The Theory of Demand: What Decides How Much People Buy

Demand the­ory is a prin­ci­ple that empha­sizes the rela­tion­ship between con­sumer demand and the price for goods and ser­vices within a mar­ket. It can also be illus­trated as the demand curve, which is down­wards slop­ing in a hor­i­zon­tal man­ner, as the price of the good decreases as quan­tity increases. Vice-versa, where the price of the good increases as the quan­tity decreases.

Demand is the quan­tity of a good or ser­vice the con­sumer is will­ing to pur­chase at spe­cific prices dur­ing a time period. The demand for a good at a cer­tain price gen­er­ally reflects the con­sumer’s will­ing­ness to pay and expec­ta­tion for con­sum­ing that prod­uct. The goods indeed range in price, from neces­si­ties to lux­u­ries.

For exam­ple, regard­ing neces­si­ties, peo­ple need food, health­care, cloth­ing, enter­tain­ment, shel­ter, and water across all wel­fares. The price of the goods tends to be fairly afford­able for most indi­vid­u­als. Whereas, designer bags, for exam­ple, tend to be priced at a pre­mium, as such goods are con­sid­ered wants and are not required to con­tinue to live a healthy life.

The demand for a good or ser­vice is gen­er­ally dri­ven by two fac­tors – util­ity and abil­ity to pay for the good or ser­vice.

The two aspects coin­cide with one another. Demand hap­pens when a good or ser­vice yields some level of util­ity while being backed by the abil­ity, which ulti­mately pro­vides sat­is­fac­tion to the con­sumer.

Demand aims to con­vey how bad peo­ple wish to pur­chase spe­cific goods, along with how much is bought based on their income lev­els and util­ity. Based on the sat­is­fac­tion that the good pro­vides, com­pa­nies adjust their sup­ply level accord­ingly, which changes prices.

For exam­ple, if a good is extremely pop­u­lar and with high util­ity, com­pa­nies will first see a scarce sup­ply, shift­ing the sup­ply curve and rais­ing prices. How­ever, over time, they will increase pro­duc­tion, shift­ing the sup­ply curve back to its orig­i­nal posi­tion, bring­ing the price back down.

Var­i­ous fac­tors affect demand, includ­ing:

• Con­sumer pref­er­ences
• Taste
• Choices
• Income
• Related goods

As var­i­ous fac­tors may affect demand, busi­nesses need to eval­u­ate demand, as it is one of the most inte­gral deci­sion-mak­ing dri­vers that must be con­sid­ered to grow the busi­ness and con­tinue to stay com­pet­i­tive within the mar­ket.

Deter­mi­nants of demand (Indi­vid­ual demand)

Demand for a com­mod­ity increases or decreases due to a num­ber of fac­tors. The var­i­ous fac­tors affect­ing demand are :-

• Price of the Given com­mod­ity :

It is the most impor­tant fac­tor affect­ing demand for the given com­mod­ity. Gen­er­ally there exists an inverse rela­tion­ship between price and quan­tity demanded. It means as price increases, quan­tity demanded falls due to decrease in the sat­is­fac­tion level of con­sumers.

For exam­ple:-

If the price of the given com­mod­ity (say tea) increases its quan­tity falls as sat­is­fac­tion derived from tea will fall due to rise in its price.

• Price of related goods

Demand for the given com­mod­ity is also affected by the change in prices of the related goods. Related goods are of two types :

Sub­sti­tute goods Sub­sti­tute goods are those goods which can be used in place of one another for sat­is­fac­tion of a par­tic­u­lar want, like tea and cof­fee. An increase in the price of sub­sti­tute leads to an increase in the demand for given com­mod­ity and vice – versa.

For exam­ple

If price of a sub­sti­tute good (say, cof­fee) increases then demand for given com­mod­ity (say, tea) will rise as tea will become rel­a­tively cheaper in com­par­i­son to cof­fee. So, demand for a given com­mod­ity is directly affected by change in price of sub­sti­tute goods.

• Com­ple­men­tary goods:

Com­ple­men­tary goods are those goods which are used together to sat­isfy a par­tic­u­lar want, like tea and sugar, An increase in the price of com­ple­men­tary good leads to a decrease in the demand for given com­mod­ity and vice – versa.

For exam­ple if the price of a com­ple­men­tary good (say, sugar) increases, then demand for given com­mod­ity (say, tea) will fall as it will be rel­a­tively cost­lier to use both the goods together. So, demand for a given com­mod­ity is inversely affected by change in price of com­ple­men­tary goods.

Exam­ple of sub­sti­tute goods

• Tea and cof­fee
• Coke and Pepsi
• Pen and Pen­cil
• CD and DVD
• Ink pen and ball pen
• Rice and wheat
• Exam­ple of com­ple­men­tary goods:-
• Tea and Sugar
• Pen and ink
• Car and Petrol
• Bread and But­ter
• Pen and Refill
• Brick and cement
• Income of the con­sumer

Demand for a com­mod­ity is also affected by income of the con­sumer. How­ever, the effect of change in income on demand depends on the nature of com­mod­ity under con­sid­er­a­tion.

If the given com­mod­ity is a nor­mal good, then an increase in income lads to rise in its demand, while a decrease in income reduces the demand.

If the given com­mod­ity is an infe­rior good, then an increase in income reduces the demand while a decrease in income leads to rise in demand.

Exam­ple

Sup­pose income of a con­sumer increases. As a result, the con­sumer reduces con­sump­tion of toned milk and increases con­sump­tion of full cream milk. In this case ‘Toned milk’ is an infe­rior good for the con­sumer and ‘Full cream milk’ is a nor­mal good.

• Tastes and Pref­er­ences :

Tastes and pref­er­ences of the con­sumer directly influ­ence the demand for a com­mod­ity. They include changes in fash­ion, cus­toms, habits etc. If a com­mod­ity is in fash­ion or is pre­ferred by the con­sumers, then demand for such a com­mod­ity rises. On the other hand, demand for a com­mod­ity falls, if the con­sumers have no taste for that com­mod­ity.

• Expec­ta­tion of change in the price in future :

If the price of a cer­tain com­mod­ity is respected to increase in near future, then peo­ple will buy more of that com­mod­ity than what they nor­mally buy. There exists a direct rela­tion­ship between expec­ta­tion of change in the prices in future and change in demand in the cur­rent period.

For exam­ple

If the price of petrol is expected to rise in future, its present demand will increase. Change in quan­tity demanded vs change in demand:

Change in quan­tity demanded : –

When­ever demand for the given com­mod­ity changes due to change in its own price, then such change in demand is known as “ Change in Quan­tity Demand”. For exam­ple, if demand for Pepsi changes due to. Change in its own price, then such change in demand is known as “Change in Quan­tity Demanded”. For exam­ple, if demand for Pepsi changes due to change in its own price, then such change in demand for Pepsi is known as change in quan­tity demanded.

Change in Demand : –

When­ever demand for the given com­mod­ity changes due to fac­tors other than price, then such change in demand is known as “Change in demand”. For exam­ple : – If demand for Pepsi changes due to change in price of Coke or due to change in income or due to a change in taste, then such change in demand for Pepsi is known as change in demand.

Deter­mi­nants of Mar­ket demand

• Size and com­po­si­tion of Pop­u­la­tion :

Mar­ket demand for a com­mod­ity is affected by size of pop­u­la­tion in the coun­try. Increase in pop­u­la­tion in the coun­try. Increase in pop­u­la­tion in the coun­try. Increase in pop­u­la­tion raises the mar­ket demand, while decrease in pop­u­la­tion reduces the mar­ket demand. Com­po­si­tion of pop­u­la­tion i.e. ratio of males, females, chil­dren and num­ber of old peo­ple in the pop­u­la­tion also affects the demand for a com­mod­ity. For exam­ple :- if a mar­ket has larger pro­por­tion of women, then there will be more demand for arti­cles of their use such as lip­stick, sarees etc.

• Sea­son and weather :

The sea­sonal and weather con­di­tions also affect the mar­ket demand for a com­mod­ity. For exam­ple : – dur­ing win­ters, demand for woolen clothes and jack­ets increases, whereas, mar­ket demand for rain­coat and umbrel­las increases dur­ing the rainy sea­son.

• Dis­tri­b­u­tion of Income :

If income in the coun­try is equi­tably dis­trib­uted, then mar­ket demand for com­modi­ties will be more. How­ever if income dis­tri­b­u­tion is uneven i.e. peo­ple are either very rich or very poor, then mar­ket demand will remain at lower level.

Demand func­tion

Demand func­tion shows the rela­tion­ship between quan­tity demanded for a par­tic­u­lar com­mod­ity and the fac­tors influ­enc­ing it. It can be either with respect to one con­sumer (indi­vid­ual demand func­tion) or to al the con­sumers in the mar­ket (mar­ket demand func­tion).

Indi­vid­ual Demand func­tion

Indi­vid­ual demand func­tion refers to the func­tional rela­tion­ship between indi­vid­ual demand and the fac­tor affect­ing indi­vid­ual demand.

It is expressed as

Dx = f (Px, Pr, Y, T, F)

Where

• Dx = Demand for com­mod­ity x
• Px = Price of the given com­mod­ity x,
• Pr = Prices of related Goods
• y = Income of the con­sumer
• T = Tastes and Pref­er­ences
• F = Expec­ta­tion of change in price in future.

Mar­ket demand func­tion :

Mar­ket demand func­tion refers to the func­tional rela­tion­ship between mar­ket demand and the fac­tors affect­ing mar­ket demand. Mar­ket demand func­tion can be expressed as

• Dx = Mar­ket demand of com­mod­ity x,
• Px = Price of given com­mod­ity x,
• Pr = Prices of related goods;
• y = Income of the con­sumers;
• T = Tastes and Pref­er­ences,
• F = Expec­ta­tion of change in price in future;
• Po = Size and com­po­si­tion of pop­u­la­tion;
• S = Sea­son and weather;
• D = Dis­tri­b­u­tion of Income.

Demand sched­ule

Demand sched­ule is a tab­u­lar state­ment show­ing var­i­ous quan­ti­ties of a com­mod­ity being demand at var­i­ous lev­els of price, dur­ing a given period of time. It shows the rela­tion­ship between price of the com­mod­ity and its quan­tity demanded.

A demand sched­ule can be deter­mined both for indi­vid­ual buy­ers and for the entire mar­ket. So, demand sched­ule is of two types:-

Indi­vid­ual demand sched­ule

Mar­ket demand sched­ule

Indi­vid­ual demand sched­ule :- Indi­vid­ual demand sched­ule refers to a tab­u­lar state­ment show­ing var­i­ous quan­ti­ties of a com­mod­ity that a con­sumer is will­ing to buy at var­i­ous lev­els of price, dur­ing a given period of time.

Mar­ket demand sched­ule refers to a tab­u­lar state­ment show­ing var­i­ous quan­ti­ties of a com­mod­ity that all the con­sumers are will­ing to buy at var­i­ous lev­els of price, dur­ing a given period of time. Mar­ket demand sched­ule can be expressed asMar­ket demand sched­ule:-

Dm = DA + DB + ……..

Where

Dm is the mar­ket demand DA + DB + …….. are the indi­vid­ual demands of house­hold A, house­hold B and so on.