Causes of Market Dynamics II

Cause #4 – Expectations

This is similar to income, but instead refers to future changes that a buyer expects to happen in the near future. For example, if you expect gasoline to be more expensive next week, you are more likely to fill up this week. This will cause the equilibrium for gasoline to shift today.

Cause #5 – Taste (or Fashion)

Some things, such as music styles, car models, clothing or house furnishings change in style over time. As such, desires for certain styles can change. What is fashionable, and popular one day may be out-of-date and unwanted the next. For example, why is it that skinny ties or Britney Spears CDs sell millions in one year, but are not popular a couple of years later? This is a point where economics starts to approach psychology, which is an area where I have little expertise. At this point, we need simply be content with the fact that at different points in time, people will want to buy different quantities of things for reasons that do not have any direct economic causes.

Cause #6 – Information

Going back to fundamentals, the demand for a good is based upon the utility, or happiness, one gets from consuming it. Sometimes, new information comes onto the market that leads to a change in the happiness that someone derives from consuming a good. The most obvious example of this has to do with health information. We often learn that consumption of a good may have beneficial or detrimental effects on one’s health. A few years ago, the “Atkins” diet was popular, in which it was believed that people could lose weight by eating a diet that was high in proteins and low in carbohydrates. A lot of people adopted this diet, so much so that many bakeries went out of business because bread sales declined a great deal. A little while later, some detrimental health effects of the Atkins diet were publicized, and this caused some people to abandon this diet. Fewer people smoke today than in the past, because we have better information about the long-term effects of smoking on health.

Health information is not the only form of information that can move demand curves. For example, when some people publicized what they felt were poor working conditions in clothing factories in Asia, a number of people in the US decided against purchasing goods made in those factories. In other cases, people fall out of favor. There are probably not too many Brett Favre football jerseys being sold in Green Bay these days, even though he was a hero in that city for many years. Deciding to play for a rival team in Minnesota greatly reduced the demand for clothing with his name and picture on it in Green Bay.

Causes of Movements of the Supply Curve

Unlike changes in demand, changes in supply are usually simpler to explain. A downward shift of the supply curve, which means that more goods are supplied at the same price, usually results from a lowering of the cost of production. This cost reduction could be because of a new, more efficient technology, or could be because of lowered taxes, or cheaper labor costs.

An upward shift of the supply curve (less being offered at the same price) is usually the result of some disturbance in the market. The most common example is when crops are damaged by weather conditions: hurricanes, unexpected cold, not enough rain, and so on. If prices for materials or labor of energy, any of the things that go into making a good, have increased in price, then the supply curve shifts upwards. If a tax on a good is increased, then the supply curve will shift upwards, as a tax is a cost that has to be paid on the good, not to the seller of the good or to the sellers of the factors of production, but to government. We will talk more about the incidence and effects of taxes later in the course.

Sample Question

Let us suppose that the following two events happen simultaneously:

1. The Food and Drug Administration releases a report showing that drinking orange juice causes bald men to grow hair.
2. A giant freeze destroys the orange crop in Florida, meaning that we have to import all of our oranges from Brazil for a year.

What do you expect to happen to the equilibrium price and quantity of orange juice?

Answer

The first statement will likely cause many bald men to start drinking more orange juice. This will cause an outward shift of the demand curve.

The second statement means that oranges will likely be more expensive to produce, which corresponding to an upward shift of the supply curve.

The demand curve movement will increase the equilibrium price and quantity. The supply curve movement will increase the equilibrium price, but reduce the equilibrium quantity.

Therefore, the net result will be an increase in the price of orange juice (both curve movements cause price to increase), but the change in quantity sold is unknown from the information at hand. One movement increases quantity sold, the other decreases it. Without measurement, we do not know which effect will dominate the other.

Conclusion

When prices change, they change because either the supply curve or demand curve (or both) has moved. Whenever a price changes, to understand why we want to figure out which of the underlying curves has moved, and why. After working through this lesson, you should be able to explain what happens when supply and demand curves move, and what some of the common causes of such movements are.

Take Aways

After working through the material on this page and reading the associated textbook content, you should be able to confidently:

• explain the basic causes of the movements of the demand curve;
  • changes in tastes
  • the prices of other goods
  • changes in income
  • new information
  • expectations
  • population changes
• understand the concepts of complementary and substitute goods;
  • explain how cross-elasticity is linked to the definition of substitutes and complements
  • understand what the sign of the cross-elasticity implies
• understand the concepts of normal and inferior goods;
  • explain how income-elasticity is linked to the definition of substitutes and complements
  • understand what the sign of the income elasticity implies
• explain the basic causes of upwards and downwards shifts of the supply curve;
• understand that the supply curve is strongly related to the cost of producing goods.