Exceptions to the law of demand

Veblen Goods are good which have a snob value status. Consumption of the good means more to consumers than just the direct utility received, people consume goods for the associated status and exclusivity. Not consuming enough of a Veblen good can also be a mark of inferiority and be considered demerit.

Any Veblen good starts off with a normal demand curve (under the snob value status price), the transformation to a Veblen good begins when the price rises above the Snob Price after which consumers believe that they should consume more of the good due to their high prices. Examples of such goods are diamonds and perfume. The increased consumption of such goods makes the user appear wealthy and cultured, which are not directly caused by the consumption of Veblen products.

Giffen Goods are a unique type of inferior goods that only exists in poverty. First of all, inferior goods are goods for which demand falls as prices rise, this is because consumers are now able to afford goods of better quality that perform the same functions. Perhaps the best example is matches, as the price of goods increase in general, consumers are likely to change their spending patterns and replace matches with lighters.
Examples of Giffen Goods are rice and potatoes, they are as such because of their importance to consumers. Being the main staple food for their respective cultures people are dependent on them and would always purchase such products regardless of its price. The price would just affect the quantity purchased.

While the law of demand states that as prices increase, the level of demand would fall, this is not observed for giffen goods. A good way to understand this phenonmom is to use a short example.

When the price of rice is low the demand for rice is low. This is because the people in poverty can purchase the same amount of rice that they would need for a lower price, meaning they have more disposible income to buy better quality products such as meat and vegetables. As prices increase, their real disposible income would fall, meaning consumers would be unable to buy the better products and resort back to the purchase of the staple good. This occurs because staple goods have NO substitutes.

Role of Expectations

The role of expectations can affect any good, but the most common goods affected are shares, stocks and resources such as gold and oil.

The expectations of consumers have direct impacts on their consumption patterns. If consumers expect inflation to be high, they would most likely spend more money in the near future. The opposite occurs if interest rates are expected to rise.

If the prices of goods are expected to rise, consumers would more likely purchase the good earlier to avoid having to pay extra charges in the future. There are many other examples.

Difference between Movement and Shift Along Demand Curve

A movement along a demand curve occurs when the ONLY factor that changes is price. Because only price changes and price is the Y Axis, there is no physical need for any translation of the demand curve. To find out the level of demand for the new price, you simply draw a line along the price and where it intersects the demand curve would be level of demand.
The diagram above indicates how a movement along a demand curve is best illustrated in a diagram. It is just an arrow along the demand curve in the correct direction. As price increases the movement would be to the left, as price decreases the movement would be to the right.

If the quantity decreases it is known as contraction.
If the quantity increases it is known as expansion.

*assumption is that price is the only factor that changes* Ceteris Paribus

In this diagram the shift from demand curve D1 to demand curve D2 is represented by an actual translation across the plane. This particular diagram features an inward shift to the left, or a shrink in demand. An outward shift would be an increase in demand.

This shift is caused by any actual changes in the determinants of demand.

The Fundamental Law of Demand

Demand is the quantity of a good or service that consumers are willing and able to purchase in a certain given time period.

The law of demand states that price has an inverse relationship with the level of demand. ie. As the price of a good decreases demand increases. This is best seen through the analysis of the following diagram.The demand curve is a downward sloping line because of diminishing marginal utility.
The extra utility from consuming more of any normal product falls, therefore consumers are less willing to pay as much for the consumption of another good.

As seen, the price of the goods and services decreases as you move along the demand curve.

"As goods get rarer, its price increases" Chinese Proverb.

The determinants of demand.

• price of the good
• price of other goods (substitute goods and complementary goods)

Substitute goods - the increase of the price of a substitute good leads to increased demand of the good identified.

Complementary goods - the increase in the price of a complementary good leads to a defcrease of demand for the good identified.

• changes in real disposable income (changes in the Fiscal and or Monetary policy/ interest rates and investment)
• availability of credit (if making loans or using credit cards is made easier or more popular demand would increase)
• expectations of the future, if consumer confidence is high or if consumers believe that supply would be scarce in the future demand would increase, leading to increasing prices
• taste changes would affect the demand as consumers tend to shop for "in" products
• advertising would increase demand of the good as more consumers would know about the good
• Seasonal Demand is affected by weather changes (example. demand for umbrellas and icecream)
• Population level would affect the level of demand (more people = more demand)

Importance of Price as a Signal

Changes in price indicates changes in demand and supply.
This is how it works:
Demand for shares fall, this is indicated by the inward shift of the demand curve from D1 to D2 towards the left.

Prices fall to indicate demand fell. Which as shown in the diagram is from Price level P1 to P2.

Revenue and Profits falls, these are indicators to producers who realise that their products' demand has fallen from Q1 to Q2. Factors of production are made redundant and resources are allocated to other more profitable products.

The change in price indicates to producers the level of demand in any economy in any certain time period. It acts as a link between consumers and scarce resources and this in turn influences the choice that producers make when deciding what goods and services they are willing to supply, and where resources are best allocated to.

Section 2 Microeconomics : Markets

A market is a place where buyers and sellers meet and trade goods and services.

The IB requires examples of markets in a local market scale, national scale and international scale. The corresponding examples could be a corner kiosk, a national newspaper and a car manufacturer.

There are 4 basic market forms that we must know in brief for all students. Other than this Higher Level students would learn about this in more depth in the theory of the firm.

Perfect Competition is the "ideal" form of competition, where there are many competitors producing same products and selling it at the price that the market sets it at. No barriers to entry exist.

Monopoly is where there is little or no competition, the producer has the power to 'make' price and profits high. Barriers to entry exist.

Oligopoly is where a few firms own or control the production or provision of goods and services in an economy. They act together to maintain prices at a high level and rely on non competition. They use advertisment and promotions to build up a sense of brand loyalty. Barriers to entry exist.

Monopolistic Competition is where each firm has a little market power and a small ability to set prices, they sell slightly differentiated products. No barriers to entry exist.

Following that glitchy table I have decided to insert a photo in place of another table.

Disadvantages of these Market Structures

Disadvantages of these economies. *Yes, the IB are pessimistics and more often than not ask for the faults of market structures than the benefits*

Free Market Economy	Planned Economy
over provision of demerit goods (high prices and profits - more in market failure)	there will be misallocation of resource (shortages and surpluses exist) as production, investment and trade are too complicated to plan, it is also difficult to predict consumer spending patterns
under provision of merit goods (only for those who can afford them)	the lack of price systems causes inefficiency
unsustainable development (resources used too much, environment polluted as they want to minimise costs and maximise profits)	lack of incentives (guaranteed employment and no share of profits) would mean output and quality suffers
poor people wouldn't be looked after (orphans, sick and unemployed would suffer more)	government control leads to loss of freedom and of choice
large firms can monopolise, leading to inefficiency and high prices	government may not share

Sorry about the messy table, but my html manipulation skills are limited.

Rationing Systems

Rationing Systems is just a fancy name for the process through which people go through to produce goods and services. It is governed by the basic economic questions.

There are 3 basic economic questions any producer must ask before production.

• WHAT should be produced and in WHAT quantities?
• HOW should they be produced? (what combination of factors of production)
• WHO is the goods produced for? (price levels, who is able to afford it, how the price allocates goods in a "fair" way.

Rationing Systems are either known as a Free Market Economy or a Centrally Planned Economies. Markets with features of both economies are classified by the collective term of Mixed Economics. In each form of market consumers, producers and/or the government decides the answers to the basic economic questions.

In a Free Market Economy all decisions are made by the private sector or consumers. Demand and supply is used to set wages, prices and determine what goods and services are produced and for whom.

There are normally few cases of surpluses and shortages as it is in the best interest of firms to provide what consumers demand. This is to maximise profits, this will be studied in greater depth in Theory of the Firm.

Centrally planned economics are economies for which the basic economic questions are answered by the government, they arrange prices, sets wages and arranges for the production of different types of goods and services. The economy and factors of production are collectively owned by everyone. There is supposed to be a more equal distribution of wealth.

In a Mixed Economy the public sector are the firms, businesses and industries the government controls. The private sector consists of firms and businesses that entrepreneurs control and make decisions for. The government tends to decide the production of merit goods and public goods while the private sector decides the production of consumer goods and services.

In reality all economies are mixed economies.

Transition Economies are economies which are changing from being planned economies to a more market orientated economy. These economies are often developing and have improving demographic trends and health and educational development. There is also more freedom and an increase in the status of women.