4 Demand and Demand Functions

Dr. Savita

 

Learning Outcome

 

After completing this module the students will be able to understand:

  • The concept of Law of Demand
  • The Demand Curve
  • Demand function: identifying the relevant variables in a real-world business situation.
  • Various types of demand in view point managerial economics

 

Downward sloping of demand curve and upward sloping of demand curve.

 

Demand

 

The demand for a good is consumer’s desire to have it for which he is willing and able to pay. So Desire for certain good or a service which is supported by the capacity to purchase is called demand. Generally people refer to the Want or the Desire for a thing as Demand but in economics they have different meaning. Desire is a wishful thinking. If a man willing to purchase a LED but he has no money to purchase it, then it is only a desire. If he has money with him but he is not ready to spend it, then it will remain his want. And if he has money and is willing to spend it, to buy a LED at a given price at a given period of time then it will become his demand.

 

In simple words we can say that demand for a good is the amount of it that a consumer will purchase at a various prices during a period of time. Demand is a quantitative expression of preferences and in fact it is a photographic picture of consumer’s attitude toward a commodity.

 

According to Prof. Benham, “The demand for anything at a given price is the amount of it which will be bought per unit of time at that price “.

 

According to Hibdon, “Demand means various quantities of a good that would be purchased per time period at different prices at a given market.”

 

Constituents of Demand:

 

1. Desire for good / service

2. Availability of resources/Ability to pay

3. Willingness to pay

4. At a given price, and

5. At a given period of time

 

Demand function/Factors affecting demand

 

Demand function for the commodity explains the relationship between the quantity demanded and factors that influence it. There are many factors which influence the demand for a commodity. Some of these factors are given below:

 

  1. Price of related good/service—when change in the price of one good changes the demand of another good then we can say that two goods are related with each other. It is of two types (a) substitute and (b) complementary goods. When price of one good increases the demand of another good it is called substitute goods and when increase in price of one good decreases the demand of another good it is called complementary goods. So substitute goods are positively related and complementary goods are negatively related.
  1. Income of the consumer—- income of the consumer is an important determinant of demand. More the income of the people more will be the demand. When income of the people increases, they can afford to buy more. So income has a positive effect on demand. People will buy more with increase in income and buy less when income decreases. So income spending on different goods can be classified as under

 

(a) For Necessities of life: In case of Necessities of life there is no change in demand with the changing level of income level of consumer. We can take an example of salt here. Amount of salt used by the consumer has nothing to do with the change of income. Amount of salt used by the consumer is same irrespective of income. It can be shown with the help of diagram

(b) For Comforts—comfort goods are those goods which make our lives comfortable. After satisfying necessities of life, people spent money on comforts. Comfort goods are used to maintain or increase efficiency. For example use of AC in summers and heater in winter make life comfortable .In comfort we can include two types of goods ie Normal goods and Inferior goods. For normal good demand always increase with the increase in income so there is always positive relationship between income and quantity demanded. In case of inferior goods demand decreases with the increase of income. So there is inverse relationship it can also be shown with the help of diagram.

 

(C) For Luxuries—After satisfying comforts people go for luxuries of life. It is directely related with the income. People will buy more with the increase in income.it can be shown with the help of diagram also.

 

  1. Price of good/ service—Demand is also influenced by its price. People will buy more at lower prices and but less when prices increase. A fall in price of goods leads to rise in consumers purchasing power
  2. Quality of the good /service—Quality of the product also influences demand. Better quality of the product creates more demand.
  3. Taste and preferences of the consumer— Taste, preferences and fashion also influences demand to a great extent .Demand of a product goes up if consumers have taste and preference for it, and demand goes down if consumers have no taste of the commodity.
  4. Advertising—- Amount spent on advertisement of product will also influence demand. Advertisement of product increases their sales.
  5. Weather—weather condition of region also effect demand for a particular product. Demand for umbrellas goes up in a rainy season. On the other hand demand for woollens goes up in winter season.
  6. Expectations—consumer’s expectations also play a very important role in deciding demand. If consumer expect that prices of the product may rise in future then demand will goes up. On the other hand expectations of fall in prices, will diminish the demand. Similarly if a consumer expect higher income in future, he spend more at present and if he expect lower income in future his demand will goes down.
  7. Size/Growth of population–– Demand of the product depends upon the size/ growth of population also. Larger the size of the population greater will be the demand and vice versa.
  8. Distribution of income and wealth––Level of national income and wealth is also very important factor of determining demand. Higher the income more will be the demand and, lower the income lesser will be the demand.

LAW OF DEMAND

 

Law of demand describes the general tendency of consumer’s behaviour. It explains the functional relationship between two variables that is price and quantity demanded. Law of demand explains the inverse relationship between price and demand. It means people will buy more at lower prices and buy less when price rises. In other words we can say that when price of the commodity falls, demand for the commodity increases and when price rises, the demand for the commodity decreases.

 

According to Samuelson: “ Law of demand states that people will buy more at lower prices and buy less at higher prices, if other things remains the same( ceteris paribus).”

 

According to Ferguson: “The quantity demanded varies inversely with price.”

 

So according to law of demand if other things being equal, when price of a commodity falls, quantity demanded of it will rise, and if the price of commodity rise its quantity demanding will decline. These other things which are assumed to be constant are the taste and preferences of consumer, income of consumer, prices of related good, size of population and future expectations of rise or fall in prices.

ASSUMPTIONS OF THE LAW.

 

According to Stigler and Boulding, the law of demand based on the following assumptions:

 

1. There should be no change in the income of consumers.

2. There should be no change in the taste and preferences of the consumer.

3. There should be no change in the prices of related goods.

4. There should be no change in the size of population.

5. Consumer is a rational consumer.

6. There should be no expectation of rise or fall in price of related goods in future.

7. There should be perfect competition in the market.

 

Law of demand can be explained with the help of demand schedule and demand curve.

 

Demand Schedule—-It shows the relationship between price and quantities demanded at different prices.

 

Demand schedule can be classified into two categories:

 

1. Individual demand schedule: it shows quantities of commodities demanded by the individual consumer at different prices. It can be shown with the help of following table.

 

INDIVIDUAL DEMAND SCHEDULE of person X

 

 

From the above table it is seen that consumer X buy more units of commodity A when its prices goes down, and buy less when prices high.

  1. Market demand schedule— It shows quantities of commodities demanded by all the consumers in a market. In other words we can say that Market demand schedule is defined as the quantities of a given commodity which all consumers will buy at all possible prices at a given point of time. It can be shown with the help of following table.

 

It is shown in a table that when price is 50 per unit then consumer X’s demand is 10 units, consumer Y’s demand is 15 units and consumer Z’s demand is 5 units of commodity A. So market demand is 30. Similarly at price 40,30,20,and10 per unit total demand by all three is 55,80,105 and 130.

 

Demand curve—demand curve is a graphical presentation of demand schedule. It is of two types Individual demand curve and Market demand curve.

 

Individual demand curve—-when individual demand schedule is presented diagrammatically it is known as individual demand curve. In other words we can say it is a graphical presentation of demand schedule.

 

sloping    demand    curve    which    shows consumer will buy more at lower prices and buy less when prices are high.

 

Market demand curve— Market demand curve is a graphical presentation of market demand schedule. It is a lateral summation of the individual demand curve of each consumer.

 

In these figures different quantities are shown at different price level demanded by individual customer X,Y,Z.

 

And in market demand, curve is drawn by taking the lateral summation of individual demand curves.

 

Why demand curve slopes downward or Causes of downward slope of demand curve

 

Law of demand shows inverse relationship between demand and price. It means people buy less at higher prices and buy more at lower prices. When this relationship presented with the help of graph the slope of curve that we got downward, it means it is left to right downward. Here are some reasons which are responsible for its downward sloping.

  1. Income effect—- when the price of the commodity falls the consumer can buy more quantities of the commodities with his given income .Because with fall in price his real income goes up. Real income is that income which is measured in term of goods and services. For example consumer has 50 rupees and he wants to buy 5 units of commodity “A” now suppose price of “A” commodity falls which leads to an increase in his real income by rupees 10 as now he is able to buy 5 units of “A” commodity for rupees 40 only. So it is observed that at high price real income will be less and at lower price real income will be more.
  2. Substitution effect—demand curve slope downward due to substitution effect also. A fall in the price of good, while the prices of its substitutes remain same, will make it attractive ti the buyer who will now demand more of it. On the other hand a rise in the price of good, when the prices of its substitutes remain same will make it unattractive to the consumer and they will buy lesser quantities of it. We can take here example of Tea and Coffee, when price of tea rise demand for coffee also rise and when price of tea fall demand of coffee also falls. It can be shown with the help of diagram too.
  1. Law of diminishing marginal utility—law of diminishing marginal utility is also a reason for its downward slopping. The law of diminishing marginal utility states that as consumer goes on consuming more and more units of commodities, the utility derived from each successive unit goes on diminishing. It means consumer is in equilibrium when marginal utility of commodity is equal to its price. It means as the price of commodity falls, consumer purchases more of the commodity so that his marginal utility from the commodity falls to be equal to the reduced price and vice-versa.
  2. New consumer—A commodity tends to be put more use by costumers when its price falls. Many other consumers who were not consuming that commodity now will start to consume as a result total marker demand goes up.
  3. Too many uses—there are some commodities which have several uses. So when price of such commodities goes down people use it more for other purposes too. And when their price goes up they use it for important purposes only.
  4. Psychological effect —- it’s a natural phenomenon that people buy more at lower prices and buy less at higher prices. So with fall in prices demand increases and with rise in prices demand of commodities decreases.

 

Exceptions to the law of demand

As we know with the fall in prices people demanded more quantities and with the rise in prices they demanded less quantities, if other things being equal. But in certain cases people buy more even at higher prices, which are called exceptions to the law of demand. In such circumstances demand curve will slope upward or positive. So positive sloping demand curve shows the direct relationship between price and demand. It can be shown with the help of diagram.

 

It shows a direct relation between price and demand, which means demand, goes up with the rise in prices and goes down when prices falls. So the factors which are responsible for positive slope of demand curve are given below.

  1. Prestigious goods: Veblen effect—According to Veblen (American economist) some consumer measure the utility of commodity by its price, they consider greater the price of a commodity, the greater its utility. So in case of Veblen goods or Article of distinction people buy more at higher prices just to show off their status .for example, diamonds are considered prestige goods in the society and for upper strata of a society the higher the price of diamond higher the prestige value for them.
  2. Giffen goods—Sir Robert Giffen observed that in case of inferior goods with the fall in prices people buy less quantities of it, because they are ready to purchase some superior goods as with the fall in price their Real income increased. After the name of Sir Robert Giffen, such goods in whose case there is a direct relationship are called Giffen goods.
  3. Expectations—people will buy more even when there is increase in prices , if they expect that price may rise in near future. Similarly they will buy less even at lower prices if they expect that prices of commodities goes down in near future. So that is the reason of upward sloping of demand curve.
  4. During war or emergency—during the period of war, people may start buying for hoarding or building stocks even at higher prices. But in case of depression, they will less even at lower prices.
  5. Ignorance—some consumers think that more will be the price higher will be the quality. Or sometimes they purchases good at higher prices out of sheer ignorance.

 

Change in demand

 

Change in demand means change in demand due to its price as well as other factors such as income, fashion etc. When demand changes due to change in price such change is called Extension and Contraction of demand. It is also known as movement along a demand curve. If demand of goods increases due to fall in price, it is called Extension in demand, only price is a main determinant. And if demand decreases with a rise in prices, it is called Contraction in demand.

 

It can be shown with the help of schedule and diagram.

  1. Extension and Contraction in Demand or Movement along demand curve. It happens when reason of change in demand is price only.

Extension of demand

This table shows that when prices of goods fall, demand extended.

 

Contraction in demand—when decreases with the rise in prices. It is called contraction in demand . It is shown by following table and diagram.

Contraction in Demand

 

This table shows that when prices rise, demand diminishes.

 

  1. Increase and decrease in demand curve or shift of demand curve.

When demand changes due to change in other factors instead of price like fashion, taste and preference. It is increase or decrease in demand.

 

(1) Increase in demand

(a) same price , more demand

(b)More price, same demand

(a) Same price, more demand—When there is more demand even at same prices and same demand even at more prices. It can be shown with the help of following table and diagram.

 

 

It can be shown with the help of diagram.

Decrease in demand—Demand can be decrease in two ways

 

(a) Same price ,less demand

(b) Less price, same demand

 

(a) Same price, less demand—when there is same price but demand goes on decreasing. it is called decrease in demand.

 

It can be shown will the help of following table and diagram.

 

 

It can be shown by following diagram.

On the basis of business point of view managerial economics have various types. These are:

 

  1. Direct and Derived Demand: Direct demand refers to demand for goods meant for final consumption; it is the demand for consumers’ goods like food items, readymade garments etc. it is a demand which satisfy human wants directly. On the other hand, derived demand refers to demand for goods which are needed for further production, it is the demand for producers’ goods like industrial raw materials, machine tools etc.
  2. Joint and composite Demand: Two or more goods are said to be jointly demanded when they must be consumed together to provided a given level of satisfaction. Some examples are cars and fuel, compact disc players and CD. On the other hand Composite demand refers to a good that has multiple purposes and satisfies different needs. The demand for power is composite as it is used for several purposes.
  3. Competitive and Complementary Demand: Competitive demand is the demand for products that are competing for sales. People can substitute one competing product for another. If the demand for one product increases, the demand for its competitor will decrease. For example, Coke and Pepsi are competing soft drinks. If the price of Pepsi drops below that of Coke, consumer demand for Pepsi will increase while the demand for Coke decreases. Complementary demand, occurs when two products are necessary to meet one demand. A change in the demand for one of these goods causes a similar change in demand for the other product. For example, cars need gasoline or diesel fuel. An increase in the demand for automobiles leads to an increase in the demand for fuel. Both competitive and complementary demand collectively known as Cross Demand
  4. Price, Income and Cross Demand: It indicates the relation between price and demand. It refers to the various quantities of the commodity which the consumer will buy at a particular time at a particular price. It shows inverse relationship between and demand or vice versa. On the other hand Income demand indicates the relation between income and demand of the consumer. Generally it shows the direct relationship between income and demand. Cross demand
  5. New and Replacement Demands: If commodity is purchase for the purpose of an addition to stock, it is a new demand. And if commodity is purchase for maintaining the old stock of capital/asset, it is replacement demand. Such replacement expenditure is to overcome depreciation in the existing stock.
  6. Individual and Market Demands: individual demand refer to the quantity of product demanded by individual at a point of time or over a period of time given. On the other hand market demand for a commodity is the sum of all individual demands by all consumers.
  7. Demand for consumer’s and producer’s goods—consumer goods are needed for direct consumption. It is demanded for ultimate consumption like soft drinks, milk bread etc. On the other hand producers good are demanded for production of other goods such as tools machinery etc.
  8. Demand for Perishable and Durable goods—Demand for perishable goods is made at regular intervals. Perishable goods are those goods which cannot be used more than once or cannot stores over a long period. For example soap, sweets, fruits etc. Durable goods are those goods which have repeated uses. Durable goods meet both the current as well as future demand these goods could be stored for a long period. For example shoes, books, etc.