Lesson # 2

DEMAND

DEMAND

Demand is the effective desire or want for a commodity, which is backed up by the ability (i.e. money or purchasing power) and willingness to pay for it.

Demand = Desire + Ability to pay + will to spend

The demand for a product refers to the amount of it which will be bought per unit of time at a particular price.

Consumer Demand

Two levels: Individual Demand

Market Demand

Market Demand is the sum total of all individual demands.

Prices are determined based on Market Demand.

Factors influencing individual demands:

Price of the products. Income of the buyer. Tastes, Habits and Preferences. Relative prices of other goods. Relative prices of substitute and complementary

products. Consumer’s expectations about future price of the

commodity. Advertisement effect.

Factors influencing Market Demand

Price of the product. Distribution of Income and Wealth. Community’s common habits and scale of preferences. General standards of living and spending habits of the people. Number of buyers in the market and the growth of population. Age structure and sex ratio of the population. Future expecations. Level of taxation and Tax structure. Inventions and Innovations. Fashions Climate and weather conditions. Customs Advertisement and Sales propaganda.

Important factors (key variables)affecting demand:

“own price” of the product (P) Price of substitute or (Ps) Price of complimentary product (Pc) Level of disposable income (Yd)

(income left with buyers after paying tax) Change in the buyers Taste (T) Advertisement effect (level of ad. Exp) (A) Changes in population (or number of buyers) (N)

Thus, Demand Function, Dx = f(Px, Ps, Pc, Yd, T, A, N, u)Commodity = x Hence, price = Px, Demand = Dx

LAW OF DEMAND

Ceteris Paribus: (All other things remaining the same)

Other things remaining unchanged, the demand varies inversely to changes in price. Dx = f(Px).

The higher the price of a commodity, the smaller is the quantity demanded and lower the price, larger the quantity demanded. Other things remaining unchanged, the demand varies inversely to changes in price. Dx = f(Px).

Why does a Demand Curve Slope downward?

The demand varies inversely to changes in price. Dx = f(Px). The demand curve is downward sloping indicating an inverse relationship between price and demand.

The price is measured on the Y – axis and Demand on the X- axis. When the price falls, demand increases. The downward slope of demand curve implies that the consumer tends to buy more when the price falls. Thus the demand curve is shown as downward sloping.

What are the assumptions underlying law of demand?

No change in Consumer’s income. No change in consumer’s preferences. No change in the Fashion. No change in the Price of Related Goods. No expectation of Future price changes of shortages. No change in size, age composition, sex ratio of the population. No change in the range of goods available to the consumers. No change in the distribution of income and wealth of the

community. No change in government policy. No change in weather conditions.

What are the exceptions to the Law of Demand?

Sometimes it may be observed, that with a fall in price, demand also falls and with a rise in price, demand also rises. This is apparently contrary to the law of demand. The demand curve in such cases will be typically unusual and will be upward sloping.

What are the exceptions to the Law of Demand?

Giffen Goods: In the case of certain Giffen goods, when price falls, quite often less quantity will be purchased because of the negative income effect and people’s increasing preference for a superior commodity with rise in their real income. E.g. staple foods such as cheap potatoes, cheap bread, pucca rice, vegetable ghee, etc. as against good potatoes, cake, basmati rice and pure ghee.

What are the exceptions to the Law of Demand?

Articles of Snob appeal (Veblen effect) : Sometimes, certain commodities are demanded just because they happen to be expensive or prestige goods and have a ‘snob appeal’. They satisfy the aristocratic desire to preserve the exclusiveness for unique goods. These goods are purchased by few rich people who use them as status symbol. When prices of articles like diamonds rise, their demand rises. Rolls Royce car is another example.

What are the exceptions to the Law of Demand?

Speculation: When people are convinced that the price of a particular commodity will rise further, they will not contract their demand; on the contrary they may purchase more for profiteering. In the stock exchange, people tend to buy more and more when prices are rising and unload heavily when prices start falling.

What are the exceptions to the Law of Demand?

Consumer’s phychological bias or illusion:

When the consumer is wrongly biased against the quality of a commodity with reduction in the price such as in the case of a stock clearance sale and does not buy at reduced prices, thinking that these goods on ‘sale’ are of inferior quality.

Reasons for change (increase or decrease) in demand:

Change in income. Changes in taste, habits and preference. Change in fashions and customs Change in distributioin of wealth. Change in substitutes. Change in demand of position of complementary goods. Change in population. Advertisement and publicity persuasion. Change in the value of money. Change in the level of taxation. Expectation of future changes in price.