the price of Balaji is low the demand for Balaji is high. What if Balaji decides to double its price for the same packet? People are going to get hesitant to buying Balaji now which in turn is going to decrease the quantity demanded in the market. So the demand went down when the price increased. This is an example of how the law of demand works.

The law of demand states that the quantity demanded and the price of a commodity are inversely proportional to each other.

The Demand Curve

Well, there are some reasons as to why demand and price are inversely proportional to each other. These are namely the substitution effect, the income effect and the law of diminishing marginal utility (phew, so much for making it simple).

Let’s again move to our previous example and look at each of these effects and how they affect the price. When Balaji increased its price, people would have been more open to buying some other chips which is maybe cheaper than Balaji maybe chips XYZ. Here the consumers are replacing (substituting) Balaji with some other brand thus decreasing the demand for Balaji. So an increase in the price of Balaji is causing it to get substituted by some other cheaper product, this is known as the substitution effect. Now, suppose our moms decide to increase our pocket money (cause we still live in our parent’s basement duh!), thus now we have more to spend and may start considering buying that packet of Balaji cause is tastes better than the cheaper substitute. If this phenomenon is seen in a large population where they have more to spend cause of an increase in their incomes then the demand for Balaji is again going to go up which will be cause by the income effect.

Now, imagine a situation where you have bought yourself ten packets of Balaji because why not, when you have the first packet of chips you love the taste, with the second packet of chips its not as great as the first one and as you keep on having more and more chips the satisfaction you receive from it keeps on decreasing at a steady rate and you reach a point where you don’t feel like eating any more chips at all. Then we maybe start looking for chocolates to eat. This is what happens when there is surplus of some commodity in the market, the consumers hit a point where the amount of satisfaction (in some case gratification) received from a commodity is not high enough to spend money on it, which in turn is going to decrease the demand for the commodity. This phenomenon is known as the law of diminishing (decreasing) marginal (additional) utility (satisfaction).

Different effects on the demand curve

Note: All the above mentioned effects only affect the price and the demand and do not shift the demand curve, thus they only move the point along the curve.

Let’s look at the ways in which there can be a shift in these graphs i.e. a change in the demand. Actually any factor apart from a change in price is going to cause a change in the demand (in turn causing a shift in the graph).

There are namely five major shifters of demand :

  1. Taste/Preference: Suppose a study comes out which states that eating Balaji everyday is the root cause to developing cholesterol. People are surely going to be reluctant to buying Balaji even if the price didn’t change. Thus this is going to cause a shift (left shift in this case) in the graph of the demand.
The shift is to the left due to the decrease in demand

2. Number of Consumers: If there is an influx of people in the states where Balaji is the only brand of chips available, people would be compelled to buy Balaji which is going to increase the demand of Balaji even when the price is constant. Thus an increase in the number of consumers can shift (right shift in this case) the graph.

The shift is to the right due to an increase in the demand

3. Price of related goods: This one is simple to understand, when the price of a competitive commodity like Lays goes down the demand for Balaji is going to decrease (left shift in graph) as people will opt to buy Lays more. Whereas when a complementing commodity like cold drink gets cheaper, then people would prefer to buy both chips and coke cause of their complementing nature. This is going to increase (right shift in graph) the demand for Balaji.

4. Expectation: If you anticipate that the price of Balaji is going to decrease in the coming few days owing to the festive season, you may choose to withhold buying that packet of chips for now. This is in turn going to decease (left shift in the graph) the demand for Balaji even though there has been no change in price, rather just an expectation of the change in the price.

These were the factors that cause a shift in the graphs to the left or the right i.e. an increase or decrease in demand caused from something apart from change in price.

In the next article I am going to look at what happens when we consider both supply and demand together and how an equilibrium in the price and quantity is achieved. I am also going to take up the different changes that can shift the equilibrium.

Hope you all found this interesting and easy to understand. I would really appreciate your support. Your support will motivate me to write more articles like this so maybe leave a clap and share it if you found this piece of article useful. I will soon release the next part of this series. Till then Cheers!

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