Factors Affecting Demand | Compulsory Reading

Compulsory Reading – Week 3 Factors Affecting Demand What do we mean by Demand? effective desire Demand is defined as the ability and willingness to buy specific quantities of goods in a given period of time at a particular price. Let me explain this...

Compulsory Reading – Week 3 Factors Affecting Demand What do we mean by Demand? effective desire Demand is defined as the ability and willingness to buy specific quantities of goods in a given period of time at a particular price. Let me explain this with an example- A person wants to buy a certain model of a mobile. He definitely has the willingness to purchase. However, if he does not have the ability to pay then he has not created demand. On the other there is another person who has the ability to pay but is not interested in buying the model. He too has not created demand. Hence Demand is created when the consumer has both the willingness to buy the product and the ability to pay for it. There are many factors which affect demand. There are 9 factors affecting demand 1. Price of the Commodity Price of the Commodity is an important factor which affects demand. When the Price goes up the demand goes down. Let’s understand this with an example. Tomatoes are used in every Indian household. When the price of tomatoes is Rs 20/kg let us assume that the consumer buys two kilograms of tomato. If the price of tomato increases to Rs 60/ kg, then the consumer does not buy two kilograms and reduces the purchase to maybe one kilogram. As the price increased the demand went down. 2. Income The next factor that we will discuss is Income. Income of the consumer is directly related to the quantity demanded of the product. So, what does this mean? In simple language it means that as the Income of the consumer increases his ability to buy increases and he creates more demand. – What would happen to the demand for tea if the price of coffee goes up? – What would happen to the demand for onion if the price is expected to go up in the future? Write down your answers and then resume the video Coffee and tea are usually considered as substitutes for each other. Substitute goods are goods which due to changed conditions, may replace each other in use (or consumption). Tea and coffee are such type of goods. So, if price of coffee increases, quantity demanded for coffee will decrease. So, the consumers using coffee will now shift themselves to tea unless the price decreases for coffee. So, demand for tea is expected to increase now. If the price of onions is expected to go up, people will demand more in the current times and will start buying more and storing them. This will lead to a shortage in onion supply, which would lead to an actual increase in its price. Just like Tea and Coffee, Coke and Pepsi are also considered as substitute products. Thus, increase in price of Coke will increase the demand for Pepsi as more consumer will prefer to buy Pepsi due to its cheaper price than coke. Another category of goods is called complimentary goods. Example Petrol is a complimentary good to car. An increase in the price of the complimentary good (petrol) will lead to a fall in the demand for the current good (car). They together behave as an individual good and hence are also referred to as joint demand goods 3. Consumer Expectations from the future Consumers also have expectations from the future. If the consumers expect the prices to rise in the future, the demand in the current time would go up and vice-versa. Let us understand this with an example: If consumers feel that price of a share in stock market will go up in the future then they start buying that share in the current time and create a surge in the demand of the share. There exists a direct relationship between expectation in change in prices in future and change in demand in current period. 4. Population and distribution of population Population and distribution of population is also an important factor to that affects demand. More populations mean more demand for the product. Obviously, the demand will be affected by other factors of population also like age groups, demographics etc. So, in an aging population there would be more demand for medical products. On the other a young population may create a demand for more eateries or more places where they can spend time with friends and have fun. 5. Income Distribution Income distribution also affects the demand. If income in a country is distributed evenly then demand for commodities would be more. However, if income distribution is not equal, that is thee is a wide gap between rich and poor then market demand will remain at lower level. Again, to explain it with an example—let us compare two hypothetical islands with equal population but in Island A income disparity is less compared to Island B. The demand for the commodity will be less in Island B because the number of people who can afford to but it will be less compared to number of people who can afford the commodity in Island A.  6. Geographic location and seasonality Geographic location and seasonality is another factor that affects demand. This is case where certain goods are demanded in certain places or only in certain seasons: Thus, Umbrella/ raincoats would have more demand in a place that gets rainfall rather than a desert. Woolen clothes create a bigger demand in Northern states of India in November to February compared to Southern states of India as winter is very severe in North India. Even in the northern states the demand for woolen clothing is more in winter season rather than the summer season. 7. Tastes and Preferences are the next factor that we will understand. With a change in taste & preference the demand for the product also changes. Hence, certain items move out of the shelves and are replace by other items which are liked by the consumers. An example which I think we can all relate to is about sweets. We all love sweets or maybe most of us love sweets…however in the past decade the importance of healthy living has made us realize that too much sugar is not good for health. Thus, health conscious people prefer sweets which are not too sweet…this has resulted in demand for sweets which have less sugar and less calories. 8. Advertisements and promotions The next factor that we will discuss is advertisements and promotions.You would have seen that before the launch of a film, there is a huge promotion undertaken by the film unit to make people aware of the new release and generate interest. They undertake this activity as advertisements and promotions help in inducing a liking for the products, and help to increase in their demand. 9. Government Policy Government policy also plays a crucial role in increasing/ decreasing demand. Government policy may alter the demand for a product by changing the price of the product. If the government wants to promote a product they may provide subsidies and levy lower taxes and vice-versa.  Law of Demand Individual Demand As the name suggests, individual demand refers to the demand for a good or a service by an individual (or a household). For example, the quantity of detergent purchased by an individual household, in a month, is termed as individual demand. You can see in the graph that the demand created by Consumer A is different from Consumer B Market Demand On the other hand, Market demand is the total quantity demanded across all consumers in a market for a given good. Thus, as you can see in the graph the market demand created by Consumer A and consumer B is the total of the demands created by them. In short Market demand is the vertical summation of the total individual's demand curves. Thus, demand equation is a function of relationship between the quantity demanded of a particular product and the factors influencing it. Further this demand equation can be either an individual demand equation or a market demand equation. And now we come to a very important concept which is Law of Demand. In microeconomics, the law of demand is a fundamental principle which states that there is an inverse relationship between price and quantity demanded. The law states that other things remaining constant, quantity demanded of a commodity increases with a fall in its own price and diminishes with a rise in its own price, i.e. there exist an inverse relationship between price and quantity demanded. Movement Along the Demand Curve Having understood demand and law of demand let us now look at what movement in the demand curve and what is a shift in the demand curve. Let’s begin with the Movement in the demand curve. Movement along the demand curve is a result of change in price of the commodity keeping all the other determinants of demand constant. As one can see in the graph, if price increases quantity demanded decreases and vice-versa (similar to what we have studies as the law of demand). This is referred to as a movement along the demand curve. Shift in the Demand Curve On the other hand, a shift in the demand curve a is a result of change in any of the other determinants of demand (Income, price of related goods, etc.) keeping price constant. If the other determinants change, they cause quantity demanded to either increase, in which case the DD Curve shifts outward or decrease in which case the demand curve shifts inwards, as can be seen on the graph. We now come to the end of this video and all learners should be able to differentiate between Individual Demand and Market Demand and to interpret demand equation and Law of Demand.  Why does Demand Curve Slope Downwards Figure: Demand Curve Factors that cause the Demand curve to slope downwards: Price Effect (which can be further bifurcated into) – Income Effect – Substitution Effect LDMU (Law of Diminishing Marginal Utility) Multiple Uses of a commodity More number of users Price Effect The price effect is simply the increase in the quantity demanded of a good as a result of a fall in the price of the commodity and vice-versa (demonstrating an inverse relationship as per the law of demand) It is further divided into: Income Effect Substitution Effect The Income effect refers to the increase in the purchasing power as a result of a fall in the price of the commodity & vice-versa. Hence, the consumer is able to purchase additional units of the commodity with the same nominal income. For example, if we spend Rs. 40 on coffee per day and if the price of coffee fall from Rs. 10 per cup to Rs. 8 per cup. Then as a result of this we can now purchase an extra cup of coffee per day. This is regarded as the income effect. In addition to the income effect is the substitution effect, which refers to substituting the current good for other goods as the price goes down & vice-versa. So as a result of fall in the price of coffee if consumers choose to substitute more coffee for tea. This would increase the quantity demanded for coffee and is regarded as the substitution effect. LDMU LDMU states that as the consumption of a good goes on increasing the utility derived goes on declining (as we have already studied in the Utility Module). As a result, we would be willing to consume more only if the price is reduced (since the utility is going down) Hence, as price declines demand increases and vice-versa Multiple Uses of a commodity In certain cases, goods have multiple uses, for example – milk or electricity. So, when the price of these goods increases, we consume the good for the most basic use (milk for making tea or electricity for lighting). While when the price decreases, we consume the goods for all possible uses (milk for making curd/ butter/ ghee/ etc. or electricity for heating/ cooling/ cooking/ etc). More number of users As the prices goes down, more new users are now able to demand the commodity, who were earlier left out. On the other hand, if the price goes up, existing users are now not able to demand the commodity as it becomes unaffordable. Exceptions to the Law of Demand We have studied that, the law of demand states that there an inverse relationship between the price of a commodity and the quantity demanded of a commodity. SO, an exception would mean that: Either there is a direct relationship between the price of a commodity and the quantity demanded of a commodity Or, the quantity demanded is not responsive to the change in the price The major exceptions to the law of demand: Veblen Goods Giffen Goods Necessity Goods Price – Quality Relationship Demonstration Effect Emergency/ Natural Disasters Veblen goods are goods that have a positive price-quantity relationship, meaning when the price of these goods goes, their demand also goes up. This behaviour is observed in the highest income groups of the economy, and this happens in the case of high-end goods as these are status symbol goods whose value increases with the increase in their price For example: High end cars/ rare jewellery/ rare painting/ etc. Giffen goods also have a positive price-quantity relationship. However, this behaviour is seen in the lowest income groups with regard to their staple diet (rice/ wheat). As the price of these goods goes up, the rest of the food basket becomes more unaffordable; Hence, the poor choose to consume more of the staple and lesser of the accompaniments. With the fall in their price, the consumers consume less of this good and more accompaniments. In the case of necessity goods, the quantity demanded is independent of the price. Hence, the price does not affect their demand. For example: medicines/ salt/ etc. whether the price is very high or very low our consumption would remain the same. Price – Quality Relationship In some cases, consumers assume that higher price implies better quality. As a result, the demand increases with the increase in the price of the commodity. Like in case of imported goods, we feel the quality is better and hence are willing to pay a higher price. Demonstration effect simply means to try and imitate someone; so, in some cases consumers want to be like their idols (stars/ politicians/ sports personalities/ etc.) and try to imitate their consumption behaviour/ buying behaviour. This could lead to an increase in demand even if the prices are high Emergency/ Natural Disasters This is an extreme case, as a result of supply shocks, the demand for the commodities goes up even as prices are increasing. This is due to the fear that the prices may go up even further. ******************************************************************************