Question

What are the determinants of supply and demand in a market? Explain how these changes impact on supply and demand and use examples to support your answer.

(this question is worth 25 marks)

Answer 1

The five determinants of demand are:

• The price of the good or service.
• The income of buyers.
• The prices of related goods or services. These are either complementary (those purchased along with a particular good or service), or substitutes (those purchased instead of a certain good or service).
• The tastes or preferences of consumers.
• Consumer expectations. Most often, this refers to whether a consumer believes prices for the product will rise or fall in the future.

The major determinants of supply are:

• Greater the number of sellers, greater will be the quantity of a product or service supplied in a market and vice versa.
• Increase in resource prices increases the production costs thus shrinking profits and vice versa.
• Taxes reduces profits, therefore increase in taxes reduce supply whereas decrease in taxes increase supply. Subsidies reduce the burden of production costs on suppliers, thus increasing the profits.
• Improvement in technology enables more efficient production of goods and services.
• Change in expectations of suppliers about future price of a product or service may affect their current supply
• When two or more goods are produced in a joint process and the price of any of the product increases, the supply of all the joint products will be increased and vice versa.

Each factor's impact on demand is unique. When the income of the buyer increases, for example, that could also increase demand—the buyer has more money and is more likely to spend it. But when other factors increase—like the price of related goods,

• When income rises, so will the quantity demanded. When income falls, so will demand. But if your income doubles, you won't always buy twice as much of a particular good or service. There's only so many pints of ice cream you'd want to eat, no matter how wealthy you are,
• The price of complementary goods or services raises the cost of using the product you demand, so you'll want less. For example, when gas prices rose to $4 a gallon in 2008, the demand for gas-guzzling trucks and SUVs fell.
• When the public’s desires, emotions, or preferences change in favor of a product, so does the quantity demanded. Likewise, when tastes go against it, that depresses the amount demanded. Brand advertising tries to increase the desire for consumer goods.
• When people expect that the value of something will rise, they demand more of it. That helps explains the housing asset bubble of 2005
• The number of consumers affects overall, or “aggregate,” demand. As more buyers enter the market, demand rises
• Price of Inputs: When goods require less inputs (material, money, etc.), they are cheaper to make, so the supply increases. This would also apply to inferior goods.
• Price of Related Goods: If a similar good is at a higher price AND makes you more profit, the supply of the original good would fall while the supply of the similar good rises. This would also apply to inferior goods: if those inferior goods make less money, the supply drops, and vice versa.
• Number of Suppliers: When more people are making a good, the supply increases. The same would happen with inferior goods, for more people may make it which results in a rise of supply.
• Technology Improvements: When a technology makes it cheaper or easier to produce a good, you can make more. Therefore, the amount of that good that can be produced increases, and the supply rises. The same can be applied to inferior goods; if inferior goods are now easier to make, you may as well make more of them.
• Expected Prices: If the expected price of a good is greater than the current price, suppliers will hold back their goods so that they can sell them later at higher prices. This results in a drop of CURRENT supply. If an inferior good's price is expected to increase in the future, the suppliers will also hold back which drops supply.