Theory of Demand -1 #

8/2/2019 Theory of Demand -1 #

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Individual demand/Market demand

Individual demand :It refers to demand from the individuals /family/house-

hold. It is a single consuming entitys demand.

Market demand: It refers to the total demand of all buyers ,taken together.

It is the aggregate of the quantities of a product demanded by all theindividuals buyers at a given price over a given period of time-it is the sumtotal of individual demand function

Market demand is more important from the business point of view, salesdepends on market demand ,so does planning future marketing strategyPrices are determined on the basis of demand for the product etc.

The following table shows individual demands for eggs and how themarket demand eggs at various prices is derived from it :


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Price

/doz Rs

A B C D E Total dd

for eggs

10 1 3 0 0 0 4

9 2 4 1 0 0 7

8 3 5 3 1 0 12

7 4 6 5 2 1 18

6 5 7 6 3 2 23

5 6 8 7 4 3 28

4 7 9 8 5 4 33


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Determinants of Demand

INDIVIDUAL DEMAND

Price of the products

Income

Tastes, Habits, Preferences

Relative price of other goods-

substitutes and complementarygoods

Consumers Expectations

Advertisement Effect

MARKET DEMAND

Price of the product Distribution of wealth and

income in the community

Communitys common habits andscale of preferences

General standard of living andspending habits of the people

Growth of the population

Age structure/sex ratio of thepopulation

Future Expectations Level of taxation and tax structure

Fashions/inventions/innovations/customs/weather/climate

Advertisement/sales propaganda


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DEMAND FUNCTIONAt any point of time, the quantity of a given product(good/service) that will

be purchased by the consumers depends on a number of key

variables/determinants.

The most important variables are listed below:

The own price of the product (P)

The price of the substitute and complementary goods(Ps or Pc)

The level of disposable income(Yd) with the buyers(ie; income left afterdirect taxes)

Change in the buyers taste and preferences(T)

The advertisement effect measured through the level of advertising

expenditure(A)

Changes in the population number or number of buyers(N)


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Using the symbolic notations, the demand function can expressed as

follows:

Dx=f(Px, Ps, Pc, Yd, T, A, N, u)

Where xcommodity

Dx - the amount demanded of the commodity

Px- price of x

u- other unspecified determinants of the demand for

commodity x

it can also be expressed as

Qd=f(P,X1,X2..Xn)

Where, Qd

quantity demanded

Pprice

X1,X2..Xnother determinants of demand


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In economics ,a very simple statement of demand function is adopted where

all variables, that determine demand are held to be constant ,expect for

price.So demand function is denoted as

Dx=f(Px)

this denotes that demand for commodity x is the function

of its price.

Demand Equation

A linear demand function may be stated as

D = abP

Where, Damount demandeda - is a constant parameter which signifies initial price

irrespective of price

b- denotes functional relationship b/w (P) &(D)


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b having a minus sign denotes a negative function, ie; demand for a

commodity is a decreasing function of its price.

To illustrate a demand equation & the computation of demand schedule

assuming estimated demand functions, as Dx = 20 - 2Px, whereDx = Amount demanded for the commodity X

Px = Price of X

Suppose, the given prices per unit of the commodityX are: Rs.1,2,3,4 and 5 alternatively.

In relation to these prices, a demand schedule may be constructed as below

Demand schedule for commodity X

Price per unit Rs. (Px) Units Demanded (Dx)

1 182 16

3 14

4 12

5 10


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LAW OF DEMAND

The law of demand expresses the nature of functional relationship b/w two

variables of the demand relation viz; the price and the quantity

demanded.

It simply states that demand varies inversely to change in price.

Statement of law of demand

Ceteris paribus, the higher the price of a commodity the smaller is the

quantity demanded and lower the price ,larger the quantity demandedOther things remaining unchanged ,demand varies inversely with price

so, D=f(P)


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Price of commodity X Quantity demanded

(in Rs) (units per week)

5 100

4 200

3 300

2 400

1 500

The schedule for commodity X, as price falls demand raises so there is an

inverse relationship b/w price and quantity demanded.

Assumptions of law of demand

The law of demand is based on certain assumptions

No change in consumers income

No change in consumers preferences


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No change in fashion

No change in the price of related goods

No expectation of future price changes or shortages

No change in government policy etc.


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Exceptions to the law of demand

The upward sloping curve is contrary to the law of demand, where there is a

direct relationship b/w price and demand (as shown in fig-2)

These exceptional cases can be listed as Giffen goods : In the case of certain inferior goods called Giffen

goods(named after Sir Robert Giffen), in spite of price rise, demand will

also rise. It was seen in Ireland in 19th. Century people were so poor that

they spent a major part of income on potatoes and a small part on meat,

as price of potatoes, rose the demand also rose since they could notsubstitute it for meat which was very expensive. Giffens paradox is seen

the case of inferior goods like potatoes, cheap bread etc.

Speculation : when people speculate about prices on the commodity in

the future they may not act according to the laws of demand. Speculating

the prices of the commodity will further increase they will demand moreof the commodity for hoarding etc. In the stock market, people tend to

buy more shares when prices are rising in the hope of bull runs in

anticipation of future profits.


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Article of snob appeal : Certain commodities are demanded because they

happen to be expensive or prestige goods or snob value having a status

symbol. So increase in price will lead to increase in demand for suchgoods. E.g. Diamonds ,exclusive cars etc.

Consumer psychological Bias: when a customer is wrongly biased against

quality of a commodity a fall in price may not lead to an increase in

demand example clearance of stock , discounted sale , etc.


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Extension and contraction of demand

A variation in demand implies extension or contraction of demand. A change in

demand due to change in price is called extension or contraction of demand.

It is a movement along the same demand curve due to changes in price. In the following diagram , demand increases from a to b and then decreases to

point c indicating various changes to demand due to price change.


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Increase and decrease in demand

Changes in demand are a result of the change in the conditions / factorsdetermining demand other than price.

Change in demand thus implies an increase or decrease in demand with priceremaining constant.

An increase /decrease signifies either more or less will be demanded at agiven price. This is represented graphically by movement of the demandcurve upwards (in case of increase in demand) and downward movement ofdemand curve incase of decrease in demand.

Reasons for change in Demand:

Changes in income

Changes in taste, habits and preferences

Change in distribution of wealth and population

Change in demand of complimentary / substitute goods Change in tax structure

Change in value of money

Effect of advertisement and publicity


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Types of demand

The demand behavior of the consumer differs with different types of demand

in the study of managerial economics it is important to distinguish these

types of demand Demand for consumers goods and producers goods

Goods /services that are demanded by the consumer for direct

satisfaction of their wants ie; for consumption purpose- food, clothes,

services of doctors ,maids, teachers

Goods that demanded by producers in the process of production are called

production goods eg; tools and equipment, machinery, raw material,

factory building, offices

Demand for consumer goods is direct /autonomous ,whereas demand

for producer goods is derived ie; based on demand for output

Demand for consumer goods is based on marginal utility, whereas the

demand for producer goods is based on marginal productivity of the

factors of production


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Dean (1976) explained this distinctive demand behavior for producer goods in

the economy.

Buyers of producers goods are professionals /experts, so they are less likely to

be influenced by sales promotion.

Producer buyers are more sensitive to factor price differences and

substitutes. The motive of the producers are purely economic and capital

goods are bought on account of profit prospective. The demand of

producers goods is derived from consumption demand, so there are

frequent fluctuations in demand levels.

Demand for perishable and durable goods:

Perishable goods have no durability , they cannot be stored for a long period

of time eg. Fish, egg, vegetables etc.

Durable good have a long shelf life and can be stored example furniture , caretc.

Perishable goods give a one shot service whereas durable goods can be used

for several years.


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Demand for perishable goods depends on convenience, style & income of the

consumer. This demand is always immediate.

Demand for durable goods depends on product design, current trends, incomelevels, price etc. this demand is postponable.

Autonomous and derived demand:

Spontaneous demand for goods is based on a urge to satisfy some want

directly, such a demand is called Autonomous demand. Demand for consumer

goods is autonomous. It is a direct demand, it is a final demand .When the demand of the product depends on the demand of some other

product, it is called derived demand. When the demand of the product is tied

to the purchase of some parent product its demand is called derived(Dean

1976). Eg. Demand for doors derived from demand from houses., demand for

bulbs derive from demand for lamps.Demand for dependent product is caused by complementary consumption.

Example demand for sugar emerges from demand for tea.

Demand for all capital goods are derived. Nowadays it is rare to see demand

for goods to be wholly dependent of all other demands. Most demands are

derived demands.


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Example demand for car by an individual is derived from demand of

transportation service.

This distinction between two types of demand is a matter of degree.

Industry demand and firm / company demand :

A firm is a business unit , where as industry is a group of closely competitive

firms.

A firms/companys demand relates to the market demand for the firmsoutput. An industrys refers to the to the total demand for a commodity

produced by a particular industry eg; Car industry, Sugar industry etc.

The basic relationship of a firms demand and industry/market depends on the

market structure whether perfect competition, monopoly or monopolistic

competition. The elasticity of the demand curve will vary accordingly.


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Short run demand and Long run demand

Short run demand refers to existing demand with its immediate reaction

to price changes ,income fluctuations etc., whereas long run demand is

that which will ultimately exist as a result of the changes in pricing,promotion or product improvement ,after time is allowed to let market

adjust itself to the new situations (Dean 1976)

Y In the short run the demand is not elastic

(not very responsive to change) due to the

following reasons

D * Cultural lags in information/experience

D X * Capital investment required of buyers

to shift consumption patterns*Time adjustment involved-to change consumption patterns, habits, arrange

for finance.


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Joint demand and composite demand

There are certain commodities the demand for which are interrelated. There

are two types of interrelationships for such commodities.

(1) Joint or complimentary: two goods that are demanded in conjunction

with one another at the same time to satisfy the same want, such goods

are said to be complimentary in nature. Eg. Bread / butter, cars/fuel,

pen/ink, key/lock.

(2) Composite demand: A commodity is said to be in composite demand

when it is wanted for several different uses. Eg. Steel needed for cars,

building,railways etc., Coal for factories, railways etc., wool for carpet,

clothing etc., electricity for tv, radio etc. sugar for sweets, preservatives

etc.

A change in demand for the commodity by one user will affect its

supplies to others and will bring about a change in its price and hencealter its demand pattern

Theory of Demand -1 #

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