Unit:-2

Demand Theory - Demand Analysis

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

Factors affecting demand

Demand function for the commodity explains the relationship between the Quantities 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 goods
2. Income of consumer
3. Price of good/ service
4. Quality of the goods/service
5. Taste and preferences of the consumer
6. Advertising
7. Weather
8. Expectations
9. Size/Growth of Population
10. Distribution of income and wealth
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.

For substitute goods for complementary goods

DEMAND
DEMAND
PRICE

PRICE
2. 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.
Demand for Necessities
D

PRICE

DEMAND
(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 i.e 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.

DEMAND FOR NORMAL GOODS

DEMAND FOR INFERIOR GOODS

INCOME

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

INCOME

O X
DEMAND
3. 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 consumer’s purchasing power.

4. Quality of the good /service - Quality of the product also influences demand. Better quality of the
product creates more demand.
5. 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.

6. Advertising - Amount spent on advertisement of product will also influence demand.

Advertisement of product increases their sales.

7. 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 woolens goes up in winter season.

8. 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.

9. 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.

10. 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.

Symbolically:
P D
OR
P D
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
Price per unit of commodity A Quantity demanded in units
50 10
40 20
30 30
20 40
10 50
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.

2. 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.
Price per unit of Quantity
Market Demand of A Demanded by X Demanded by Y Demanded by Z (X+Y+Z)
50 10 15 5 30
40 20 25 10 55
30 30 35 15 80
20 40 45 20 105
10 50 55 25 130
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.

DEMAND

PRICE
D 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.

D
D
D

D
D D

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.
Following are some reasons for slope of curve:
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 to 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.
 3. 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.

4. 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.

5. 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
them use it for important purposes only.

6. 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.

PRICE

DEMAND

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 it’s 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.
CHANGE IN DEMAND

Due to Price Due to Others Factors

Extension in Contraction in Increase in Demand Decrease in Demand

Demand 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 in Demand – When Increase with the fall in prices. It is called Extension in demand. It is
shown by following:

Price (per Unit) Quantity Demanded

5 14
4 16
3 18
2 20
Contraction in demand— When decreases with the rise in prices. It is called contraction in demand. It is
shown by following:

Price (per Unit) Quantity Demanded

2 20
3 18
4 16
5 14

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.
Same price more demand
10 10
10 15
(b) More price, same demand
More price same demand
10 10
15 10
(2) Decrease in demand—Demand can be decrease in two ways
(a) Same price, less demand
(b) Less price, same demand

TYPES OF DEMAND/ NATURE OF DEMAND

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 provide 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.