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Thursday, 4 August 2011

Conditions that affect Supply and Demand

Demand

These following conditions cause demand to fall and shift leftwards:
  • Low prices of substitute goods (goods that perform the same function as each other and can be used as substitutes for one another, for example, a computer and a laptop). If substitute goods are cheaper, then demand for the original good will fall because consumers are buying the substitutes (assuming everything else remains constant – ceteris paribus).
  • High prices of complementary goods (goods that are bought with each other, for example a printer and printer ink). If complementary goods are sold at high prices, consumers may decide the purchase is not worth it, ceteris paribus.
  • Low personal income. This leads the household with lower disposable income for spending, therefore demand for goods and services may fall.
  • Tastes and preferences for the good changes.
The reverse of these factors will cause demand to rise and shift rightwards.

Supply

The following factors cause (short run) supply to fall and shift leftwards:

  • High costs of production
    • Wage costs
    • Rent prices
    • Commodity/raw material costs
    • Cost of borrowing (higher interest rates)
  • Higher taxes
    • Corporation tax
    •  VAT
    • Excise duties
  • Lack of subsidies/grants

These factors can cause firms to leave the market, thus resulting in a fall of supply.


The opposite of the factors above can cause supply to increase and shift rightwards, along with the addition of technical progress.

Word of the Day

Law of Diminishing Marginal Returns

States that when a variable factor of production is added to a fixed factor of production, the result will be an increase in marginal output. However after a certain point, the marginal returns will eventually start to fall. The law only operates in the SHORT RUN

When more and more labour (variable factor) is added to machinery and equipment (fixed factor), the marginal product of labour will fall because the workers are getting in each other's way. They are not any less hard working or motivated.
The LoDMR is also the reason why the AC curve falls and then increases.

Before point A, average costs fall as output increases because the addition of variable factors cause an increase in marginal output. Also, the average variable cost (AVC) curve falls slightly , accounting for the fall in average total costs.

After point A, AC rises due to the LoDMR because variable costs to rise.
Remember AC = AVC+AFC  therefore if AVC rises, AC rises. (AFC - average fixed cost)
The spreading of fixed costs become insufficient in the short run.