The demand curve tells us how much of a good or service people are willing to buy at any given price (see Law of Supply and Demand). However, we know that demand is not constant over time. As a result, the demand curve constantly shifts left or right. Depending on the direction of the shift, this equals a decrease or an increase in demand. There are a five major factors that cause a shift in the demand curve: income, trends and tastes, prices of related goods, expectations as well as size and composition of the population. We will look at each of them in more detail below.
A change in income can affect the demand curve in different ways, depending on the type of good we are looking at; normal goods or inferior goods (see also Price Elasticity of Demand).
In the case of a normal good, demand increases as income grows. That is, a higher income shifts the demand curve to the right. The reason for this is that with a higher income, people can afford to buy more of any given good. And since people have unlimited wants, more is generally considered better. For example, students with a low income usually don’t eat at fancy restaurants that often. However, as their income grows, they are more likely to treat themselves to a nice dinner.
By contrast, in the case of an inferior good, demand decreases as income grows. That means, a higher income shifts the demand curve to the left. This holds true for goods that are usually replaced as income grows. A common example of an inferior good are bus rides. If people don’t have enough money to buy a car or pay for a taxi, they have to travel by bus. However, once their income allows them to buy a car, they don’t need bus rides anymore. Therefore, demand for bus rides decreases as income increases and vice versa.
Trends and Tastes
When a good or service comes into fashion, its demand curve shifts to the right. By contrast, the demand curve shifts to the left, once a new trend emerges and the good or service goes out of fashion again.
Just think of the clothes people used to wear back in the 60’s. They look a lot different from what most people wear today. This is because trends and tastes have changed over time. You would probably have a hard time selling clothes from the 60’s today (even though some of them may already be considered fashionable again).
Prices of Related Goods
There are two types of related goods, which shift the demand curve in opposite directions: substitutes and complements (see also Price Elasticity of Demand).
We speak of substitutes, when a fall in the price of one good results in a decrease in the demand of another good. Thus, substitutes are goods that can be used to replace one another. In fact, the more closely related they are, the stronger the demand curve shifts in case of a price change of the related good. For example, let’s assume the price of ice cream falls. People will buy more ice cream. At the same time however, they will buy less candy bars, because they can satisfy most of their need for sweets with the ice cream.
Meanwhile, we speak of complements when a fall in the price of one good results in an increase in the demand of another good. This is usually the case, when the two goods are used together. To give an example, think of cars and petrol. When cars become cheaper, more people will buy them. As a consequence, the demand for petrol increases because the newly bought cars also need gas.
People’s expectations about the future can have a significant impact on demand. Or more specifically, their expectations of future prices and/or other factors that can change demand. If consumers expect prices to increase in the near future, current demand often increases, i.e. the demand curve shifts to the right.
For example, if consumers have reason to believe that the price of ice cream will fall significantly tomorrow, they will probably not buy ice cream today, but wait until they can get it cheaper. Meanwhile, if they expect their income to increase next month, they will be more likely to spend a few dollars more on ice cream this month, even though their income hasn’t changed yet.
Size and Composition of the Population
As a rule of thumb, a larger population results in a higher demand for most goods. As a result, the demand curve shifts to the right. For example, as the population grows, the demand for food increases as well, simply because there are more mouths to feed.
In addition to that, the composition of the population also affects the demand curve. However, this relationship is quite complex, which makes it difficult to provide general statements about the direction and magnitude of the resulting shifts. This becomes apparent when we look at a simple example: Let’s say a country currently experiences a baby boom. As a consequence, demand for diapers increases. Many years later, the population has grown old and birthrates are down. Now, demand for medical care and retirement homes is on the rise, while demand for diapers decreases.
In a Nutshell
Demand for goods and services is not constant over time. As a result, the demand curve constantly shifts left or right. There are a five major factors that cause a shift in the demand curve: income, trends and tastes, prices of related goods, expectations as well as size and composition of the population.