Demand

DemandMeaning of Demand Demand in economics means a desire to possess a

good supported by willingness and ability to pay for it.

If you have a desire to buy a certain commodity, say, a tractor, but do not have the adequate means to pay for it, it will simply be a wish, a desire or a want and not demand.

Demand, cont.Meaning of Demand In the other words, "Demand means the various

quantities of a good that would be purchased per unit of time at different prices in a given market.”

Demand, cont.There are three main characteristics of demand in economics.i. Willingness and ability to pay. Demand is the amount of a commodity for which

a consumer has the willingness and also the ability to buy.

Demand, cont.ii. Demand is always at a price. If we talk of demand without reference to price, it

will be meaningless. The consumer must know both the price and the commodity. He will then be able to tell the quantity demanded by him.

iii. Demand is always per unit of time. The time may be a day, a week, a month, or a year.

Demand, cont.Individual's Demand for a commodity: The individual’s demand for a commodity is the

amount of a commodity which the consumer is willing to purchase at any given price over a specified period of time.

The individual's demand for a commodity varies inversely with price ceteris paribus. As the price of a good rises, other things remaining the same, the quantity demanded decreases and as the price falls, the quantity demanded increases.

Demand, cont.The Market Demand for a Commodity: The market demand for a commodity is obtained

by adding up the total quantity demanded at various prices by all the individuals over a specified period of time in the market.

The Demand CurvePrice

Quantity demanded per unit of time

Demand Curve

Demand, cont. Two types of demand:1) Derived demand.Derived demand refers to demand for goods which are needed for further production. It is the demand for producer’s goods like industrial raw material, machine tools and equipment.

Demand, cont.2) Autonomous demand  Autonomous demand is independent of the

other product or main product. It is not linked or tie-up with the other goods or commodity.

eg: food articles, clothes.

Demand, cont. Price Demand : It refers to various

quantities of a good or service that a consumer would be willing to purchase at all possible prices in a given market at a given point in time, ceteris paribus.

Demand, cont. Income Demand : It refers to various

quantities of a good or service that a consumer would be willing to purchase at different levels of income, ceteris paribus.

Demand, cont. Cross Demand : It refers to various

quantities of a good or service that a consumer would be willing to purchase due to changes in the price of related commodity. For example: Demand for pork is more not because price of pork has fallen but because price of beaf has risen. Thus demand for substitutes take the form of cross demand.

Surplus and Shortage We could have a surplus and still have a

scarce commodity, RIGHT?

Surplus

A SURPLUS Pe and Qe represent the market clearing

price and quantity. Assume the government sets a price at P1:

1. There is a surplus of goods.2. Price must fall for the market to

clear.

Shortage

A SHORTAGE Assume the government sets a price at P2:

1. There is a shortage of goods.2. Price must rise for the market to

clear.

Law of DemandPrinciple stating that as the price of a

commodity increases, the less consumers will purchase per unit of time, ceteris paribus.

As price decreases, the quantity demanded increases per unit of time, ceteris paribus.

Law of Demand P Qd P Qd

Law of Demand As price falls from P1 to P2 the quantity

demanded increases from Q1 to Q2. This is a negative relation between price and quantity, hence the negative slope of the demand schedule; as predicted by the law of demand.

Change in Demand Changes in demand for a commodity can be

shown through the demand curve in two ways:

(1) Movement along the demand curve (Extension and contraction)

(2) Shifts of the demand curve (Increase and decrease).

Change in Demand, cont.(1) Movement along the demand curve: A movement along a demand curve is

defined as a change in the quantity demanded due to changes in the price of a good will result in a movement along the demand curve.

Law of Demand

Change in Demand, cont.2) Shifts in the demand curve: A shift of the demand curve is referred to as

a change in demand due any factor other than price.

Change in Demand, cont. A demand curve will shift if any of these

occurs:1. Change in the price of other goods

(complements and substitutes)2. Change in the income level3. Change in consumers’ tastes and

preferences…

Determinants of demand Movements along a demand curve is the

result of increase or decrease of the price of the good, while the demand curve shifts when any demand determinant other than price changes.

Determinants of demand These other determinants, in addition to the

commodity's own price are:a. Consumer disposable income.b. Price of substitutes.c. Price of complements.d. Consumer preferences.e. Expectations about the future.

Determinants of demandf. Changes in the population.g. Length of adjustment period. h. Availability of substitutes.i. The proportion of the consumers budget a good or service

represent

A. Consumer’s Disposable Income

1. If we increase consumer's disposable income, ceteris paribus, what happens?

• He/she is able to purchase more at all price levels.

2. The demand curve shifts to the right.

Price

D1

D0

Quantity

3. If we decrease the consumer's disposable income ceteris paribus, what happens ?

· The consumer cannot purchase the same amount of the commodity as before, over the entire range of prices.

4. The demand curve is said to shift to the left.

Price

D0

D1

Quantity

5. Associated with this income effect, we can create another sub-classification for commodities:

Normal Goods or ServicesAn Increase in disposable income, shifts

Demand curve right.

Id Demand

Price

D1

D0

Quantity

Normal Goods or ServicesA Decrease in disposable income shifts

Demand curve left

Id Demand

Price

D0

D1

Quantity

Inferior Good or ServiceAn Increase in disposable income shifts

curve left.

Id Demand

Price

D0

D1

Quantity

Inferior Good or ServiceA Decrease in disposable income shifts

curve right.

Id Demand

Price

D1

D0

Quantity

Inferior Good or ServiceExamples:

potatoes, and rice

B. Change in the price of substitutes, ceteris paribus:

An increase in the price of a substitute will result in an increase in the demand of the commodity of interest (COI)

(demand shifts right).

For example, lets look at beef while considering pork as a substitute:

Let the quantity of pork available become restricted. What happens?

· There is an increase in the price of pork.

Increase in price of pork due to a decrease in Supply of pork:

Price S1 S0 Pork Market

P1

P0

D

Q1 Q0 Qd of pork

There is an increase in the demand for beef (COI) because of the increase in the price of pork

(SUBSTITUTE).

Price S0 Beef Market P1

P0

D1

D0

Q0

Qd of beef

Substitutes:Therefore, an increase in the price of a

substitute will shift the entire demand curve of the commodity of interest to the right.

Substitutes:A decrease in the price of a substitute will

shift the entire demand curve of the commodity of interest to the left.

Substitutes

Psub DCOI

AND

Psub DCOI

C. Change in the price of a complement, ceteris paribus:

Complements are goods that go together, such as:

left and right shoes, gas and cars, milk and cereal, Gasoline and bio-gas etc.

Compliments:If the price of a complement increases, then

the demand for the COI decreases.

Pcomp DCOI

Compliments:Price Let the price of gasoline increase. Since bio-gas is a complement of

gasoline, its demand will decrease.

D0

D1

Qd

Compliments:If the price of a complement decreases, the

demand for the COI increases.

Pcomp DCOI

Compliments:Price Let the price of gasoline decrease. Since bio-gas is a complement of

gasoline, its demand will increase.

D1

D0

Qd

D. Consumer preferences and taste

As preferences change the demand curve will also change.

For example: What would be the result of the following statements, if true, on the demand curve for each commodity ?

Animal fat leads to a higher risk of heart attacks.

Price Result: Demand for red meat

D0

D1

Qd

Increasing fiber in the diet reduces the chance of getting colon cancer.

Price

D1

D0

Quantity / unit of time

Result: Demand for high fibercereals and popcorn.

E. Expectations about the futureThe peanut butter scare:

a news release said that the peanut crop would be short that year and peanut butter prices were expected to double.

Expectations about the futureResult: People bought 3 kg. of peanut butter that

month instead of 1 kg.

Demand for peanut butter.

Due to Expectations of higher Price.

Since consumers expect prices to increase, they all run out to buy NOW.

This causes demand to increase, and prices are pushed up very quickly!

Graphically Speaking:Price

$2.00 D1

D0

1 3 kg. per month

F. Changes in the population of consumers

Price

D1

D0

Quantitiy/unit time

Increase in population will result in increase in Demand for G&S.

Changes in the population of consumers

Price

D0

D1

Quantitiy/unit time

Decrease in population will result in decrease in Demand for G&S.

G. Length of the Adjustment Period

This is tied to, or related to the availability of substitutes. Price

Short Run: Consumers have little time to find suitable substitutes.

D

Quantity per Unit of Time

Demand is not very sensitiveto price changes, c.p.

We say demand is relatively inelastic

Length of the Adjustment PeriodPrice

D

Quantity Demanded per Unit of Time

Long Run: Consumers have time to find suitable substitutes.

Demand becomes moresensitive to prices changesas time progresses, c.p.

We say demandis relativelyelastic.

An Example: Demand for GasolineIf the price of gas increases from $1.20 per

gallon to $2.20 per gallon, how will consumers respond?

First:Are we asking how consumers will respond

over the next day, week, month, year, etc.

It makes a difference!Demand for gas will be different for different

time periods

The longer the time period considered, the flatter the demand curve becomes; or the more elastic it becomes.

What occurred in the 1970’s?What was a simplified sequence of events that

occurred when gas prices at the pump increased so dramatically in the 1970's?

The Sequence of Events:(1) People griped.(2) Car pools formed, and bus usage increased.(3) Big cars were replaced with small ones.(4) Some people moved closer to work.(5) New technology that decreased fuel consumption was developed.

What was the result of this sequence of events on Demand?

Price

Quantity demanded

$1.20

$2.20

Q1 Q0

In Short Run, the very large increasein gas price resulted in a very small decrease in consumption of gasoline.

D

Consumption of gas will not be veryresponsive to the increase in price.

We say demand is relatively inelastic

As time progressed:As time progressed:

Price

Quantity demanded

$1.20

$2.20

Q1Q0

In Long Run, consumers have time tofind substitutes, and the very largeincrease in gas price will eventuallyresult in a significant decrease inconsumption of gasoline.

This of course assumes that consumers perceive the increasedprice of gas to be persistent, not just a temporary price increase.

D

H. The Availability of Substitutes

D

Price

Quantity/unit time

If a commodity has FEW substitutes,demand for the commodity will tendto be more inelastic or less responsiveto price changes.

P0

P1

Q1 Q0

Demand curve will tend to have avery steep slope.

D

Price

Qd/unit time

If a commodity has MANY substitutes,demand for the commodity will tendto be more elastic or more responsiveto price changes.

P0

P1

Q1 Q0

The Availability of Substitutes

Demand will tend to havea very flat slope.

I. Proportion of the Consumers Budget a Good or Service Represents

D

Price

Qd/u.t.

Salt

$.50

$1.00

Q0Q1

If the price of SALT doubles, how muchwill this price increase affect the consumptionof salt?

Why?

Proportion of the Consumers Budget a Good or Service Represents

The less of a consumers budget a commodity represents, the more inelastic the demand curve will tend to be.

The price of salt is such a small percentage of our budgets, that consumption of salt will not be affected very much by a price increase.

Proportion of the Consumers Budget a Good or Service Represents

D

Price

Qd/u.t.

Automobile

$20,000

$40,000

Q0Q1

If the average price of an AUTO doubles,how much will this price increase affect theconsumption of Automobiles?

Why?

Proportion of the Consumers Budget a Good or Service Represents

The more of a consumers budget a commodity represents, the more elastic the demand curve will tend to be.

The price of an automobile is such a large percentage of our budgets, that consumption of automobiles will be affected very much by a price increase.

Exceptions to the law of demand Few exceptions of the law of demand are as follows:1. These are those inferior goods whose quantity demanded

decreases with decrease in price of the good.2. Commodities which are regarded as status symbols:

Expensive commodities like jewelry, AC cars, etc., are used to define status and to display one’s wealth.

3. Expectation of change in the price of the goods in future: if a consumer expects the price of a good to increase in future, it may start accumulating greater amount of the goods for future consumption even at the presently increased price.