Demand Curves

The new Business Awareness unit at AAT level 3 Q2022 looks at a wide variety of factors that affect a business, from interest rates and exchange rates, to factors such as the behaviour of competitors and customers.  One of the most significant influences on a business is the market that the business operates.  The market can be broken down into supply and demand.

Demand Curves

The new Business Awareness unit at AAT level 3 Q2022 looks at a wide variety of factors that affect a business, from interest rates and exchange rates, to factors such as the behaviour of competitors and customers.  One of the most significant influences on a business is the market that the business operates.  The market can be broken down into supply and demand.

What is Demand?

This month I am going to look at demand, and next month I will look at supply.  Demand is how much people want a product and how much they want to pay for it.  Whereas supply is how much of a product there is available and how much a supplier wants for their goods.  Sounds simple right?  Well not so much as we all know things never stay the same.

Typically, most goods follow what is known as the Law of Demand.  This means that demand for a product goes up as the price goes down.  This also works the other way in that if the price goes up, the demand goes down.  At different prices you will have different demand, and at these points you can plot this demand as a graph, known as the demand curve (even though typically it is a straight line).  This gives you a graph which shows that as the price goes up, the demand goes down. Imagine this as a graph with the demand on the horizontal axis and the price on the vertical axis.  You will have line graph that looks like the below:

You can then use this to predict demand at different price points.

However, just when you think you have everything in hand, something can occur that will shift the demand curve either to the left or the right.  This means that that quantity demanded will be more or less than it was at a certain price point.  So, what could cause the demand curve to move?  If the curve moves to the less the demand at the price point will be less, if it moves to the right the demand at that price point will be greater.

We all know about the cost of living at the moment, and this will change how much income people have.  Some products will see a fall in demand if people have less money, these are known as normal goods.  Most items are normal goods.  There are goods however, which will see their demand increase if people have less money.  In this case the demand curve will move to the right, and there will be more demand for a product at a certain price point.  These goods are known as inferior goods, and an example of these might be supermarket’s own brand goods.  People may buy the less premium goods if they feel they have less disposable income.  Finally, we then have the goods where demand will not change depending on people’s income.  These are known as necessity goods.  You don’t buy more of them if your income goes up, but you don’t buy any less of them if your income goes down.  A good example of this is your water bill.  You generally don’t get a pay rise think that you will splurge it all on flushing the toilet more!  The demand curve doesn’t move.

What else can cause the demand curve to move?

Changes to customers tastes and preferences will mean that there is now more demand for some products at a certain price point, and perhaps less demand for other products than there was previously at certain price points.  For example, there might be more demand for more sustainable clothing now, and there is less demand for what you could describe as more cheaper, disposable clothing than there was previously.

A change in price of a different product can affect the demand for your product.  How might you ask?  Well, your product might have a complementary product that goes along with your product.  You might sell diesel cars, and if the price of diesel goes up, the demand for your diesel cars goes down.

A substitute product is a product that customers can use instead of your product.  A change in the price of a substitute product can change the demand for your product. Going back to our diesel car example, if the prices of electric cars fall, you may well see that demand for diesel cars fall, and the demand curve moves to the left.

Why don’t you have a go at the below questions to see if you know what will happen to the demand curve for various situations:

1) Which of the following are likely to be necessity goods:

  • Tobacco
  • Milk
  • Air travel
  • Laptops

2) If the price of a substitute product increases, will the demand curve move to the left or to the right?

3) If the price of a complementary product increases will the demand curve more the left or to the right?

Click below to view the answers to the questions above!

Answers

1) Tobacco and milk

2) The demand curve would move to the right as people are less likely to buy the substitute product and more likely to buy your product.

3) The demand curve would move to the left, as if the demand for your complementary product falls, the demand for your product will fall.

FURTHER READING

AAT Q2022 Level 3 Business Awareness – PESTLE analysis

AAT Q2022 - Level 3 - Learn More

AAT Q2022 – Level 3 Diploma in Accounting

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