Economics I

Reading 12. Topics in Demand and Supply Analysis

Learning Outcome Statements

a. calculate and interpret price, income, and cross-price elasticities of demand and describe factors that affect each measure;

CFA Curriculum, 2020, Volume 2

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Subject 1. Demand Concepts

The demand function represents buyers' behavior.

The quantity demanded of good X depends on its price, consumers' income, and the price of good Y, etc.

Prices influence consumers' purchase decisions. The demand function can be depicted as a negatively sloped demand curve.

  • If all other factors are equal, as the price of a good rises, consumer demand falls. This is mainly due to the availability of substitutes, which are goods that perform similar functions.
  • As the price of a good falls, consumer demand rises.

Therefore, there is an inverse relationship between the price of a good and the amount that consumers are willing to buy. The demand curve normally slopes downward. It tells the analyst the quantity that consumers are willing to buy for each possible price when all other influences on consumers' planned purchases remain the same.

Example 1

Refer to the graph below. What is the quantity of cassettes demanded when their price is $4.00 per week?

Answer: Two cassettes per week. The demand curve tells how much is demanded at each price. To determine the quantity demanded, find $4.00 on the vertical axis and read across until you meet the demand curve. Then read the quantity from the horizontal axis.

When any factor that influences buying plans, other than the price of the good, changes, there is a change in demand for that good. When the quantity of the good that people plan to buy changes at each and every price, there is a new demand curve. These factors include changes in income, number of consumers in the market, changes in the price of a related good, etc.

Example 2

Assume the graph below reflects demand in the automobile market. Which arrow best captures the impact of increased consumer income on the automobile market?

Answer: D. Income is a shift factor of demand. An increase in income increases the number of automobiles demanded at each price. Therefore demand has shifted to the right.

  • When demand increases, the quantity that people plan to buy increases at each and every price, so the demand curve shifts rightward.
  • When demand decreases, the quantity that people plan to buy decreases at each and every price, so the demand curve shifts leftward.

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