2 – Market Demand

Introduction

Demand and supply are two of the most fundamental economic concepts. Demand has a broader and more specific meaning than in common parlance. Typically, demand would be defined as your desire to purchase something, but in economic terms, demand is more than just a desire. It is interpreted as your desire supported by your purchasing power. Furthermore, demand is expressed as a unit of time, such as per day, week, etc. Furthermore, mentioning demand without mentioning price is meaningless. Considering all these factors, the term “demand” can be defined as “the quantity of that commodity desired to be purchased at a given price per unit of time.”

Example: Assume a pen costs ten cents per unit of time. People are willing to buy 100 units of that pen at this price at a specific time. As a result, there is a high demand for that pen.

2.1 Market Demand

Demand is one of the most essential requirements for the survival of any business. The demand for a company’s product affects its profit and/or sales, which are important. Management decisions regarding production, advertising, cost allocation, pricing, and so on necessitate a demand analysis.

Demand is the quantity of a commodity that an individual household is willing and able to purchase per unit of time at a specific price.

Demand for a commodity implies three things:

1. a desire to acquire it;

2. a willingness to pay for it; and

3. the ability to pay for it.

The term “demand” has a specific meaning. As previously stated, a mere desire to purchase a product does not constitute demand.

A miser’s desire for and ability to pay for a car, for example, is not demand because he lacks the necessary will to pay for it. Similarly, a poor man’s desire for and willingness to pay for a car does not constitute demand because he lacks the necessary ability to pay (purchasing power).

Consider a person with the will and the purchasing power to pay for a commodity, but there is no demand for that commodity if he does not desire to own it.

The demand for a commodity must be stated in terms of time, its price and that of related commodities, consumer income and taste, and so on. Changes in these factors affect demand.

For example, as the demand for sweets rises, so does the demand for sugar. Alternatively, as your income rises, so does your desire for branded clothing.

In economics, demand means the desire to purchase a commodity, backed by willingness and the ability to pay for it.

Demand= Desire + Willingness to buy + Ability to pay

Types of Demand

Types of Demand	Meaning
Price Demand	The quantity of goods and/or services an individual wants to purchase at a specific price.
Cross Demand	The demand for a commodity is unaffected by its price but influenced by the prices of similar products.
Income Demand	The willingness of an individual to buy a specific quantity of a commodity at a given income level.
Joint Demand	When two commodities are sought together because they complement each other, they provide a combined benefit to the consumer.
Composite Demand	When commodities serve multiple purposes, an increase in the demand for one product leads to a decrease in the supply of the other.
Derived Demand	The demand for commodities necessary in the manufacturing process indirectly satisfies consumer needs.

2.1.1 Determinants of Demand

The consumer’s willingness and ability to purchase a commodity determine its demand. According to demand theory, the quantity demanded of a commodity is a function of or depends on not only the price of the commodity but also the person’s income, the price of related goods (both substitutes and complements), consumer tastes, price expectations, and all other factors. A demand function is a comprehensive formulation specifying the factors influencing product demand.

Dx = f(Px, Py, Pz, B, A, E, T, U)
Where,
Dx = Demand for item x
Px = Price of item x
Py = Price of substitutes
Pz = Price of complements
B = Income of consumer
E = Price expectation of the user
A = Advertisement Expenditure

T = Taste or preference of user Notes
U = All other factors

The impact of these determinants on demand is:

1. Price of a commodity: Demand for x is inversely related to its price.
This can be shown as:

Dx  x 1 / P

This shows that demand for x is inversely proportional to the price of x. This means that as the price of x increases, the quantity demanded of x falls.

2. Substitution effect on demand: If y is a substitute for x, then as the price of y increases, demand for x also increases.

This can be shown as:
Dx   X  Py
This shows that the demand for x is directly proportional to the price of the substitute commodity y. This means that the demand for x and the price of the substitute commodity y are directly related.

For example, Tea and coffee, cold drinks and juice, etc., are substitutes.

3. Complementary effect on demand: If z is a complement of x, then as the price of z falls, the demand for z goes up, and thus the demand for x also tends to rise.

This can be shown as:

Dx  X 1 / Pz

This shows that the demand for x is inversely proportional to the price of the complementary commodity z. This means the demand for x and the price of the complementary commodity y are inversely related.

For example, Ink and pen, bread and butter, etc. are complements.

4. Price expectation effect on demand: Here the relation may not be definite as the psychology of the consumer comes into play. Your expectations of a price increase might differ from those of your friends.

5. Income: As income rises, consumers buy more normal goods (positive effect) and less inferior goods (negative effect). Examples of normal goods are t-shirts, tea, sugar, noodles, watches, etc., and inferior goods are low-quality rice, jowar, and second-hand goods.
This can be shown as:

Dx  X B, if X is a normal good.
And,
Dx  X 1/B, if X is an inferior good.

6. Promotional effect on demand: Advertisement increases the sale of a firm up to a point.

This can be shown as:

Dx  X A

This means that demand for x is directly proportional to the advertisement expenditure of the firm producing x.

7. Taste and Preference: Changes in fashion, culture, and tradition also affect the demand for a commodity. Demand fluctuates as buyers’ tastes and preferences vary. As a result, a consumer’s taste and preferences play an important role.

2.1.2 Basis of Demand

Individuals’ needs are the primary source of demand. Individuals require products and services and are willing to pay a price for those products and services. Firms analyse needs and develop products and services to meet them. A company’s product market cannot be studied without considering demand conditions. The extent of demand determines the market size for a firm or an industry comprised of several firms. As a result, successful businesses devote significant time, energy, and effort to analysing the demand for their products. Without a clear understanding of consumer behaviour and market demand conditions, the firm’s attempt at profit planning or any other business strategy planning is hampered.

Example: Estimating current demand and forecasting future demand is the first step in measuring and determining the flow of sales revenue and profits that generate internal resources for business financing. The size and structure of demand are linked to a business’s stability and growth.

2.1.3 Direct and Derived Demand

You’ve probably noticed that our demand for necessities, such as food, clothing, and shelter, is unrelated to the demand for any other good. On the other hand, the demand for labour depends on our demand for houses or products, and the demand for mobile phones depends on our demand for communication. Direct demand refers to goods whose demand is independent of the demand for other goods, whereas derived demand refers to goods whose demand is dependent on the demand for other goods. However, there isn’t much demand entirely independent of any other demand. However, the degree of dependence varies significantly from product to product. As a result, the degree of variation in direct and derived demand is more significant than in kind.

2.1.4 Law of Demand

The Law of Demand explains the functional relationship between a commodity’s price and the quantity demanded. It has been discovered that price and demand are inversely related, which means they move in opposite directions. When the price rises, the quantity demanded falls, and vice versa. “Other things being equal, the demand for a commodity varies inversely with the price,” states the relationship.

For instance, Tim wants a motorcycle from Company A. Now, if Company A raises the price of the bike significantly, say by 10%, Tim may change his mind and decide to buy a motorbike from Company B, whose price is lower, or he may postpone his demand entirely.

Assumptions:

The demand law is based on the following assumptions:

1. No change in consumer income: Under the law of demand, consumer income should remain constant. If a consumer’s income rises, he or she may buy more things at the same price or the same amount, even if prices rise. The income is considered to stay constant since it may persuade consumers to buy more things and generate demand for a commodity despite an increase in the price of the commodity.

2. No change in the price of other goods: The price of substitute and complementary goods should not vary. If any prices change, the demand for the other item may change, influencing the law of demand.

3. No change in taste or preference: The law presumes that a consumer’s taste and choice for a commodity remain constant. If consumer tastes and preferences change, so will the demand for the goods.

4. No change in future price expectations: The rule of demand remains valid if there is no change in commodity prices. If a consumer expects a price increase in the future, he will buy more even if the price is greater now, and vice versa.

5. No change in the size and composition of the population: The legislation also presumes that the size and composition of a country’s total population shall not vary. That is, the population cannot rise or decrease. Because an increase in population would raise the demand for commodities. Along with population size, population composition is essential. If the number of senior citizens increases, so will the demand for medical care. If the female population grows, so will the demand for cosmetics.

6. No change in government policies: The legislation presumes that no change will raise or decrease demand for the product.

Demand Schedule and Demand Curve:

A demand curve considers only the price-demand relationship, while all other factors remain constant. The demand schedule for a commodity is the inverse relationship between the price and the quantity demanded for the commodity per period, and the data plot (with price on the vertical axis and quantity on the horizontal axis) gives the individual’s demand curve.

Example:

a. Demand Schedule

An Individual’s Demand Schedule for Commodity X

Price x (per Unit) Px	Quantity of x demanded (in Units) Dx
2.0	1.0
1.5	2.0
1.0	3.0
0.5	4.5

b. Demand Curve

 

 

 

 

 

 

 

 

 

 

 

The demand curve slopes downward from left to right when prices are lower, meaning people buy more of the product when it’s cheaper, assuming other things are the same. This opposite connection between the price of the product and how much people want is called the Law of Demand.

If the product’s price (Px) goes down, more of it is wanted (Dx), making the curve slope down. This happens because of the substitution effect and the income effect. So the slope is negative.

The main reason why demand curves slope down is that lower prices attract new buyers. Also, when a product’s price drops, people’s real income or buying power increases, making them more likely to buy that product—the income effect. Additionally, when the price of a product falls while other goods stay at the same price, that product becomes relatively cheaper. This makes people switch to buying this product instead of others that are relatively more expensive, known as the substitution effect.

Exceptions to the Law of Demand:

While the law of demand is generally valid in most instances, there are a few exceptions. The following are examples of such cases:

1. Goods with a high prestige value (Veblen effect):

This exception to the law of demand was proposed by economist Thorstein Veblen in his book “conspicuous consumption.” According to him, some consumers measure a commodity’s utility by its price, i.e., the higher the price of a commodity, the greater its utility. For example, people sometimes pay exorbitant rates for expensive or prestigious commodities such as diamonds, not for their inherent value but for snob value. However, as prices fall, they demand less due to the loss of snob value. This is known as the Veblen effect or the Snob value.

2. Giffen goods: Sir Robert Giffen, an economist, proposed yet another exception to the law of demand. In the case of Giffen goods, there is a direct price-demand link. When the price of a Giffen good rises, the quantity demand increases, and when the price falls, the quantity demand reduces, and the demand curve slopes upward rather than downward.

3. Price Expectations: If a consumer expects the price of a commodity to climb in the future, he or she may purchase more of the commodity now. Where the law of demand does not apply.

4. Emergencies: During an emergency, such as a natural or man-made disaster, the law of demand becomes ineffective. In such cases, people frequently fear a lack of essential items and demand more goods and services at higher costs.

5. Changes in fashion, taste, and preferences: Changes in customer taste and preferences negate the influence of the rule of demand. Even at higher prices, consumers choose to purchase things that are in demand in the market. When a product, on the other hand, falls out of favour, lowering the price of the product may not create demand for it.

3.1 Nature of demand curves under different markets

Economists categorise the numerous marketplaces that exist in a capitalist system as

(a) perfect or pure competition,

(b) monopolistic competition,

(c) oligopoly, and

(d) monopoly.

According to French economist Cournot, “Economists understand by the term market not any particular marketplace in which things are bought and sold but the entire region in which buyers and sellers are in such free interaction with one another that the price of the same good tends to equality easily and quickly.” A variety of things influence the sort of market. As a result, the nature of the demand curve varies by market.

The following are the characteristics of the demand curve under various market structures:

1. Demand Curve in Perfect Competition:

Perfect competition exists when a large number of producers (firms) make and sell a homogeneous product. Because the maximum output produced by one firm is very little compared to the entire demand for the industry product, the firm cannot change the price by adjusting its production supply. The seller is a price taker; he accepts the market price defined by market demand and supply. Thus, under perfect competition, individual prices are determined by market demand and market supply.

2. Market Demand Curve:

Under perfect competition, the market demand curve slopes downward. Because price and quantity demand are inversely related, as the price of a commodity rises, so does demand for that good. The combination of market demand and supply determines the market price at which enterprises sell their commodity. Once the market establishes the product’s price, all firms will set their prices to equal the price because they are price takers in a perfect market. As a result, the individual demand curve equals the market equilibrium price. The diagram depicts a downward-sloping market demand curve, with P0 representing the equilibrium market price followed by all individual firms and the individual firms facing the horizontal demand curve.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3. Individual Firm Demand Curve:

The demand curve confronting an individual firm operating in perfect competition is perfectly elastic, i.e. a horizontal straight line parallel to the X axis for a given price determined by market demand and supply. The diagram depicts the quantity demanded on the X-axis and the commodity price on the Y-axis. Where OP1 is the price determined by the interaction of the market supply and demand curves. It demonstrates that the corporation will lose money if it tries to cut the price.

 

 

 

 

 

 

 

 

 

 

 

4. Demand Curve in Monopoly:

A monopoly is a market in which a single firm produces and sells a product without a close substitute. As the single seller monopoly, he has control over supply and can set the price of a commodity. However, a rational monopolist seeking maximum profit will control either the price or the supply. Monopolies constitute the entire industry because they are the only single seller in the market. As a result, the demand curve in a monopolistic market is downward-sloping and has a greater slope, as illustrated in the diagram. As a result, there is a high barrier to entry for new firms in monopolies. If the monopolist firm wishes to grow its market sales, it must cut the price of its commodity.

 

 

 

 

 

 

 

 

 

 

 

 

 

5. Demand Curve in Monopolistic Competition:

In a monopolistic market, many firms manufacture or sell relatively distinct products with close substitutes. As a result, the demand curve confronting a firm under monopolistic competition slopes downward. It has an extremely elastic flatter form, indicating that the firm has some price control over a commodity. The demand curve confronting an individual firm under monopolistic competition is depicted in the diagram below.

 

 

 

 

 

 

 

 

 

 

 

 

 

6. Demand curve in an oligopoly market:

An oligopoly market is one in which only a few firms or sellers produce or sell differentiated products. Because there are fewer firms, each has some power over the price of the product, and the demand curves facing each other are downward sloping, indicating that the price elasticity of demand for each firm is not infinite. Because of the firm’s dependency. Any move to adjust the output price elicits a reaction from rival enterprises. As a result, the demand curve for an oligopoly firm is ambiguous, which means that it cannot be depicted precisely as an exact behaviour pattern of a producer with confidence.
The following diagram depicts the firm’s demand curve under oligopoly.

 

 

 

 

 

 

 

 

 

 

 

 

 

The demand curve confronting an oligopolist is naturally kinked.
Because the section of the demand curve above the prevailing price level, i.e. Kd, is very elastic, and the segment below the prevailing price level, i.e. Kd1, is very elastic, the kink is formed at a prevailing level, the point K. This is due to the diverse reactions of the various firms.