Analysis
of Demand, Significance, Estimation:
MEANING OF DEMAND:
In
economic science, the term "demand" refers to the desire, backed by
the necessary ability to pay. The demand for a good at a given price is the
quantity of it that can be bought per unit of time at the price.
There
are three important things about the demand:
1.
It is the quantity desired at a given price.
2.
It is the demand at a price during a given time.
3.
It is the quantity demanded per unit of time.
DETERMINANTS OF DEMAND:
The
factors that determine the size and amount of demand are manifold. The term
"function" is employed to show such "determined" and
"determinant" relationship. For instance, we say that the quantity of
a good demanded is a function of its price
i.e., Q = f(p)
Where Q represents quantity demanded f means
function, and p represents price of the good.
There are many important
determinants of the demand for a commodity:
1.
Price of the goods: The first and foremost determinant of the demand for good
is price. Usually, higher the price of goods, lesser will be the quantity
demanded of them.
2.
Income of the buyer: The size of income of the buyers also influences the
demand for a commodity. Mostly it is true that "larger the income, more
will be the quantity demanded".
3. Prices of Related Goods: The prices of
related goods also affect the demand for a good. In some cases, the demand for
a good will go up as the price of related good rises. The goods so
inter-related arc known as substitutes, e.g. radio and gramophone. In some
other cases, demand for a good will comes down as the price of related good
rises. The goods so inter-related are complements, e.g. car and petrol, pen and
ink, cart and horse, etc.
4.
Tastes of the buyer: This is a subjective factor. A commodity may not be
purchased by the consumer even though it is very cheap and useful, if the
commodity is not up to his taste or liking. Contrarily, a good may be purchased
by the buyer, even though it is very costly, if it is very much liked by him.
5.
Seasons prevailing at the time of purchase; In winter, the demand for woollen
clothes will rise; in summer, the demand for cool drinks rises substantially;
in the rainy season, the demand for umbrellas goes up.
6. Fashion: When a new film becomes a success,
the type of garments worn by the hero or the heroine or both becomes an article
of fashion and the demand goes up for such garments.
7. Advertisement and Sales promotion:
Advertisement in newspapers and magazines, on outdoor hoardings on buses and
trains and in radio and television broadcasts, etc. has a substantial effect on
the demand for the good and thereby improves sales.
Law of Demand:
Among
the many causal factors affecting demand, price is the most significant and the
price- quantity relationship called as the Law of Demand is stated as follows:
"The greater the amount to be sold, the smaller must be the price at which
it is offered in order that it may find purchasers, or in other words, the
amount demanded increases with a fall in price and diminishes with a rise in price"
(Alfred Marshall). In simple words other things being equal, quantity demanded
will be more at a lower price than at higher price. The law assumes that
income, taste, fashion, prices of related goods, etc. remain the same in a
given period. The law indicates the inverse relation between the price of a
commodity and its quantity demanded in the market. However, it should be
remembered that the law is only an indicative and not a quantitative statement.
This means that it is not necessary that such variation in demand be
proportionate to the change in price.
Demand Schedule:
It
is a list of alternative hypothetical prices and the quantities demanded of a
good corresponding to these prices. It refers to the series of quantities an
individual is ready to buy at different prices. An imaginary demand schedule of
an individual for apples is given below:
Demand
of a Consumer for apples:
|
Price
of apple per unit (in rupees)
|
Quantity
demanded of apples (in dozens)
|
|
5
|
1
|
|
4
|
2
|
|
3
|
3
|
|
2
|
4
|
Assuming
the individual to be rational in his purchasing behaviour, the above schedule
illustrates the law of demand. At Rs.5/- per apple, the consumer demands 1
dozen of apples; at Rs.4/- per unit 2 dozens, at Rs.3/- per unit 3 dozens and
at Rs.2/~ per unit 4 dozens. Thus the inverse relationship between price and
demand is shown in the demand schedule.
Demand Curve:
When the data presented in the demand schedule
can be plotted on a graph with quantities demanded on the horizontal or X- axis
and hypothetical prices on the vertical or Y- axis, and a smooth curve is
hypothetical prices on the vertical or Y- axis, and a smooth curve is drawn
Joining all the points so plotted, it gives a demand curve. Thus, the demand
schedule is translated into a diagram known as the demand curve.
The
demand curve slopes downwards from left to right, showing the inverse
relationship between price and quantity.
The
market demand reflects the total quantity purchased by all consumers at
alternative hypothetical prices. It is the sum-total of all individual demands.
It is derived by adding the quantities demanded by each consumer for the
product in the market at a particular price. The table presenting the series of
quantities demanded of all consumers for a product in the market at alternative
hypothetical prices is known as the Market Demand Schedule. If the data are
represented on a two dimensional graph, the resulting curve will be the Market
Demand Curve. From the point of view of the seller of the product, the market
demand curve shows the various quantities that he can sell at different prices.
Since the demand curve of an individual is downward sloping, the lateral
addition of such curves to get market demand curve will also result in downward
sloping curve.
Shifts in Demand Curve:
The
price-quantity relationship represented by the law of demand is important but
it is more important for the manager of the firm to know about the shifts in
the demand function (or curve). For many products, change in price has little
effect in the quantity demanded in relevant price ranges. Many other
determinants like incomes, tastes, fashion, and business activity have larger
effect on demand for such product. Thus, changes or shifts in demand curve
rather than movement along the demand curve is of greater significance to the
decision-maker in the firm. Let us clearly know the difference between movement
along one and the same demand curve and shift in demand curve due to changes
in
demand. When price of a good alone varies, ceteris paribus, the quantity
demanded of the good changes. These changes due to price variations alone are
called as extension or contraction of demand represented by movement along the
same demand curve. Such movement along the same demand curve is shown in Figure
2(a). Price declines from OP1 to OP2 and demand goes up from OM1 to OM2. Here
the demand for the good is said to have extended or expanded. This is
represented by movement from point A to point B along the demand curve. On the
contrary, if price rises from OP2 to OP1 demand falls from OM2 to OM1. Here the
demand for the good is said to have contracted. This is represented by movement
from point B to point A along the demand curve D1D1.
Shifts
in demand curve take place on account of determinants other than price such as
changes in income, fashion, tastes, etc. The ceteris paribus assumption is
relaxed; other factors than price influence demand and the impact of these
factors on demand is described as changes in demand or shifts in demand,
showing increase or decrease in demand. This kind of change is shown in Figure
2(b). The quantity demanded at OP1 is OM1. If, as a result of increase in
income, more of the product is demanded, say OM2 at the same price OP1. Note
that OM2 is due to the new demand curve D2D2. This is a case of shift in demand.
Due to fall in income, less of the good may be demanded at the same price and
this will be a case of decrease in demand. Thus increase or decrease in demand
with shifts in demand curves upward or downward are different from extension or
contraction of demand.
Causes of changes in demand may be
due to:
1.
Changes in the consumer's income.
2.
Changes in the tastes of the consumer.
3. Changes in the prices of related goods
(substitutes and complements).
4. Changes in exogenous factors like fashion,
social structure, etc.
Q. WHY THE DEMAND CURVE SLOPES
DOWNWARD OR REASONS FOR THE LAW OF DEMAND?
The demand curve slopes left downward to right,
throughout its length although the slope may be much steeper in some parts. It
means, demand increases with the fall in price and contracts with an increase
in price. There are several reasons responsible for the inverse price demand
relationship which has been explained as under:
1. Law of Diminishing Marginal
Utility: The law of demand is based on the law of diminishing
marginal utility which states that as the consumer purchases more and more
units of a commodity, the utility derived from each successive unit goes on
decreasing. It means as the price of the 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.
Substitution Effect: Substitution effect also leads the demand curve to
slope from left downward to right. As the price of a commodity falls, prices of
its substitute goods remain the same, the consumer will buy more of that
commodity. For instance, tea and coffee are the substitute goods. If the price
of tea goes down, the consumers may substitute tea for coffee, although price
of coffee remains the same. Therefore, with a fall in price, the demand will
increase due to favourable substitution effect. On the other hand with the rise
in price, the demand falls due to unfavourable substitution effect. This is
nothing but the application of Law of Demand.
3. Income Effect:
Another reason for the downward slope of demand curve is the income effect. As
the price of the commodity falls, the real income of the consumer goes up. Real
income is that income which is measured in terms of goods and services. For
example, a consumer has Rs.20, he wants to buy oranges whose price is Rs.20 per
dozen. It means the consumer can buy one dozen of oranges with his fixed
income. Now, suppose, the price of the oranges falls to Rs.15 per dozen which
leads to an increase in his real income by Rs.5. In this case, either the
consumer will buy more quantity of oranges than before or he will buy some
other commodity with his increased income.
4. New Consumers:
When the price of commodity falls, many other consumers who were not consuming
that commodity previously will start consuming the commodity. As a result,
total market demand goes up. For example, if the price of radio set falls, even
the poor man can buy the radio set. Consequently, the total demand for radios
goes up.
5. Several Uses:
Some commodities can be put to several uses which lead to downward slope of the
demand curve. When the price of such commodities goes up they will be used for
important purposes, so their demand will be limited. On the other hand, when
the price falls, the commodity in question will extend its demand. For
instance, when the price of coal increases, it will be used for important
purposes but as the price falls its demand will increase and it will be used
for many other uses.
6.
Psychological Effects: When the price of a commodity falls, people favour
to buy more which is natural and psychological. Therefore, the demand increases
with the fall in prices. For example, when the price of silk falls, it is
purchased for all the members of the family.
EXCEPTIONS TO THE LAW OF DEMAND:
The
Law of Demand will not hold good in certain peculiar cases in which more will
be demanded at a higher price and less at a lower price. In these cases the
demand curves will be exceptionally different, differing from the usual
downward sloping shape of the demand curve. The exceptions are as follows:
(i)
Conspicuous goods: Some consumers
measure the utility of a commodity by its price i.e., if the commodity is
expensive they think that it has got more utility. As such, they buy less of
this commodity at low price and more of it at high price. Diamonds are often
given as example of this case. Higher the price of diamonds, higher is the
prestige value attached to them and hence higher is the demand for them.
(ii)
Giffen goods: Sir Robert Giffen, an economist,
was surprised to find out that as the price of bread increased, the British
workers purchased more bread and not less of it. This was something against the
law of demand. Why did this happen? The reason given for this is that when the
price of bread went up, it caused such a large decline in the purchasing power
of the poor people that they were forced to cut down the consumption of meat
and other more expensive foods. Since bread even when its price was higher than
before was still the cheapest food article, people consumed more of it and not
less when its price went up. Such goods which exhibit direct price-demand
relationship are called 'Giffen goods'. Generally those goods which are
considered inferior by the consumers and which occupy a substantial place in
consumer's budget are called 'Giffen goods'. Examples of such goods are coarse
grains like bajra, low quality of rice and wheat etc.
(iii)
Future expectations about prices: It has
been observed that when the prices are rising, households expecting that the
prices in the future will be still higher tend to buy larger quantities of the
commodities. For example, when there is wide-spread drought, people expect that
prices of food grains would rise in future. They demand greater quantities of
food grains as their price rise. But it is to be noted that here it is not the
law of demand which is invalidated but there is a change in one of the factors
which was held constant while deriving the law of demand, namely change in the
price expectations of the people.
(iv)
The law has been derived assuming
consumers to be rational and knowledgeable about market-conditions. However, at
times consumers tend to be irrational and make impulsive purchases without any
cool calculations about price and usefulness of the product and in such
contexts the law of demand fails.
(v)
Similarly, in practice, a household may
demand larger quantity of a commodity even at a higher price because it may be
ignorant of the ruling price of the commodity. Under such circumstances, the
law will not remain valid.
The
law of demand will also fail if there is any significant change in other
factors on which demand of a commodity depends. If there is a change in income
of the household, or in prices of the related commodities or in tastes and
fashion etc. the inverse demand and price relation may not hold good.
TYPES
OF DEMAND:
There are three types
of demand. They are
1. Price Demand
2. Income Demand and
3. Cross Demand which are explained below:
1. Price Demand:
It refers to the various quantities of the
good which consumers will purchase at a given time and at certain hypothetical
prices assuming that other conditions remain the same. We are generally
concerned with price demand only. In the explanation of the law of demand given
above, we dealt in detail with price demand only.
Income
demand: Income demand refers to the various quantities of a
commodity that a consumer would buy at a given time at various levels of
income. Generally, when the income increases, demand increases and vice versa.
Cross
Demand: When the demand of one commodity is related with the
price of other commodity is called cross demand. The commodity may be
substitute or complementary.
Substitute goods are
those goods which can be used in case of each other. For example, tea and
coffee, Coca-cola and Pepsi. In such case demand and price are positively
related. This means if the price of one increased then the demand for other
also increases and vise versa. Complementary goods are those goods which are
jointly used to satisfy a want. In other words, complementary goods are those
which are incomplete without each other. These are things that go together,
often used simultaneously. For example, pen and ink.
Tennis rackets and
tennis balls, cameras and film, etc. In such goods the price and demand are
negatively related. This means when the price of one commodity increases the
demand for the other falls.
Extension and
Contraction of Demand The change in demand due to change in price only (when
other factors remain constant) is called extension and contraction of demand.
Increase in demand due to fall in price is called extension of demand. Decrease
in demand due to rise in price is called contraction of demand. Extension and
Contraction of demand results in movement on the same demand curve.
It is
shown in the following diagram.
When price is OP, the
quantity demanded is OQ. Suppose the price falls from OP2 to 0P2 demand will be
increased to OQ2. This is a downward movement along the demand curve DD from a
to c. This indicates extension of demand. When the price rises to OP1, the
demand will be decreased to OQ2 this is an upward movement along the demand
curve from a to b. This indicates contraction of demand.
Shift
in Demand:
We have seen that the
demand depends not only on price but also on other factors like income,
population, taste and preference of consumers etc. The change in demand due to
change in any of the factors other than the price is'called shift in demand.
Change in any one of the factors shifts the entire demand curve. A change in
demand will shift the demand curve either upwards or downwards. An upward shift
in demand curve is called increase in demand. Downward shift in demand curve is
called decrease in demand. Shift in demand is shown in the following diagram:
In the given figure DD
is the original demand curve. When the demand increases, (e.g., due to increase
in income) the curve will shift upwards to D2D2 without any increase in price.
It is constant at OP. Similarly when the demand decreases, (e.g., due to
decrease in income) the curve will shift downwards to D1D1. The price remains
constant. Thus extension of demand is different from increase in demand.
Likewise, contraction of demand doesn't mean decrease in demand.
It should be noted that
exclusion and contraction of demand is called "change in quantity
demanded" and shift in demand is called "change in demand".
Other
Types of Demand:
Joint
demand: When several commodities are demanded for a joint
purpose or to satisfy a particular want. It is a case of a joint demand. Milk ,
sugar and tea dust are jointly demanded to make tea. Similarly, we may demand
paper, pen and ink for writing. Demand for such commodities in bunch is known
as joint demand. Demand for land, labour, capital and organisation for
producing commodity is also a case of joint demand.
Composite
demand: The demand for a commodity which can be put to several uses is a
composite demand. In this case a single product is wanted for a number of uses.
For example, electricity is used for lighting, heating, for running the engine,
for the fans etc. Similarly coal is used in industries, for cooking etc.'
Direct
and Derived demand: The demand for a commodity which is for
direct consumption, i.e.. Demand for ultimate object, is called direct demand,
e.g food, cloth, etc. Direct demand is called autonomous demand. Here the
demand is not linked with the purchase of some main products. When the
commodity is demanded as a result of the demand for another commodity or
service, it is known as the derived demand or induced demand. For example,
demand for cement is derived from the demand for building construction; demand
for tires is derived from the demand for cars or scooters, etc.
Importance
of the Law of Demand:
The law of demand plays
a crucial role in decision-making and forward planning of a business unit. The
production planning in a firm mainly rests on accurate demand analysis. The law
of demand has theoretical as well as practical advantages. These are as
follows:
- Price
determination: With the help of law of demand a monopolist fixes the price
of his product. He is able to decide the most profitable quantity of
output for him.
- Useful
to government: The finance minister takes the help of this law to know the
effects of his tax reforms and policies. Only those commodities which have
relatively inelastic demand should be taxed.
- Useful
to farmers: From the law of demand, the farmer knows how far a good or bad
crop will affect the economic condition of the fanner. If there is a good
crop and demand for it remains the same, price will definitely go down.
The farmer will not have much benefit from a good crop, but the rest of
the society will be benefited.
- In
the field of planning: The demand schedule has great importance in
planning for individual commodities and industries. In such cases it is
necessary to know whether a given change in the price of the commodity
will have the desired effect on the demand for commodity within the
country or abroad. This is known from a study of the nature of demand
schedule for the commodity.
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