Demand Analysis

Demand = Desire + Ability to Pay + Willingness to Pay


Teaching Points
3.1     Introduction
3.2     Concept of Demand
3.3     Individual Demand and Market Demand
3.4     Factors affecting Demand
3.5     Types of Demand
3.6     Law of Demand
3.7     Variation and Changes in Demand


Teaching Objectives
To enable the students to know the basic concepts related to demand analysis


'The busiest man has the most time.'


3.1     Introduction
Ordinarily by demand we mean desire. But demand is different from desire. The willingness to have something can be called as desire. Those desires become demand which are backed by purchasing power, e:g., ability to pay and willingness to pay for it. It means the following three conditions are necessary for demand.
1.       Desire
         2.       Purchasing power or ability to pay
         3.       Willingness to pay.
Above conditions must be there to create demand.


3.2     Concept of Demand
Goods are demanded because they have utility. Demand is that quantity of a commodity which a person is ready to buy at a particular price and during a specific period of time. When price of sugar is Rs. 30 per kg the demand for it is 10 kgs per week. The reference of price and time is essential for-demand, because demand differs with price and time. Thus following features of demand are clear from the above.
1.     Utility is the base of demand.
2.     Demand is a relative concept.
3.     Reference of price and time is necessary for demand.


3.3   Individual Demand and Market Demand
       Individual demand is a demand by an individual. Individual demand indicates amount of goods purchased by an individual at different prices during a given period of time. Market demand is aggregate of all quantities purchased by all buyers of a commodity at different prices during a given period of time. Since there are numerous consumers of a commodity, market demand is the total of all individual demand.      
Individual Demand Schedule - It is a tabular representation of a commodity that is purchased by an individual at various prices in a given period of time. This can be explained with the help of following individual demand schedule.
Table No. 3.1 – Individual Demand Schedule
Price of Sugar (Rs.)
Demand (Kg.)
25
10
26
9
27
8
28
7
29
6
30
5


         The above table shows different quantity of sugar purchased by a household at different prices. It can be observed that less quantity of sugar is demanded at rising price and vice versa. For example, when price of sugar is Rs. 25/- per kg. Demand for sugar is 10 kg. But 5 kg. of sugar is demanded at price of Rs. 30/- per kg.
Market Demand Schedule – It is a tabular representation of quantities of a commodity demanded or purchased at varying prices by all the consumers in the market, at a given period of time. It is obtained by horizontal summation of demand of all individuals at various prices. This can be explained with the help of the following market demand schedule.
Table No. 3.2 – Market Demand Schedule
Price of Sugar (Rs.)
Quantity of Sugar Demanded Kg.
Market Demand Kg.
(Per Kg.)
Consumer A
Consumer B
Consumer C
(A+B+C)
25
10
11
12
33
26
9
10
11
30
27
8
9
10
27
28
7
8
9
24
29
6
7
8
21
30
5
6
7
18


         In the above schedule there are three consumers of sugar, namely, A, B and C. It is clear from the table that market demand for sugar is the total demand of all consumers of sugar at varying prices. For example, at price Rs. 25/- per kg. market demand of sugar (33 kg) = demand of consumer A (10 kg.) + demand by B (11 kg.) + demand by C (12 kg.). Market demand varies inversely with the changes in price. Market demand is always, greater than individual demand.


3.4     Factors Affecting Demand
         Demand is influenced by the following factors.
1.       Price : Price is one of the most important factors that affect demand. When price rises demand falls, and when price falls demand rises.
2.       Income: Income is yet one more important factor that affects demand. Demand depends upon income of individuals in the society. Normally, Demand rises with increasing income of the society.
3.       Population: An increase in population, leads to an increase in market demand for goods and services.
4.       Tastes, Habits and Fashions : Some factors such as taste, habit of consumers affect demand; in the market.
5.       Prices of Substitute and Complementary Goods: Demand changes due to changes in the prices of substitute and complementary goods. For example demand for tea changes because of change in the price of coffee. Similarly, demand for motor cars changes , because of change in the price of petrol.
6.       Distribution of Income : Unequal distribution of income and wealth would lead to less demand for goods and services. i.e. demand depends on the distribution of National Income and Wealth.
7.       Expectation about Future Price : If consumers expect a fall in the price of a commodity in the near future, they will demand less at present price and vice versa: It shows that expectations about the future prices affect demand.
8.       Advertisement: The goods which are advertised powerfully on, radio; television and newspapers,    etc.,   push   up demand. Advertisement is an important factor today that affects demand.
9.       Taxation Policy: Government's taxation policy affects demand. For example, a change in income tax will change consumer's disposable income arid therefore demand.
10.     Other Factors: Change in any climatic conditions, traditions, political and social factors also influences demand.


3.5     Types of Demand
1.       Direct Demand: When a commodity is demanded to satisfy human wants directly, it is direct or conventional demand. For example, the demand for food; clothes have direct demand. Consumer goods have direct demand.
2.       Indirect Demand: Indirect demand is also known as derived demand. When goods are demanded indirectly, i.e., to produce consumer goods, it is indirect demand. For example, the demand for factors of production is indirect demand.
3.       Joint Demand: When two or more goods are demanded jointly to satisfy a single need, it is known as joint demand for example, to make tea, water, sugar, tea powder, milk etc. isjointly demanded. The demand for complementary goods is joint demand.
4.       Composite Demand: The demand for commodities, which is used for satisfying several want at a time, is composite demand. For example, the demand for electricity is composite demand.
5.       Competitive Demand: Competitive demand is when demand for a commodity competes with its substitutes. For example tea and coffee have competitive deinand.


3.6     Law of Demand
Law of demand is one of the important basic laws of consumption. Dr. Alfred Marshall, in his book "Principles of Economics", has explained the law of demand as follows.
         "Other things being constant the higher the price of the commodity, smaller is the quantity demanded arid lower the Mice of the commodity larger is the quantity demanded."       
The law of demand explains change in the behaviour of consumer demand due to various changes in price. Marshall's Law of demand describes functional relation between demand and price. It can be expressed as D = f (P) that is demand is function of price. The relation between price and demand is inverse, because larger quantity is demanded when price falls and smaller quantity will be demanded when price rises. The law of demand is explained with the help of the following schedule and diagram.
Table No. 3.3 = Demand Schedule
Price of Mangoes
Per Kg. (Rs.)
Demand for Mangoes
(Kg.)
50
1
40
2
30
3
20
4
10
5


       As shown in the schedule when price of mangoes is Rs. 5O/- per kg. demand is, 1 kg. When price falls to the level of Rs. 40/- per kg. and demand rises to 2 kg. Similarly, at the price Rs. 10/- per kg. demand of mangoes is 5 kg., whereas 4 kg. of mangoes are demanded at price Rs. 20/- per kg. This shows inverse relation between price and demand.
In this diagram X axis represents demand for mangoes, whereas Y" axis represents price of mangoes. DD is demand! curve which slopes downwards from left to right. In other words, its slope is negative because of inverse relationship between price and demand.


Why demand curve slopes downwards from left to right?
The reasons for downward slopping demand curve are as follows:
1.       The law of diminishing marginal utility: We have seen that marginal utility goes on diminishing with increasing stock of a commodity. Therefore, a consumer tends to buy more when price falls.
2.       Income effect: When price falls, purchasing power of a consumer rises, which enables him to buy more of that commodity whose price falls. This is income effect.
3.       Substitution effect : In case of substitute goods, when price of a commodity rises, its substitutes become relatively cheaper. Therefore, a consumer will purchase more of that commodity.
4.       Multipurpose uses: When a commodity can be used for satisfying several needs, its demand will rise with a fall in its price and fall with a rise in its price.


Assumptions of the law of Demand
The law of demand is based on following assumptions.
1.       Size and composition of population remains constant: There should not be any change in the size and composition of population. Because a change in population will bring about a change in demand even if price remains the same.
2.       Income of the consumer remains constant : Income of consumer should remain constant. If there is any change in income, demand tends to change even though price is constant. For example, if income increases people will demand more quantity of a commodity even at a higher price.
3.       Tastes and habits remain constant: Taste, habit, custom, tradition and fashion etc. should remain unchanged. Due to changes in taste and preference, people's demand for goods undergoes a change.     
4.       No change in expectations about future price changes: There should not be any change in the expectations about the prices of, goods in future. If consumers expect that price will rise or fall in future, they will change their present demand though price is.constant.
5.       Prices of substitutes and, complementary goods remain constant: The prices of substitute and complementary goods should remain constant. For instance, if price of tea rises, its demand will fall but demand for coffee will increase.
6.       Government Policy remains constant: Taxation and fiscal policy of government should not change. A change in income tax, for instance, may cause changes in consumer's disposable income and hence demand.


Exceptions to the Law of Demand
The Law of Demand explain's an inverse relationship between the price of a commodity and the quantity demanded of it. Sometimes however we see a direct relationship between price and quantity demanded of a commodity.
Under exceptions to the Law of Demand, the demand curve slopes upwards from left to right which shows a direct relationship between price and quantity demanded. It can be shown in the following diagram.
Exceptional Demand Curve


Fig. No. 3.2
Following are the exceptions to the Law of Demand.
1.       Giffen goods – Certain inferior goods are-ca1Md Giffen goods, when the price falls, quite often less quantity will be purchased than before because of the negative income effect and people's increasing preference for a superior commodity with the rise in their real income. Sir Robert Giffen observed the situation related to demand for bread & meat in England. When price of bread was decresing, less bread was purchased. Here surplus money was transferred to purchase meat, as a result demand for meat increased.
         This behaviour is known as Giffen's paradox. Thus Giffen goods are inferior goods which have a direct relationship between price and quantity demanded In this case the demand curve slopes \ upwards from left to right as shown in the above diagram.
2.       Prestige goods: Diamonds, high priced motor cars, luxurious bungalows are prestige goods. Such goods have a "snob appeal". Rich people consume such goods as status symbol. Therefore, when the price of such goods rises their demand also rises.
3.       Price illusions or  Consumers Psychological bias: Consumers have illusion that high priced goods are of a better quality. Therefore the demand for such goods tends to increase with a rise in their price. e.g. Branded products which are expensive are demanded at a high price.
4.       Demonstration effect : The, tendency of low income group to imitate the consumption pattern of high income groups is known as Demonstration effect. For example demand for consumer durables such as washing machine, latest mobile etc.
5.       Ignorance: Sometimes people do not have proper market knowledge. They may not be aware of the fall in price of a commodity and thus they tend to purchase more at a higher price.
6.       Speculation: When people speculate a change in price of a commodity in the future, they may not act according to the Law of demand. People may tend to buy, more at rising price, when they anticipate further price rise. For example, in the stock market people tend to buy more shares at rising prices. Even if prices of some goods like sugar, oil etc. are rising before Diwali, people go on purchasing more of these things at rising prices, because they think that prices of these goods may increase further during Diwali.
7.       Habitual Goods: Due to habit of consumption certain goods like tobacco, cigarettes etc are purchased even if prices are rising. Thus it is an exception.


3.7     Variation and Changes in Demand
         Variation in Demand : There are many factors that determine demand. One of the important factor is price. When demand changes due to changes in price; it is known as variation in demand. It is of two types.
1) Expansion of demand
2) Contraction of demand
Expansion of demand - With a fall in price when more of a commodity is bought there is 'Expansion' (or Extension) of demand, other things remaining constant.
Contraction of demand - With a rise in price when less of a commodity is bought there is contraction. of demand, other things remaining constant.
Expansion and contraction of demand is shown by the movement along the same demand curve. This can be explained with the help of a diagram.
Extension and Contraction in demand


fig. 3.3


As shown above 'DD' is the demand curve. A downward movement on the demano curve from point a to b shows "extension of demand" and the upward movement from point a to c shows "contraction of demand".
Change in Demand : Change in demand implies an increase or decrease in demand. There are many other factors that affect demand other than price such as population, income, tastes and habits, etc.
Increase in demand : When more quantity of a commodity is demanded because of change in the factors determining demand other than price it is an increase in demand.
Decrease in demand : When demands falls due to changes in factors other than price, it is known as decrease in demand. For example, if income of a consumer decreases, he will demand less of the commodity at constant price, and if income of the consumer increases, he will demand more of a commodity at constant price. Changes in demand can be well explained with the help of the following diagram.
Increase and Decrease in demand


Fig. 3.4
In this diagram, DD is original demand curve, which shows OQ quantity demanded at price P If we assume that the income of a consumer increases he will demand OQ1 quantity at the price P, which is greater than original demand. This is an increase in demand. Similarly, if income of a consumer is reduced, he will demand OQ2 quantity of the product, which is less than OQ. This is decrease in demand. An increase and decrease in demand cannot be shown on one demand curve. When demand increases, demand curve shifts to the right side of original demand curve. When demand decreases the demand curve is shifted to the left of the original demand curve.
1.       Fill in the blanks with appropriate alternatives given in the brackets:
         1.       When price of commodity rises; the demand for it ............... (rises/contracts/remains constant/becomes negative)
         2.       When less is purchased at the constant price, it is called .............. in demand (increase/decrease/expansion/contraction)
         3.       When the price of petrol goes up, demand of cars will .............. (rise/fall/not change/remain unchanged)
         4.       Market demand is an aggregate of purchasing by .............. buyers (some/ all/one/two)
         5.       Indirect demand is also known as .............. demand (derived/direct/ composite/joint)


2.       Match the following:
         Group "A"                                  Group "B"
         1.  Demand-and price                  a.  Substitute goods
         2.  Tea and coffee                       b.  Inverse relation
         3.  Inferior goods                       c.  Joint demand
         4.  Factors of                             d.  Distribution of production income
         5.  Pen arid ink                          e.  Composite demand
                                                         f.   Giffen goods
                                                         g.  Indirect demand


3.       State whether the following statements are TRUE and FALSE
         1.       Demand curve slopes upward from left to right.
         2.       Desire means demand.
         3.       When demand increases, the demand curve shifts to the left.
         4.       Quantity demanded varies directly with price.
         5.       Law of demand is explained by Prof. Robbins.
         6.       Individual demand is a demand, by single buyer.


Q.2    A.      Define or explain the following concepts
         1.       Demand
         2.       Increase in demand
         3.       Derived demand
         4.       Direct demand
         5.       Market demand schedule
         B.      Give reasons or explain the following statements
         1.       All desires are not demand.
         2.       Increase in demand indicates a right ward shift in the demand curve.
         3.       Demand curve-slopes downward from left to right.
         4.       Demand for factors of production is derived demand.


Q.3    Distinguish between
         1.       Desire and demand
         2.       Increase in demand and decrease in demand
         3.       Individual demand and market demand
         4.       Inferior goods and superior goods
         B.      Write short note
         1.       Giffen's paradox
         2.       Types of demand    
         3.       Concept of demand


Q.4    Answer the following questions
         1.       What do you mean by demand?
         2.       What are the assumptions of the Law of Demand?


Q.5    Do you agree with the following statements? Give reasons
         1.       There are no exceptions to the law of demand.
         2.       Many factors influence the demand for a commodity.


Q.6    1.       State and explain the law of demand.
         2.       Explain determinants of market demand:


Project :
Collect data of changes in demand for various vegetable with respect to change in price, during one week.

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