Short Notes: Theory of Demand

Demand: Individual Demand and Market Demand

What is Demand? Not, what you wish to have! What you wish to have is simply your wishful thinking or desire. Demand is what you wish to buy against a particular price. It is the desire to buy a commodity (or a particular amount of a commodity) at its particular price, at a point of time.

Demand refers to the desire to buy a particular commodity (or its particular amount/quantity) against a particular price, at a point of time.

Important thing to remember is that demand for a commodity cannot be discussed independent of price of the commodity.

Ask your mother: How much of fruit (say apples) she wishes to buy? Pat should come the reply: It depends on the price of apples. Higher the price of the commodity, lower the purchase of the commodity. It is a standard relationship between price and purchase, on the assumption that other things (other than price and purchase of the commodity) do not change.

A Standard Relation between Price and Purchase

It is that higher the price, lower the purchase of the commodity on the assumption that other things do not change

Individual Demand

It refers to demand for a commodity by an individual buyer in the market. ?Ram buying 10 shirts at a price of Rs. 500 per shirt? is an example of individual demand.

Market Demand

It refers to total demand for a commodity by all the buyers in the market. If Ram and Shyam are the only two buyers in the market, and both of them are buying 25 shirts at a price of (say) Rs. 500 per shirt, market demand would be: 25 shirts at a price of Rs. 500 per shirt. Or it could be 30 shirts at a price of (say) Rs. 400 per shirt, and so on.

Note: Both in case of individual demand and market demand, the inverse relationship between price and purchase holds goods. In fact, buying more at a lower price and buying less at a higher price is a phenomenon related to human psychology. We shall discuss more about it in the subsequent sections.

Determinants of Demand

  • Price of the Commodity: Price, of course, is the prime determinant of demand for a commodity. Higher the price, lower the purchase? operates like a law in the market. Often this relationship is referred to as the, Law of Purchase or Law of Demand. But there are other determinants of demand as well, as under:
  • Income of the Consumer: Higher the income (implying purchasing power), higher the purchase.
  • Tastes and Preferences: A South Indian buys more rice while a North Indian buys more wheat. Why? Because of the difference in tastes and preferences.
  • Price of the Related Commodity: Demand for a commodity also depends on price of the related commodity. It is called Cross-Price-Effect.

 

Cross Price Effect

It refers to effect of a change in price of one commodity on the demand for the other commodity.

Example: If price of diesel decreases, it is very likely that the demand for petrol also decreases. Some people may shift from petrol cars to diesel Cars. Implying a fall in demand for petrol when price of diesel has fallen, even when price of petrol continues to be the same

  • Market Expectations: Expectations about the market include (a) behaviour of price in the near future and (b) availability of commodity in the near future. If a curfew is clamped in an area (like in the city of Jammu these days) owing to social unrest, people expect prices of essential goods to increase; also they expect overall shortage of these goods owing to problems of transportation. Consequently, the tendency would be to buy more of essential goods at their existing price. People will like to store these goods for use in the near future.
  • Credit Facility: Credit facility through bank loans and credit cards has emerged to be an important determinant of demand, particularly of consumer durables like Cars, TVs, Televisions, etc. A check on credit (during inflation) tends to lower demand while liberal availability of credit (during deflation) tends to raise it.
  • Population Size: China and Indian are the emerging demand centres for consumer goods. Why? Simply because of their population size. Demand expands when population expands. However, population size as a determinant of demand, is to be considered only in the context of market demand. This, determinant of demand is Not Valid in the context of individual demand.
  • Size and Distribution of Income: This is yet another determinant of market demand only. When national income of a country increases, market demand tends to rise and vice versa. Likewise, if distribution of income is skewed (or unequal) and a large number of people in the country are below poverty line, market demand for luxury goods (big cars or LCD TVs) is likely to be low. However, the students are advised not to consider this determinant in the context of individual demand.
A caution
Price of the commodity, consumer’s income, market expectations, price of the related commodity and credit facility are the five principal determinants of individual demand or consumer’s demand.

Size and distribution of income and size of population are to be considered as determinants of demand only with reference to market demand.

When you are listing the determinants of market demand, state the following:

(i) Price of the commodity

(ii) Price of the related commodity,

(iii) Size and distribution of income

(iv) Population size

(v) Credit facility

(vi) Market expectations

(vii) Tastes and Preferences.

When you are listing the determinants of individual demand state the following:

(i) Price of the commodity

(ii) Price of the related commodity,

(iii) Consumer’s income

(iv) Market expectations

(v) Tastes and Preferences

(vi) Credit facility

Demand Schedule and Demand Curve


Consider any normal good/commodity, say Good-X. Ask anybody the following question:

What is your demand for Good-X?

Depends upon price is the standard reply you are going to get. Lower the price, higher the purchase is the standard expression of demand. Thus, demand for a commodity is invariably expressed in terms of a schedule showing inverse relationship between price and purchase of a commodity. It is like the following:

Table 1. Individual Demand Schedule

P(Rs.)

QX (Units)

Individual Demand Schedule is a table showing different amounts of a commodity that an individual consumer is ready to buy corresponding to different possible prices of that commodity, at a point of time.

10

9

8

7

6

5

100

120

140

160

180

200

Individual Demand Curve

Demand curve is a graphic presentation of demand schedule, showing an inverse relationship between price and quantity demanded of a commodity.

Fig. 1.

Note: Demand curve, as in Fig. 1, generally slopes downward. Its downward slope points to the inverse relationship between price of commodity and purchase of a commodity.

Market Demand Schedule

We know market demand refers to demand for a commodity by all the buyers in the market. Accordingly, market demand schedule is a table showing different amounts of a commodity that all the buyers in the market are ready to buy corresponding to different possible prices of that commodity. Table 2 is an example of market demand schedule.

Table 2. Market Demand Schedule

Price(Rs.) Quantity Demanded by A Quantity Demanded by B Market Demand Market demand schedule refers to
a table showing different amounts
of a commodity that all buyers in the
market are ready to buy
corresponding different possible
prices of that commodity, at a point
of time.
6 0 5 5
5 5 10 15
4 10 15 25
3 15 20 35
2 20 25 45
1 25 30 55

Market Demand Curve

Market demand curve is simply a graphic presentation of market demand schedule, showing an inverse relationship between price and market demand of a commodity. Fig. 2 is an example of market demand curve.

Fig. 2

Important

(a) Check carefully. You will find that market demand curve is a horizontal summation (also called lateral summation) of individual demand curves.

(b) Because, market demand curve is a horizontal summation of individual demand curves, it is flatter than any individual demand curve.

(c) Like individual demand curve, market demand slopes downward, showing an inverse relationship between price and purchase of a commodity.

Difference between Demand and Quantity Demanded

It is time now to understand the difference between the terms ?demand? and ?quantity demanded?.

We have understand that demand for a commodity generally finds expression of a schedule showing higher purchase corresponding to a lower price. Thus, your demand for chocolate may take the following expression:

Demand

Demand often finds an expression
of a schedule showing different
quantities of a commodity that the
consumer is ready to buy
corresponding to different possible
prices of that commodity.

Price of Chocolate
(per unit) (Rs.)
Purchase of Chocolate
(units)
Quantity Demanded

It refers to a specific quantity
that the consumer is ready to
buy against a specific price of a
commodity.Thus, 5 units
against a price of Rs. 10 is
quntity purchased/damanded.

10 5
9 7
8 10

 

With reference to your demand for Chocolate, you are stating that if price be Rs. 10 per unit, you are buying only 5 units; if the price is Rs. 9, you are ready to buy 7 units, and if the price is Rs. 8, you are ready to buy as many as 10 units of Chocolate. Thus, your demand for Chocolate is as expressed in the entire demand schedule. Accordingly, you may define demand in the following words:

Demand for a commodity refers to a schedule showing different amounts of a commodity that the consumer is ready to buy corresponding to different possible prices of that commodity.

Quantity purchased on the other hand, refers to a specific amount of a commodity (like 5 units) to be purchased against a specific price (Rs. 10)

With reference to demand curve, we can say that any specific point on the demand curve shows Quantity demanded, while the entire demand curve shows demand for a commodity.

Movements along and Shifts in Demand Curve

Fig. 3

Refer to Fig. 3. Moving from point a to to c to d are the movements along the demand curve. Moving from a to b, from b to c, from c to d shows:

(a) higher purchase in response to lower price.

(b) inverse relationship between price and purchase of a commodity.

(c) downward slope of demand curve.

Thus, movement along the demand curve may be defined as:

a situation of change in quantity (Qx) in response to change in price (Px) of a commodity implying an inverse relationship between price and purchase or a situation of downward sloping demand curve.

A Necessary Assumption

Moving along the demand curve, (or studying the inverse relation between price and purchase of a commodity) we assume that other things remain constant. What are these other things? These are other determinants of demand, other than price of the concerned commodity. You know what the other determinants are. These are: (i) price of the related good, (ii) consumer’s income (iii) consumer’s tastes and preferences, (iv) market expectations, and (v) credit facility.

Keeping in mind this assumption, we may briefly, define movement along the demand curve in the following words, placed in the block.

Movement Along the Demand Curve

It refers to a situation of change in quantity (Qx) in response to change in price (Px) of a commodity, on the assumption that other determinants of demand (other than Px ) remain constant.

A Necessary Caution

Inverse relationship between price and purchase of a commodity is established only on the assumption that other determinants of demand (other than Px) remain constant. Hence, movement along the demand curve (showing inverse relationship between price and purchase of a commodity) must be studied on the assumption that other determinants of demand remain constant.

Shift in Demand Curve

Fig. 4

 

Refer to Fig. 4. Consider a situation that initially you were at point a. Now there is no change in price of the commodity. It continues to be = OP. But you are moving from point a to b or from point a to c.

What it could be due to? It could be due to change in any of the determinants of demand, other than Px. To illustrate, while you are at point a, and Px is constant, your income may increase. Consequently, you are buying more of X (OQinstead of OQ1), and you are shifting from point a on dx1 to point c on dx3. It is a situation of forward shift in demand curve. Your income may decrease as well. Consequently, you may buy less of X even when Px is the same: you are buying OQ2 instead of OQ1. You are shifting from point a on dx1, to point b on dx2. It is a situation of backward shift in demand curve.

Thus, a shift in demand curve occurs when demand for a commodity changes (increases or decreases) owing to change in other determinants of demand, other than price of the concerned commodity(Px).

 

A Shift in Demand Curve

A shift in demand curve is a situation when demand for a commodity (Qx) increases or decreases owing to change in other determinants of demand, other than price of the concerned commodity (Px).

Forward Shift in Demand Curve

It is a situation when demand for commodity (Qx) increases, even when price of the commodity  (Px) remains constant, owing to change in other determinants of demand, other than  (Px).

Example: Income of the consumer increases. Consequently (Qx) increases even when  (Px) is constant.

 

Fig. 5

Backward Shift in Demand Curve

It is a situation when demand for a commodity (Qx) decreases, even when price of the commodity  (Px) remains constant, owing to change in other determinants of demand, other than  (Px).
Example: Income of the consumer decreases. Consequently (Qx) decreases even when  (Px)is constant.

Fig. 6

 

Impact of Px on Qx: Law of Demand

Other things remaining constant, increase in Px causes a cut in Qx and decrease in Pxcauses a rise in Qx.

The inverse relationship between Px and Qx is generalized as the law of demand.

Law of Demand

Law of demand states that, other things remaining constant, quantity demanded
(Qx) tends to rise when price of the commodity (Px) falls, and vice versa.

Movements along the Demand Curve explain the Law of Demand

Fig. 7

Refer to Fig. 7. Moving along the demand curve (dx) we are moving from point b to or from point b to c. Moving from b to ashows: rise in Px from Pto P3, and fall in Qx from Qto Q1

Likewise, moving from point b to c shows: fall in Px from Pto P1 and rise in Qx from Qto Q3 Thus, moving along the demand curve (upward or downward), we find inverse relationship between Px and Qx. This is what law of demand states.

Assumptions of the Law of Demand

A demand curve is drawn on the assumption that other determinants of demand (other than Px) remain constant. These are therefore the assumptions of law of demand:

(a) that prices of related goods do not change.

(b) that consumer’s income is constant.

(c) that there is no change in consumer’s tastes and preferences.

(d) that there is no change in market expectations.

(e) that there is no change in credit facility to the consumer.

Exceptions to Law of Demand

Despite the above stated assumptions, there are situations when the law of demand fails. Important ones are as under:

  1. When a Consumer Judges Quality of a Commodity by its Price: It is not very uncommon when we find ourselves in a dilemma of costlier the better. We feel that a thing of high price is a thing of better quality. Accordingly, one tends to buy more of a thing at its high price. Accordingly, the law of demand fails.
  2. Articles of Snob Appeal: Articles like antique pieces of art are purchased simply because their prices are very high. These articles carry a snob-appeal. These are articles of social distinction. Law of demand fails in case of such articles.
  3. Giffen Goods: These are not normal goods. These are highly inferior. So inferior that a fall in their price causes a cut in their demand. Accordingly, law of demand fails.

Impact of Income on Demand

If our income rises, we generally tend to buy more of goods. More income would mean more pens, more shirts, more shoes, more cars, and so on. But there are exceptions. If initially you are buying coarse grain (simply because you can’t afford to buy a finer grain), how would you take your increase in income now? Perhaps, as a first step, you would discard the consumption of inferiors: you will reduce (or give up) the consumption of coarse grains and shift to the consumption of superior grains. Surely, this happens in the deserts of Rajasthan where, the rich minority eats wheat while the poor majority eats bajra as their staple food. This prompts us to divide goods as:

(a) normal goods and (b) inferior goods. Details are as under:

(a) Normal Goods: These are the goods the demand for which increases as income of the buyers rises. Thus, there is a positive relationship between income and demand. It is called positive income effect.

How Demand Curve of a Normal Good changes when Income of the buyers changes?

In a situation of increase in income, more of a (normal) good is purchased even when its price is constant. This refers to a situation of increase in demand or forward shift in demand curve. On the other hand, in a situation of decrease in income, less of a (normal) good is purchased even when its price is constant. This refers to a situation of decrease in demand or backward shift in demand curve.

Diagram (Fig. 8) illustrates these situations:

Fig. 8

(b) Inferior Goods: These are the goods the demand for which decreases as income of buyers rises. Thus, there is negative relationship between income and demand. It is called negative income effect.

How Demand Curve of an Inferior Good changes when Income of the buyers changes?

In a situation of increase in income, less of the (inferior) good is purchased. The consumer prefers to shift on to superior substitutes, because now he can afford them.

Buying less of a commodity at its existing price implies a backward shift in demand curve, or decrease in demand. On the other hand, if income decreases, the consumer, already consuming an inferior good, is further compelled to depend on it. May be he has to further cut his consumption of superior substitute and buy more of the inferior goods. It implies a situation of forward shift in demand curve or increase in demand for inferior goods. Diagram (Fig. 9) illustrates these situations:

Fig. 9

Impact of Prices of Related Goods on Demand: Cross Price Effect

Effect of change in price of a related good on the demand for a commodity is called cross price effect.

We know related goods are:

(a) substitute goods and

(b) complementary goods. Accordingly, we can split our discussion into two parts, as under:

(i) Demand for a Commodity in relation to Price of the Substitute Goods: Let us consider tea and coffee as two substitute goods. Let tea be the commodity demanded of which demand curve is as shown in Fig. 10.

Fig. 10

(1) Increase in Price of Substitute Goods: Refer to Fig. 10, if price of tea is OP1, quantity purchased is OT1 Now, suppose the price of tea remains constant but the price of coffee increases. How would you react as a consumer?

As a rational consumer, you may decide to substitute some tea in place of coffee. Or, you are expected to buy more of tea even when its price is constant. This is reflected in Fig. 11.

Fig. 11

Initially you were buying OT1 quantity of tea = P1K1 Now you are willing to buy OT2 = P1K2even when price of tea remains constant at OP1 . Greater purchase of a commodity at its constant price points to a situation of increase in demand, or forward shift in demand curve. Accordingly, demand curve for tea shifts to the right, from Dto D2.

(2) Decrease in Price of Substitute Goods: If price of coffee decreases, you will tend to substitute some coffee in place of tea. Or, you will demand less tea even when its price is constant. Fig. 12 illustrates this situation: Initially you were buying OT1  of tea (= P1K1) Now, you are buying OT2(= P1K2)of tea even when price of tea is constantOP1 , but because price of substitute (coffee) has reduced. This is a situation of backward shift in demand curve.

Fig. 12

 

 

If X and Y are substitutes and price of X remains constant:

– demand curve for X would shift to the right if price of Y increases.

– demand curve for X would shift to the left if price of Y decreases.

(ii) Demand for a Commodity in Relation to Price of the Complementary Goods: Let us consider car and petrol as complementary goods. Let cars be the commodity demanded of which the demand curve is as shown in Fig. 13.

Fig. 13

 

(1) Increase in Price of Complementary Goods: Now consider change in the price of complementary good. Refer to Fig. 14. If price of cars (say Maruti-800) is OP1, number of cars purchased is OT1. Now, suppose this price remains constant but the price of petrol increases.

Fig. 14

How would the consumers react to such a situation? They would tend to buy less cars, even when price of the cars is constant. Following diagram shows this situation:

Refer to Fig. 14. Initially, OT1(= P1K1) cars were purchased. Now, even when price of cars is constant, OT2(= P1K2) cars are purchased, because price of petrol has increased. This is a situation of decrease in demand or backward shift in demand curve. Accordingly, demand curve shifts from Dto D2

(2) Decrease in Price of Complementary Goods: If price of petrol decreases, people will have the tendency to buy more cars, even when price of cars is constant. This is a situation of increase in demand, or forward shift in demand curve, as in Fig. 15.

Fig. 15

If X and Y are complementary goods and price of X remains constant:

demand curve for X would shift forward if price of Y reduces.

demand curve for X would shift backward if price of Y increases.

Refer to Fig. 15. Initially OT1(= P1K1)  cars were purchased. As price of petrol decreases, T1T2(= K1K2) more cars are purchased even when price of cars is constant. Accordingly, demand curve shifts forward from Dto D2

Briefly, this is what we have studied in this section.

If X is the commodity in demand, Y is the substitute good and Z is the complementary good:

Forward shift in demand curve when price of the substitute good rises.

Backward shift in demand curve when price of the substitute good decreases.

Backward shift in demand curve when price of the complementary good rises.

Forward shift in demand curve when price of the complementary good decreases.

Notations:

Dx : Demand for X; Px : Price of X

PY : Price of Y; PZ : Price of Z

Padhte Chalo, Badhte Chalo

#PadhteChaloBadhteChalo – An initiative to help all the Class XII Students get access to Quality Education for FREE.

Don't miss out!
Subscribe To Our Newsletter

Learn new things. Get an article everyday.

Invalid email address
Give it a try. You can unsubscribe at any time.

Leave a Reply

Your email address will not be published. Required fields are marked *