Theme 1: Introduction to markets
and market failure
In this theme, students will consider how markets work, looking at how supply and demand interact to
allocate resources in local, national and international markets. They will learn how to apply supply and
demand analysis to real-world situations and be able to offer explanations of consumer behaviour. This
will involve looking at both how consumers act in a rational way to maximise utility and how
firms maximise profit, but also why consumers may not behave rationally.
1.2 How markets work
Subject content
1.2.2 Demand
What students
need to learn:
a) The distinction between movements along a
demand curve and shifts of a demand curve
b) The factors that may cause a shift in the demand
curve (the conditions of demand)
c) The concept of diminishing marginal utility and how
this influences the shape of the demand curve
A shift in demand
(Increase in demand)
to
the
right
A rise in the price of substitutes
A shift in demand to the left
(Decrease in demand)
A fall in consumer income
A fall in the price of substitutes
A negative change in tastes and fashion
A positive change in tastes and fashion
A rise in the price of complements
A fall in the price of complements
An increase in consumer income
Draw a diagram to illustrate what would happen under the following circumstances.
State whether you think the goods are complements or substitutes or whether there
is another reason for the effect on demand
1.
The effect for demand for petrol following an increase in the price of cars.
2.
The effect on demand for public transport following an increase in the price of petrol.
3.
The demand for Ipods following an increase in the price of downloads
4.
The effect on demand of playstation 3s if the price falls
5.
The effect on demand for holidays if income increases
6.
The effect on demand for umbrellas during a rainy spell
7.
The demand for Big Macs if the price of Whoppers rises
8.
Demand for foreign holidays if airport tax rises
The law of diminishing marginal utility
Utility is a measure of the satisfaction that we get from
purchasing and consuming a good or service
•Total utility: The total satisfaction from a given level of
consumption
•Marginal utility: The change in satisfaction from consuming an
extra unit
Standard economic theory believes in the idea of diminishing returns i.e.
the marginal utility of extra units declines as more is consumed hence the
downward sloping curve
Page 41
(a) Explain why “when it rains, prices [of
matatu fares] rise rapidly, perhaps 3 or 4
times higher than usual. At midday, in the
sunshine, prices can be very low at round
5p per ride”. Include a demand and supply
diagram in your answer. [5 marks]