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goods, trade can occur. If price reflects the opportunity cost of production, then trade between North and South makes economic sense.

In exchange there are essentially two parties – a buyer and a seller. Demand exists that might be met by supply – once quantity demanded and quantity supplied coincide at a price which the buyer is willing to pay and which the seller is willing to accept. The next section explains the process through which prices are set.

2 . 3 D E M A N D

The economic concept of demand is quite specific.

Demand describes the desire to purchase, supported by an ability to pay together with an intention of making the purchase over a specific time period, e.g. the demand for cars in 2003 describes the quantity of cars that buyers intend to buy and can pay for in that period. Across all possible buyers demand (usually) exists over a range of prices.

Demand can relate to a particular group of people, e.g. the demand for cars by fleet buyers (company cars), or demand might be related to a specific geographical area as in the demand for fish in the UK, Germany, France, London, etc. Demand is the relationship between the quantity of a good (or service) buyers intend to buy and their willingness and ability to pay.

Economists refer to a law of demand according to which at higher prices the quantity demanded of a good is expected to be lower than at lower prices. The price of a product is considered to be a central factor affecting the intention to make a purchase. Figure 2.1 presents demand for cars in Europe, i.e. the relationship between the price of cars and the quantity demanded in Europe. (See www.autoindustry.co.uk where quantities of cars sold across Europe are provided.)

Graphs of demand conventionally present quantity on the horizontal axis and price on the vertical axis. This convention is followed despite the fact that quantity is the dependent (Y) variable while price is the causal (X) or independent variable. We saw in Chapter 1, that mathematicians place the independent variable (Y) on the horizontal axis.

A negative relationship exists between price and quantity demanded, reflected in the downward slope of the demand curve since, at relatively high prices, we expect quantity demanded to be low or, if price is relatively low, we expect quantity demanded be high.

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Price					Price	Quantity
24	a				(£000)	(millions/year)
					6	30
			Demand
		b			12	15
18			for cars
					18	9
12			c		24	7
6				d
0	7 9		15	30	Quantity
F I G U R E 2 . 1 T H E D E M A N D C U R V E
A N D D E M A N D S C H E D U L E

The table presented in Figure 2.1 is a demand schedule of the quantity of cars demanded by those individuals with plans to buy cars over a range of prices. At a price of £6000, 30 million cars would be demanded. At a higher price of £12 000, the quantity demanded would be lower at 15 million. At higher prices, quantity demanded would decline further to 9 million at a price of £18 000 and to 7 million at £24 000.

For a given demand curve and demand schedule, a change in price gives rise to a change in quantity demanded.

Two reasons explain the negative relationship between price and quantity demanded. Most goods have potential substitutes – goods that might serve a similar purpose from the buyers’ perspective. For cars, possible substitutes include public transport, bicycles or motorcycles. If the price of cars increases relative to the price of substitutes, it may change people’s behaviour in terms of their intended purchases of cars.

As the price of one good increases, people buy less of it preferring its relatively cheaper substitutes. This is known as the substitution effect.

If the price of one good changes, this affects buyers’ purchasing power which is their ability to buy quantities of goods and services. Purchasing power depends on income and prices; given their income, if car prices rise, car buyers’ purchasing power is adversely affected as their income allows them to buy fewer cars (or put another way, if they buy a car they have less to spend on other goods and services). At the level of individual car buyers, effects of higher car prices will include some

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buyers opting for cheaper brand cars, some opting for smaller cars than they would otherwise choose, some buyers postponing their decisions to buy, and some moving to substitute products.

Alternatively if car prices dropped, the purchasing power of car buyers would increase and economists would expect that due to the income effect more cars would be bought.

Economists expect that in the face of higher car prices and a fixed income, buyers would plan to buy fewer cars. This is known as the income effect.

2.3.1NON-PRICE DETERMINANTS OF DEMAND

Car buyers’ intentions are related to the price of cars but price is by no means the only factor that enters into the buyers’ decisions. Other relevant factors include:

•	prices of related goods/services;	•	Population;
•	buyers’ income;	•	Expected future prices;
•	preferences;	•	consumer confidence.

The effect of each of these factors on demand, ceteris paribus, is considered in turn. In practice, any number of these factors might have an influence on demand at any point in time.

Prices of related goods/services: complements and substitutes

Many products are consumed in conjunction with others as with cars and car insurance, or cars and petrol/diesel. Car insurance and petrol are described as complements to car consumption. Changes in the prices of complement goods like petrol and insurance can have a knock-on impact on the demand for cars.

The price of oil has an effect on petrol prices. Oil prices hit a 25-year low of $11 per barrel in February 1999 but rose to a peak of almost $35 per barrel in the first week of September 2000. In many European countries, soaring fuel prices brought protesters onto the streets and road blockades were common.

Similar rises in oil prices in 1973/4 (when oil prices tripled) and 1979/80 (when prices doubled) are known as the oil-price shocks and these unexpected economic events had significant consequences on most economies dependent on oil imports because resources that would have been spent on buying other goods and services had instead to be spent on oil imports.

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Increases in the price of complement products (petrol/diesel) can alter the demand for a good (cars). The effect may not be immediate as in the case of cars where owners require fuel for their transportation needs and the fuel costs may be small relative to the cost of the purchase itself; however, rising fuel costs might tempt some individuals to alternative modes of transport, where it is available. Cars come under the category of durable consumption goods (bought by households for nonbusiness use with a lifespan of at least three years – cars, washing machines, PCs) that are not purchased regularly (by most people) and are therefore considered a ‘lumpy’ or irregular type of purchase as opposed to other non-durable purchases made on a more regular basis (food, clothing, cigarettes). For both durable and non-durable goods, the usual expected effect of an increase in the price of a complementary good (e.g. petrol) is a decline in demand for the good for which it is a complement (cars). Further effects could include an increase in demand for low-fuel consumption or smaller and lighter vehicles or increased research into vehicles that can run on alternative fuels.

Insurance costs are another complement good of cars and large increases in insurance premiums could cause some consumers to change their plans to buy a car, leading to a drop in quantity demanded at each price. Again, it is reasonable to consider that a substantial insurance price increase would be required to change demand behaviour as the decision to spend £12 000, for example, on a car will not be greatly affected by a minor change in the price of a complementary good.

As explained above, changes in prices of substitute goods can also affect demand. If public transport becomes cheaper, relative to transport by car, demand for cars could conceivably decline.

Congestion charges (£5) were introduced for motorists driving in inner-city London from February 2003. Six months after its implementation 50 000 fewer cars were entering the congestion zone daily, a drop of 16%, meeting one objective of reducing congestion (estimated at 30%) and saving time (car journeys were reduced by 14%). If as is anticipated, this makes public transport a relatively more attractive option for some drivers, demand for cars in London will fall. Hence, council or government regulations impact Demand also (this point is further developed later).

Buyers’ income

Planned expenditure on any goods or services depends on disposable income (aftertax or net income; pre-tax income is known also as gross income). As a general rule

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of thumb, if disposable incomes rise, demands for most goods rise also. This is true for goods called normal goods. For inferior goods, demand falls as income rises. Examples of such goods might be cheap cuts of meat or lowest-priced products.

If incomes rise, economists expect that the demand for cars would also rise, especially where the rise was believed to be permanent. Planned purchases might not change significantly for a temporary or one-off increase in income (a tax rebate) but would be more likely to change following a salary increase. Consumers’ expectations about their future income also play a role in their buying decisions and although they cannot know with certainty what income will be earned in the future, they make plans based on available information.

Preferences

Consumer demand also depends on tastes and preferences, which are subjective and vary across consumers. Tastes are shaped by factors as diverse as culture, background, education, past experience and advertising. An environmentally conscious consumer with access to public transport has less demand for cars than other consumers.

Population

Generally speaking, in regions with large populations, the demand for all goods and services is greater relative to regions with lower populations. Demand for cars is greater in the USA than in the UK, in cities rather than rural areas and is greater in the UK than in Ireland. The ceteris paribus assumption is relevant here, though differences in living standards are also relevant. For example, in India or China, with low relative living standards, demand for some goods will be lower than in more developed countries, irrespective of population differences.

Expected future prices

Demand for some goods is affected by expectations of future price changes. If car prices are expected to fall in the future, many consumers will postpone car buying until prices fall as the opportunity cost of the car is lower in the future. Buyers choose to purchase at different points in time depending on their expectation of prices.

Consumer confidence

Surveys of consumer confidence are conducted based on questions posed to a representative sample of consumers to gauge their opinions about their future buying plans.

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Consumer confidence reflects consumers’ opinions on their future purchasing plans.

It relates to the psychology underlying decisions about spending or saving and if consumers are pessimistic about the future, they may prefer to save rather than spend, reducing demand for some goods and services. In times of weak consumer confidence, purchases of durable goods such as cars usually fall. Often demand for non-durable ‘comfort products’ like alcohol, books or chocolate increase simultaneously.

The cause of weak consumer confidence is uncertainty about the future. Fear of future income due to job insecurity could be one cause. Expectations of higher prices could be another and there is some evidence that higher energy prices in 2001 in the USA explained some of the decline in consumer confidence. A decline in consumer confidence may be explained in terms of a negative wealth effect, according to which some consumers who feel richer as stock markets climb perceive themselves to be poorer when the markets decline, not because their earnings or savings lose value but for psychological rather than wholly rational reasons.

Businesses are concerned by consumer confidence because around two thirds of economic activity consists of consumer purchases. If consumers are not buying, businesses are not selling, stocks of unsold goods (inventories) build up and it may only be a matter of time before employees are made redundant.

Implications of changes in the influences on demand

When all other factors that could affect demand are unchanging, the effects of a price change alone on the quantity demanded can be considered. Staying with the car example, if the price of cars changes there is a movement from one point on the demand curve to another point along the curve; quantity demanded changes. If price increases from £12 000 to £18 000 quantity demanded moves from point c to b in Figure 2.1, i.e. a decline in quantity demanded from 15 to 9 million cars.

If any of the other factors influencing demand change, however, it causes a movement/shift in the demand curve; demand for the product changes. If customer preferences for sports utility vehicles (SUVs) increase, and they are substitute products for standard cars, the demand for cars is affected as illustrated with a movement of the demand curve shown in Figure 2.2.

At each price on the original demand curve (D1), the change in preferences causes a decline in quantity demanded resulting in a new demand curve (D2 ) that lies to the left of the original curve. The new demand schedule shows this decline