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Supply, Demand, and the Invisible Hand

Demand Change!

Okay, let's stop holding everything else equal. Aside from movements in prices, what factors might cause a change in the demand for a product such as beef?

Overall demand can change, moving upward or downward, because of changes in:

  • Preferences
  • Population
  • Prices of other goods and services
  • Incomes
  • Perceptions of future prices

Preferences

In Overview of Economics, I mentioned that people express their preferences in the transactions they enter into. Some people like beef and some don't. Moreover, people's preferences can, and usually do, change over time. For instance, demand for beef can increase or decrease because of social trends—say, toward or away from steakhouse dining or vegetarianism—and health concerns—beef is high in cholesterol, but also rich in iron.

Population

In GDP and the Players Three, I noted that population growth affects consumption (consumer demand). That's also true for the demand for a specific product. Imagine that Argentina's economy collapses (which it did in 2002) and hundreds of thousands of Argentines immigrate to the United States (which they did not). The people of Argentina are great beef eaters, and a huge number of Argentines entering the U.S. population could conceivably increase the demand for beef. Usually, however, population growth occurs slowly over time, exerting gentle, long-term pressure on demand.

The more important reasons for a change in demand, however, involve factors other than preferences or population. Key among these is the price of other goods and people's incomes.

Prices of Other Goods

EconoTalk

A substitute is a product or service that people use in place of another product or service. A complement is a product or service that people use with another product or service.

Normal goods are those for which demand increases as people's incomes increase. Inferior goods are those for which demand decreases as income increases.

If the price of beef remained the same while the price of chicken fell dramatically, what do you think the effect on the demand for beef would be?

Demand for beef would decrease.

Why? Because chicken is a substitute for beef. A substitute is a product or service that people use in place of another product or service. When shoppers in supermarkets see that that the price of chicken has plummeted while the price of beef has stayed the same, they'll substitute chicken for beef in their diets. They may not eliminate beef, but they will certainly start eating more chicken and less beef. This would also happen at fast-food restaurants—more Kentucky Fried Chicken and fewer Big Macs would be sold. Other examples of substitutes include rice and potatoes, bus rides and subway rides, and (to the horror of the music industry) compact discs and music shared over the Internet.

Sometimes the price of a complement to a product can affect demand for the product. A complement is a product or service that people use with another product or service. For example, if the price of hamburger rolls were to increase dramatically, we could expect demand for hamburger meat to decrease. Other examples of complements include DVD players and DVD disks, turkey and stuffing, rods and reels, gin and vermouth.

Income

Changes in income can also change overall demand for a product or service. As people's incomes rise, they demand more goods and services. They also demand better goods and services—the “good things in life.”

Most people still rate beef among those “good” things, and indeed more beef is consumed in wealthy nations than in poorer nations. Similarly, when people's incomes fall, they demand fewer goods and services—and fewer of the “good things in life.” Therefore, if incomes increase, we would expect demand for beef to increase. If people's incomes were to decrease, we would also expect a decrease in the demand for beef.

Incidentally, this assumes that beef is among what economists call normal goods. Normal goods are those for which demand increases as incomes rise, which includes many products and services. Products and services that see decreased demand when incomes rise are called inferior goods. Porgies—a bland, bony, but inexpensive fish—are a good example of such a product. Subway rides are such a service. As incomes rise, people substitute salmon for porgies and taxi rides for subway rides.

Perception of Future Prices

One other factor can shift demand for a product: the price people expect to pay for it in the future. If people suddenly learned that beef prices were going to double next month, they would probably stock up their freezers with steaks, roasts, and hamburgers this month. People buy and hoard products when they believe sharp price increases lay ahead.

Notice that this factor does not affect services as much. You might have dental work done or have your house painted right now, if you knew the price of those services was going to increase soon. But you could not have two haircuts or make two visits to your doctor now in the hope of not needing another one in the near future.

book cover

Excerpted from The Complete Idiot's Guide to Economics © 2003 by Tom Gorman. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

To order this book direct from the publisher, visit the Penguin USA website or call 1-800-253-6476. You can also purchase this book at Amazon.com and Barnes & Noble.

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