Concept and Definitions of Demand

Concept of Demand

• There exists an inverse relationship between the quantity of a commodity demanded and its price
• Demand decreases when price increases and vice versa
• This law illustrates the direction of change in quantity demanded relative to price changes
• At $5 per dozen, a consumer may buy one dozen oranges, whereas at $4 per dozen, they may buy two dozen
• The law of demand states that, all things being equal, more will be demanded at a lower price

Definitions of Demand

• Alfred Marshall: Demand increases with a fall in price and diminishes with a rise in price
• C.E. Ferguson: Quantity demanded varies inversely with price
• Paul A. Samuelson: People buy more at lower prices and less at higher prices, other things being equal

Assumptions of the Law of Demand

• Consumer income remains constant
• Product price remains constant
• Product quality remains constant
• No substitutes exist for the commodity
• Prices of related commodities remain constant
• Customs do not change
• Consumer tastes and preferences remain constant
• Population size remains the same
• Climate and weather conditions are constant
• Tax rates and fiscal measures are constant

Explanation of the Law

• The relationship between a commodity's price and demand depends on factors such as the commodity's nature
• A demand schedule shows how quantity demanded responds to price changes
• Individual demand is the demand of one person
• Market demand is the demand of many people
• Experts focus on market demand schedules, which show quantities consumers want to buy at different prices at a specific time
• Market demand schedule creation involves adding up all individual demand schedules

Demand Schedule Example

• At $5, demand is 100 kg, while at $4, it's 200 kg
• The table shows how total demand changes at various price levels

Demand Curve

• The market demand curve represents the total amount demanded by all consumers at different prices.
• The market demand curve slopes from left to right.

Factors Affecting Demand

• Price is the most important factor affecting demand
• There is an inverse relationship between price and quantity demanded
• As price increases, quantity demanded decreases due to reduced consumer satisfaction
• If tea prices increase, the quantity demanded falls because satisfaction derived from tea decreases
• Demand (D) is a function of price (P), expressed as D = f(P)
• The inverse relationship between price and demand is known as the law of demand

Related Goods

• Demand is affected by price changes in related goods
• Substitute goods can be used in place of each other, like tea and coffee
• An increase in a substitute's price leads to an increase in demand for the original good
• If the price of coffee increases, the demand for tea rises as tea becomes relatively cheaper
• Demand is directly affected by the price of substitute goods
• Complementary goods are used together, such as tea and sugar
• An increase in a complementary good’s price leads to a decrease in demand for the original good
• If sugar prices increase, the demand for tea falls because using both becomes more expensive
• Complementary goods are inversely affected by price changes

Examples of Goods

• Substitute goods: Tea and Coffee, Coke and Pepsi, Pen and Pencil, CD and DVD, Ink pen and Ball Pen, Rice and Wheat
• Complementary goods: Tea and Sugar, Pen and Ink, Car and Petrol, Bread and Butter, Pen and Refill, Brick and Cement

Consumer Income

• Demand is also affected by consumer income, which depends on the nature of the commodity
• For a normal good, an increase in income leads to a rise in demand, while a decrease in income reduces demand
• For an inferior good, an increase in income reduces demand, while a decrease in income leads to a rise in demand
• As income increases, a consumer reduces consumption of toned milk (inferior) and increases consumption of full cream milk (normal)

Consumer Tastes and Preferences

• Tastes and preferences directly influence demand
• Demand rises for commodities that are in fashion or preferred by consumers
• Demand falls for commodities if consumers have no taste for them

Expectation of Future Price Changes

• If a commodity's price is expected to increase, people will buy more ahead of time
• There is a direct relationship between expected future price changes and current demand
• If petrol prices are expected to rise, present demand will increase

Why Demand Curve Falls

• A consumer can buy more units of a commodity when its price falls, and vice versa
• Demand is higher at lower prices, causing the demand curve to fall

Price Effect

• When a commodity's price increases, consumers reduce consumption, decreasing demand
• Consumers adjust consumption based on the price effect, and the demand curve slopes downward

Income Effect

• A consumer's real income rises when prices fall, allowing them to buy more
• Higher prices reduce real income, enabling consumers to spend more on other commodities
• The demand curve slopes downward due to the positive income effect

Constant Price

• When a commodity's price falls and substitutes remain the same, consumers buy more of the commodity
• The demand curve slopes downward due to the substitution effect

Poor People's Demand

• Most people are poor, so they tend to buy more when prices fall
• The demand curve slopes downward due to poor people’s behavior

Differing Uses for Goods

• The demand curve slopes downward as prices increase

Exceptions in the Law of Demand

• The law doesn't apply to inferior goods
• When the price of an inferior commodity decreases, demand also decreases as consumers switch to superior commodities
• Wheat and rice are superior food grains, while maize is an inferior food grain

Demonstration Effect

• More demand occurs when prices are high, and less occurs when prices are low
• Rich people like to demonstrate that they have the means to consumes luxury items

Consumer Ignorance

• Consumers judge quality by price; low prices suggest inferiority, while high prices suggest superiority, violating the law of demand

Less Supply

• When the supply of a commodity is low, people buy more for stock purposes, even at high prices, expecting shortages
• The law of demand does not work when there is short supply of commodity

Depression

• During a depression, prices are low, but demand does not increase due to low purchasing power
• The law of demand does not work durng hard economic times

Speculation

• Speculators buy shares to raise prices, then sell to avoid losses, violating the law of demand

Out of Fashion

• Goods that are out of style cannot have their demand raised by decreasing prices

Importance of the Law

• A monopolist can determine the appropriate price level to charge

Tax on Commodities

• The effect of tax on various comodities is checked

Agricultural Prices

• Useful for determining the value of crops and other agricultural goods

Planning

• Affects planning for goods and industries at both national and world level

Demand and Shifts

• Increase in demand occurs because of change in price of concerned commodity
• Shifting in demand curve take place when change in demand occurs because of other variable accept price

Law of Diminishing Marginal Utility

• As consumption of a good increases, the marginal utility decreases
• Consumers purchase additional units until the marginal utility equals the market price
• Equilibrium is reached when marginal utility equals price, maximizing satisfaction

Impact of Price Reduction

• Consumers buy more to equate marginal utility with the lower price
• Higher consumption causes its marginal utility to decrease and become equal to the new price
• The curve implies that the downward-sloping demand curve, and that as the price of the goods falls, more of it will be bought

Law of Equi-Marginal Utility

• Explains the consumption of two or more products and what combination of consumption these products will give optimum satisfaction
• Marginal Utility is the additional satisfaction gained by consuming one more unit of a commodity
• Consumers should spend their limited income so that the last unit of currency spent yields equal marginal utility
• A consumer will get the maximum satisfaction in the case of equilibrium: MUA / PA = MUB / PB = … = MUN / PN

Marginal Utilities

• MUS are the marginal utilities for the commodities and Ps are the prices of the commodities
• There is no change in the price of the goods or services
• The consumer has a fixed income
• The marginal utility of money is constant
• A consumer has perfect knowledge of utility
• Consumer tries to have maximum satisfaction
• The utility is measurable in cardinal terms
• There are substitutes for goods
• A consumer has many wants
• The law is useful for workers in allocating the time between the work and rest
• It is useful in case of saving and spending
• It is useful to look for substitution in case of price rise

Budget Line

• Shows a customer's combinations of commodities with fixed income and market prices
• Is a graphical representation of commodity combinations that can be bought with available income and cost
• Slope of the budget line equals the ratio of the cost of two commodities
• The slope of the budget constraint is a straight line that bends downwards
• Includes all the potential combinations of the two commodities which a customer can purchase at market value by assigning his/her entire salary
• The consumer’s purchasing power (his/her income) and The market value of both the products

Budget Line properties

• Negative slope denotes a reverse correlation between products
• Straight line represents a constant market rate of exchange
• Real income line displays customer income and spending size
• Tangent to indifference curve defines the "consumer's equilibrium" by meeting the budget line in curve

Indifference Curve

• Is a graphical display of the combined products that gives similar satisfaction to a consumer

Indifference Curve Analysis

• Works on a simple graph having two-dimensional axis' and shows that consumers have no preference because all goods have the same level of staisfacation
• For example a child may be indifferent while having a toy, two comic book, four toy trucks and a single comic book

Indifference Map

• Refers to a set of indifference curves that reflects an understanding and gives an entire view of a consumer’s choice

Indifference Curve Features

• An indifference curve has a negative slope, i.e. it slopes downward from left to right
• If a consumer decides to have one more unit of a commodity, quantity of another good must fall so that the total satisfaction (utility) remains same
• An Indiffernce Curve is strictly convex to origin i.e. MRSxy is always diminishing
• Because the law of diminishing marginal utility exists, a consumer is always willing to sacrifice lesser units of a commodity for every additional unit of another good
• As consumer income rises, the curve rises, meaning they are able to consume more

Elasticity of Demand

• Is the degree of change in the demand curve, responding to a change in any economic factor of a product Factors that affect Price elasticity of demand

1. Nature of the commodity as ordinaries tends to have inelasticity while luxury has elasticity
2. Availability of close substitutes determines if it has a close substitute
3. Diversity of uses commodities that can be used more elastically

Price Elasticity of demand

• Change in quanity demanded in response to proportionate change in the price of the commodity
• The willingness of consumers to buy less of goods when prices rise and willingness to buy more when prices fall
• 3 types, the other two being:

1. Income elasticity of Demand
2. Cross Elasticity of demand
3. Time horizon
4. Income level

Types of Price Elasticity of Demand

• 5 distinct degrees by which various degree of elasticity measured

1. Perfectly Elastic Demand: Unlimited demand at the prevailing price
2. Perfectly Inelastic demand: Great change in price does not impact quantity
3. Unitary Elastic Demand: Total expenditure remains the constant within the commodity due to price change
4. Greater than Unitary Elastic Demand: Expenditure of the community increases when prices decreases and expenditure decreases when prices decreases
5. Less than Unitary Elastic Demand: Expenditure of the community rises when prices rise and decreases when prices fall

Methods of forecasting methods

1. Survey of Buyer's Choice a. Complete enumeration b. Sample survey method c. End-use method
2. Collective Opinion Method, salesperson of a firm predicts the estimated future sales in their region
3. Barometric Method: Based on future trends
4. Market Expiriment Method: Conducting market and experiment on consumer behaviour
5. Expert Opinion Method: Market Experts have explicit knowledge about affecting demand

Statistical forecasting methods

• Trand Projection Method: Arranging by date
• Regression analysis: Between demand and independent variables