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 to the right (Increase in demand) A shift in demand to the left (Decrease in demand) A rise in the price of substitutes 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 The effect for demand for petrol following an increase in the price of cars. The effect on demand for public transport following an increase in the price of petrol. The demand for Ipods following an increase in the price of downloads The effect on demand of playstation 3s if the price falls The effect on demand for holidays if income increases The effect on demand for umbrellas during a rainy spell The demand for Big Macs if the price of Whoppers rises 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

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(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]