Question

1.What are the determinants of demand (factors that lead the demand curve to shift). Explain how each determinant affects demand.

2. What are the determinants of supply (factors that lead the supply curve to shift). Explain how each determinant affects supply.

Answer 1

1. Determinants of demand:

a. Price of the good. According to the law of demand, when price of a good increases, its demand falls. The price of the good is inversely related to its demand.

b. Income. Consumer's income and his demand for a particular good are directly related. As the consumer's income rises, he demands more of the good.

c. Prices of related goods/services. A good can have many substitutes or complements. A good's demand is directly related to the price of its substitute and is inversely related to the price of its complement.

d. Tastes and preferences. The consumer's preferences are not constant. They keep changing and evolving with time. This leads to a shift in the demand curve for the good.

e. Future expectations. If consumers know that the price of the good will rise in the near future, its present demand increases and vice versa.

2. Determinants of supply:

a. Price of the good. As the price of the good rises, supplying more of it is profitable for the producer. Hence, the product's price and its supply are directly related.

b. Price of related goods/services. If the price of a substitute good rises, the producers shift to production of that substitute good and the supply for the substitute good rises. Hence, price of the substitute good and supply are inversely related. The price of the complementary good and supply are directly related.

c. Price of factors of production. Production of any good requires various inputs. If the price of these inputs rises, it becomes costlier for the producer to produce the good and hence, supply falls. Hence, price of factors of production and supply are inversely related.

d. State of technology. This is closely related to the price of factors of production. If it becomes cheaper/easier to produce the good, its supply increases. Hence, technology and supply are directly related.