Markets do not operate independently, as changes in demand, supply or price in one market can affect related markets through joint demand, competitive demand, composite demand, derived demand and joint supply. For example, an increase in demand for cars can raise demand for petrol, while a rise in the price of coffee may increase demand for tea. These interrelationships are important because they help explain how changes in one market can influence prices, output, demand and resource allocation in other parts of the economy, which firms and governments must consider when making decisions.
This topic can be found in:
- AQA A-Level Economics | Component 1: Individuals, Firms, Markets and Market Failure | Topic 3: Price Determination in a Competitive Market
Definitions
- Interrelationship between markets: The way changes in one market affect related markets.
- Joint demand: Demand for two or more goods that are used together.
- Competitive demand: Demand for goods that are substitutes and compete to satisfy the same need.
- Composite demand: Demand for a good that has several different uses.
- Derived demand: Demand for a factor of production that arises from demand for the final good or service it helps produce.
Key Features
Joint and Competitive Demand
Joint demand occurs when two or more goods are demanded together because they are used together. Examples include cars and petrol, printers and ink cartridges, and bread and butter. An increase in demand for one good is likely to increase demand for its complement. Competitive demand, by contrast, occurs when goods are substitutes that can replace each other in consumption. Examples include tea and coffee, butter and margarine, and buses and trains. If the price of coffee rises, consumers may switch towards tea, increasing the demand for tea. Therefore, changes in one market can directly affect demand in another through complementary and substitute relationships.
Composite and Derived Demand
Composite demand occurs when a good has several possible uses, meaning that different markets compete for the same product. For example, timber can be used for furniture, construction and paper production, while wheat can be used for bread, animal feed and biofuels. If demand for timber in construction increases, less may be available for paper production, potentially increasing its price. Derived demand occurs when demand for a factor of production comes from demand for the final product it helps produce. For example, higher demand for houses increases demand for builders, bricks and timber. Similarly, increased demand for electric cars can increase demand for engineers, battery workers and raw materials.
Joint Supply and Market Diagrams
Joint supply occurs when two or more products are produced together through the same production process. Examples include beef and leather, crude oil and petrol, diesel and kerosene, and lamb and wool. If demand for petrol increases, more crude oil may be refined, increasing the supply of other oil products such as diesel. When analysing interrelated markets using diagrams, it is important to identify the original market and the initial change before explaining how it affects the related market. The analysis should then show the resulting changes in equilibrium price and quantity in both markets. For example, an increase in demand for cars shifts the demand curve for petrol to the right, increasing the equilibrium price and quantity of petrol.
Evaluation
Advantages
- Explains wider market effects: Interrelationships help explain how a change in one market can create changes in other markets, providing a more complete understanding of economic activity.
- Supports business decision-making: Firms can consider substitutes, complements and related markets when setting prices, forecasting demand and deciding how much to produce.
- Explains resource allocation: Interrelationships such as composite and derived demand show how changes in demand can influence the allocation of scarce labour, land, capital and raw materials between different uses.
Disadvantages
- Effects depend on the strength of the relationship: A change in one market will not always have a large effect on another. The impact depends on how closely the markets are connected and how easily consumers or producers can respond.
- Multiple changes can occur simultaneously: Demand and supply may change in several related markets at the same time, making it difficult to identify the effect of one individual change.
- Diagrams simplify real markets: Economic diagrams generally show the relationship between two markets while holding other factors constant. Real-world markets are more complex, with several factors influencing prices, demand and supply simultaneously.
Summary
- Markets are interdependent because changes in one market can affect related markets.
- Joint demand involves goods used together, while competitive demand involves substitute goods.
- Composite demand occurs when one good has several uses, while derived demand comes from demand for a final product.
- Joint supply occurs when two or more products are produced together.
- Changes in one market can affect equilibrium prices, quantities and resource allocation in related markets.
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