UNIT 3

What is Demand?
Demand relates to the willingness and potential of consumers to obtain a provided quantity of
a good or service in any given point of time or over duration in time. Also, in economics, the
term means that the consumer has the pressing need, promoted by the ability to pay from an
income. Income brings about a purchasing power that they practice in the market through
effective demand. Economic demand is something that runs the commerce. With no
economic demand, companies would no longer be willing to supply products as they wouldn't
be making any profit by entering the market.

What a buyer pays to purchase a certain good is termed as price. Further, the total number of
units purchased at that price is said to be the quantity demanded. The price is usually
inversely proportional to the quantity demanded, i.e. when the price of any service or good
increases, the quantity demanded deliberately decreases. Similarly, when the price of the
good falls, the quantity demanded hikes up. Economists confidently pronounce this inverse
relationship between price and quantity demanded as the law of demand. However, external
factors govern economic demand; that's where determinants come into the play. Since now
we know what demand is, let's discuss the demand analysis meaning types and determinants
of demand.

Types of Determinants of Demand

Every factor has a unique impact on demand. We need to understand the meaning of
determinants and types of demand. The following are the few determinants of demand.

Price of the Product

Price is used as a parameter by the people to decide if all the other factors remain constant or
equal. According to the law of demand, the decrease in the demand follows an increase in the
price and an increase in the demand follows a reduction in price.

The Income of the Consumers

If the income rises, the number of goods demanded by the consumers also increases.
Meanwhile, a drop in income leads to lower consumption levels. Thus the relationship
between the demand and the income is not direct. However, the effect the income of a
consumer has on the demand for a product depends on the type of commodity. With most
goods, there is a positive relationship between demand and the income of the buyer. On the
other hand, a change in income can have an inverse effect on the demand for a product. In
these cases, when the income of the consumer increases, he/she tends to buy a high-quality
product and avoid inferior goods.

Number of Buyers in the Market

The number of consumers plays a vital role in net/total demands. When the number increases,
the demand also increases. In some cases, the demand for the product increase with the
changes in the population. In other cases, the demand increases as the product become more
appealing to the customers. In such scenarios, the population remains the same but more
people are buying the same commodity.
Consumer’s Expectations
Consumer expectation is one of the major factors that affect the demand for a commodity.
That is why a business has to focus on both habits and expectations of its target audience,
which makes it much harder to predict the demand for your product. Sometimes, consumers
might wait before buying a product as they are expecting what might happen in the future.
For instance, a person might not buy a mobile phone because they are waiting for a new
model.

Tastes and Preferences of The Consumers

Consumers can be picky about the product they want. When they are shopping for a product,
it depends on their tastes and preferences as to what brand or model they will choose. These
tastes and preferences of a consumer can change due to a number of reasons, both internal
and externals. These factors include age, location, marital status, and much more. Even
though taste and preference are intangible, they can have a huge impact on the demand for
any given commodity. For instance, a consumer is more likely to buy a product when they see
a certain celebrity endorsing it. However, if the consumer finds out there are some bad side
effects of a product, the demand for that commodity will decrease drastically.

Complement Goods
Complement goods are the ones that go with each other. Let’s take care and petrol, for
example. If there is an increase in the price of petrol, the demand for petrol will decrease and
so will the demand for a car. So, two goods that complement each other will have an inverse
relationship between the price of one commodity and the demand for the other.

Substitute Product
In this case, when the price of one product increases, the demand for another product rises.
No matter what you are selling, you will always face competition in the market. That is why
you have to pay attention to what your competitors are selling as they can take a large chunk
of your market share. So, to determine the demand for your product, you have to focus on the
availability of substitute goods in the market. Consider the following factors:
● The price gap between your and your competitors’ products.
● How many items of the same product line does the competitor deal in?
● The similarity between your product and the one sold by the competitor.
Now that we understand the meaning of demand and its determinants, let's discuss the types
of demand.

Types of Demand
We have already discussed what demand is. Now let's read about the types of demand.
Corporations often put a large sum of their budget into comprehending the consumer's
demand for their products. This facilitates them to drag their products to customers without
losing any capital in any undesirable factors such as overproduction. Inferring what kind of
demand your firm falls under is a fair business practice. Therefore let's take a glance at
different types of economic demands.
Individual and Market Demand
Market demand is also known as aggregate demand. It refers to the total economic demand in
view of all the individual demand in any particular market. Individual demand is a demand
for a product by an individual at a certain price. Customer tastes, distinguished quality and
brand commitment or loyalty affect individual demand.

Short-term and Long-term Demand

As the name implies, short-term demand is limited for a brief duration of time; it reflects
trends, necessity and modifications in the price more dramatically than the long-term
demand. For example, winter wear is worn only during winter, making the demand much
shorter when compared to clothing worn all over the year. On the other hand, long-term
demands pertain for a longer period of time and this demand doesn't change with respect to
time and price.

Company and Industry Demand

The demand for products at a specific price over a span of time from a sole element is known
as company demand. Industry demand includes the total aggregate demand for an industry's
products. Company demand is often written in terms of the percentage of industry demand.
For example, the demand for Coca-Cola is the company demand, and it makes up the
percentage of total industry demand.
Demand Schedule, Demand Curve and the Law of
Demand
What is demand in economics? Demand captures the desire and capacity an individual has to
buy a good or service. Demand is formed by a need/desire and is dependent on purchasing
power. The concept of demand, opposite to supply, is an essential pillar in the successful
functioning of an economy. Furthermore, quantity demanded is the amount of goods
consumers need/desire when offered at a specific price - a key principle in constructing a
demand schedule. The law of demand as a principle describes the relationship between the
quantity demanded and the price. This law points out how, as price increases, demand
decreases due to factors such as purchasing power, affordability, and level of disposable
income.
What is a definition of a demand schedule? It is a table that shows the quantities demanded at
various prices. The schedule shows how consumer behavior changes and changes in the
pricing of goods and services. It is visually illustrated as a table with two columns, one
different price level is rising or falling order, and the other demonstrating how much
consumers are willing to buy at each price. Information represented on the schedule is
gathered by doing various market analyses. Below is a theoretical representation of what a
demand schedule looks like.
 The rise in price results in a decrease in demand.

What is a market demand definition? Market demand is the summation of all the individual
demands in the market. Market demand is a fundamental determinant of production in any
economy. If consumers want/need more of a product, the free market will see to it that
suppliers jump to the profit opportunity by producing that product. On the contrary, if
individuals buy a decreasing number of a specific good or service, the fact that there's less
opportunity to profit for suppliers will inherently see supply drop.
The demand curve is a graphical illustration of what the demand schedule would look like
when drawn out on a chart. It applies to the exact same laws of demand and is thus derived
when a demand schedule is plotted. In conjunction with the abovementioned assumption
about demand schedules, the demand curve should likewise not be used in isolation when
studying the market. However, its traits make it a valuable tool that can be used as a reference
point. With price on the horizontal axis and quantity demanded on the vertical axis, the
demand curve is in a negative slope from the top-left of the graph to the bottom-right. This
illustrates how consumers buy more when prices are low due to affordability and how they
buy less when prices are high because of how their purchasing power has declined. Below
follows a demand curve illustrating the above demand schedule.
 As price increases, quantity demand decreases, which gives the curve its negative slope.

Economics involves the study of how people use limited means to satisfy unlimited wants.
The law of demand focuses on those unlimited wants. Naturally, people prioritize more
urgent wants and needs over less urgent ones in their economic behavior, and this carries over
into how people choose among the limited means available to them.

For any economic good, the first unit of that good that a consumer gets their hands on will
tend to be used to satisfy the most urgent need the consumer has that that good can satisfy.

For example, consider a castaway on a desert island who obtains a six-pack of bottled fresh
water that washes up onshore. The first bottle will be used to satisfy the castaway’s most
urgently felt need, which is most likely drinking water to avoid dying of thirst.

The second bottle might be used for bathing to stave off disease, an urgent but less immediate
need. The third bottle could be used for a less urgent need, such as boiling some fish to have
a hot meal, and on down to the last bottle, which the castaway uses for a relatively low
priority, such as watering a small potted plant to feel less alone on the island.

Because each additional bottle of water is used for a successively less highly valued want or
need by our castaway, we can say that the castaway values each additional bottle less than the
one before.
Factors Affecting Demand

Several factors can influence the shape and position of the demand curve. Rising income
tends to raise demand for common economic commodities since individuals are more eager
to spend. The availability of close alternative items that compete with particular economic
goodwill tends to reduce demand for that good since they can satisfy the same types of
consumer wants and needs. Availability of closely complementary products, on the other
hand, will tend to raise demand for an economic item, because combining two goods might
be even more useful to consumers than utilising them individually. Other variables that vary
the pattern of customer preferences for how the product may be utilized and how urgently it
is needed, such as future expectations, changes in background environmental circumstances,
or changes in the actual or perceived quality of a good, might shift the demand curve.

Importance of Law of Demand

Price Determination - The study of law of demand is helpful for a trader to fox up the price
of a commodity. He understands how much demand will decline if the price of the
commodity rises to a certain level, and how much demand will grow if the price of the
commodity falls. The market demand schedule can offer information on overall market
demand at various prices. It helps management in determining how much of a price rise or
drop in a commodity is beneficial.

Law of Demand Exceptions

In a few cases, the law of demand in economics does not follow the rule. For instance, often
it happens that the demand for a particular product rises along with the price. Therefore, it is
vital to know about the exceptions as well to comprehend the law better and understand
real-life incidents.
● For a good of prestige, the demand almost remains the same even if the price
increases.
 ● Similarly, for necessary commodities as well, the demand rises due to its increasing
consumption, despite the price rise.
● This applies as well in the case of Giffen goods.

These are some of the certain scenarios where the law deviates from its standard rendition.
Importance to the Farmers - Farmers' economic situation is affected by whether they have a
good or bad crop. If a good crop fails to generate demand, the crop's price will drop
drastically. The farmer will not benefit from a successful harvest, and vice versa.
Law of Demand
According to Marshall, the law of demand is defined as “Other things being equal, the
quantity of a commodity demanded varies inversely with its price.”
Law of demand can be expressed as D_{x} = f (P_{x})
Where,
D = demand for commodity X
X = commodity demanded
F = function of
Px = price of the commodity X
Assumptions to the law of Demand

● There will be no introduction of any substitutes

● There will be no change in prices of substitute goods
● There will be no anticipation of price change in future
● There will be no change in the income level of the consumer
● There will be no change in the taxation policy of the government
● There will be no change in consumer’s taste, preference and habit
● There will be no change in size, sex and age composition of the population

Exceptions to the Law of Demand

Note that the law of demand holds true in most cases. The price keeps fluctuating until an
equilibrium is created. However, there are some exceptions to the law of demand. These
include the Giffen goods, Veblen goods, possible price changes, and essential goods. Let us
discuss these exceptions in detail.

Giffen Goods
Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are goods
that are inferior in comparison to luxury goods. However, the unique characteristic of Giffen
goods is that as its price increases, the demand also increases. And this feature is what makes
it an exception to the law of demand.

The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a staple in
the Irish diet. During the potato famine, when the price of potatoes increased, people spent
less on luxury foods such as meat and bought more potatoes to stick to their diet. So as the
price of potatoes increased, so did the demand, which is a complete reversal of the law of
demand.
Veblen Goods
The second exception to the law of demand is the concept of Veblen goods. Veblen Goods is
a concept that is named after the economist Thorstein Veblen, who introduced the theory of
“conspicuous consumption“. According to Veblen, there are certain goods that become more
valuable as their price increases. If a product is expensive, then its value and utility are
perceived to be more, and hence the demand for that product increases.

And this happens mostly with precious metals and stones such as gold and diamonds and
luxury cars such as Rolls-Royce. As the price of these goods increases, their demand also
increases because these products then become a status symbol.

The expectation of Price Change

In addition to Giffen and Veblen goods, another exception to the law of demand is the
expectation of price change. There are times when the price of a product increases and market
conditions are such that the product may get more expensive. In such cases, consumers may
buy more of these products before the price increases any further. Consequently, when the
price drops or may be expected to drop further, consumers might postpone the purchase to
avail the benefits of a lower price.

For instance, in recent times, the price of onions had increased to quite an extent. Consumers
started buying and storing more onions fearing further price rise, which resulted in increased
demand.

There are also times when consumers may buy and store commodities due to a fear of
shortage. Therefore, even if the price of a product increases, its associated demand may also
increase as the product may be taken off the shelf or it might cease to exist in the market.

Necessary Goods and Services

Another exception to the law of demand is necessary or basic goods. People will continue to
buy necessities such as medicines or basic staples such as sugar or salt even if the price
increases. The prices of these products do not affect their associated demand.

Change in Income
Sometimes the demand for a product may change according to the change in income. If a
household’s income increases, they may purchase more products irrespective of the increase
in their price, thereby increasing the demand for the product. Similarly, they might postpone
buying a product even if its price reduces if their income has reduced. Hence, change in a
consumer’s income pattern may also be an exception to the law of demand.
Importance to the Government - Governments evaluate the law of demand when deciding
whether or not to impose additional taxes or tariffs on products, particularly when the amount
demanded is not strongly influenced by price.
Major Facts about Law of Demand

● It expresses the inverse relationship between demand and price. It basically states that
an increase in price will cause a decrease in the amount requested, whereas a decrease
in price would cause a rise in quantity demanded.
● It simply makes a qualitative statement, indicating the direction of change in the
quantity requested but not the magnitude of change.
● It does not demonstrate a proportionate link between price changes and subsequent
demand changes. If a price increases by 10%, the quantity demanded may decrease in
any proportion.
● The law of demand is one-sided since it only explains how price changes affect the
amount required. It makes no mention of the impact of changes in demand on the
price of the item.

Price Elasticity of Demand: ---------------------------------------

Elasticity of demand measures how sensitive the quantity demanded of a good or service
is to a change in price. It quantifies the percentage change in quantity demanded in
response to a one percent change in price. There are several types of elasticity of
demand, each providing insights into consumer behavior: --------------
1. Price Elasticity of Demand (PED):
Price elasticity of demand measures the responsiveness of the quantity demanded of a good to
a change in its price. It is calculated using the following formula:
Price Elasticity of Demand (PED)
=Percentage Change in Quantity Demanded/Percentage Change in Price
Price Elasticity of Demand (PED) = Percentage Change in Price/Percentage Change in
Quantity Demanded
If
PED >1
PED >1: Demand is elastic. A percentage decrease in price will lead to a proportionally larger
percentage increase in quantity demanded.
If
PED <1
PED <1: Demand is inelastic. A percentage decrease in price will lead to a proportionally
smaller percentage increase in quantity demanded.
If
PED =1
PED =1: Demand is unit elastic. A percentage change in price leads to an equal percentage
change in quantity demanded.

Let’s look at some examples:

a. The price of a radio falls from Rs. 500 to Rs. 400 per unit. As a result, the demand
increases from 100 to 150 units.

b. Due to government subsidy, the price of wheat falls from Rs. 10/kg to Rs. 9/kg. Due to
this, the demand increases from 500 kilograms to 520 kilograms.
In both cases above, you can notice that as the price decreases, the demand increases. Hence,
the demand for radios and wheat responds to price changes.

Price Elasticity of Demand

Price elasticity of demand demonstrates how a change in price affects the quantity
demanded. It is computed as the percentage change in quantity demanded over the
percentage change in price, and it will commonly result in a negative elasticity because
of the law of demand.
The law of demand states that an increase in price reduces the quantity demanded,
and it is why demand curves are downwards sloping unless the good is a Giffen good.
It is common to simply drop the negative of the quotient.
The larger the price elasticity of demand, the more responsive quantity demanded is
given a change in price. When the price elasticity of demand is greater than one, the
good is considered to demonstrate elastic demand. When the quantity demanded
drops to zero with a rise in price, it is said that demand is perfectly elastic. If the price of
an elastic good increases, there is a corresponding quantity effect, where fewer units
are sold, and therefore reducing revenue.
The lower the price elasticity of demand, the less responsive the quantity demanded is
given a change in price. When the price elasticity of demand is less than one, the good
is considered to show inelastic demand. When the quantity demanded does not
respond to a change in price, it is said that demand is perfectly inelastic. If an inelastic
good has its price increased, it will lead to increased revenues because each unit will
be sold at a higher price.
If a change in price comes with the same proportional change in the quantity
demanded, it is said that the good is unit elastic. Indicating that X% change in price
results in an X% change in the quantity demanded. Therefore, if the price elasticity of
demand equals one, the good is unit elastic. If a good shows a unit elastic demand, the
quantity effect and price effect exactly offset each other.
Calculation of Price Elasticity of Demand through the Midpoint Method

The midpoint method is a commonly used technique to calculate the percent change of
price. The primary difference is that it calculates the percentage change of quantity
demanded and the price change relative to their average.
Examples of Goods with a Price Inelastic Demand

1. Beef
2. Gasoline
3. Salt
4. Textbooks
5. Prescription drugs
Examples of Goods with a Price Elastic Demand

1. Housing
2. Furniture
3. Cars
Factors That Affect the Price Elasticity of Demand

1. Availability of close substitutes

If consumers can substitute the good for other readily available goods that consumers
regard as similar, then the price elasticity of demand would be considered to be elastic.
If consumers are unable to substitute a good, the good would experience inelastic
demand.
2. If the good is a necessity or a luxury

The price elasticity of demand is lower if the good is something the consumer needs,
such as Insulin. The price elasticity of demand tends to be higher if it is a luxury good.
3. The proportion of income spent on the good

The price elasticity of demand tends to be low when spending on a good is a small
proportion of their available income. Therefore, a change in the price of a good exerts a
very little impact on the consumer’s propensity to consume the good. Whereas, when
a good represents a large chunk of the consumer’s income, the consumer is said to
possess a more elastic demand.
4. Time elapsed since a change in price

In the long term, consumers are more elastic over longer periods, as over the long term
after a price increase of a good, they will find acceptable and less costly substitutes.
Other Demand Elasticities

1. Cross-Price Elasticity of Demand

The cross-price elasticity of demand measures how the demand for one good is
impacted by a change in the price of another good. It is calculated as the percentage
change of Quantity A divided by the percentage change in the price of the other.
If the cross-price elasticity of demand between two goods is positive, it implies that
the two goods are substitutes. Consider the following substitute goods – good A and
good B. If the price of good B rises, the demand for good A rises.
On the contrary, if the aforementioned goods were complements, when the price of
good B increases, the demand for good A should decrease. It is what is implied through
the cross-price elasticity of demand formula. It is important to note that the cross-price
elasticity of demand is a unitless measure.
2. Income Elasticity of Demand

The income elasticity of demand is defined as the measure of the percentage change of
the quantity demanded of a good in reference to changes in the consumer’s income.
Calculating the income elasticity of demand allows economists to identify normal and
inferior goods, as well as how responsive quantity demanded is to changes in income.

If the income elasticity of demand is positive, the good is considered to be a normal

good – implying that when income increases, the quantity demanded at any given
price increases.
If the income elasticity of demand is negative, the good is considered to be an inferior
good – implying that when income increases, the quantity demanded at any given
price decreases.
If the income elasticity of demand is higher than 1, then the good is considered to be
income elastic – implying that demand rises faster than income. Luxury goods include
international vacations or second homes.
If the income elasticity of demand is higher than 0 but less than 1, then the good is
income inelastic – implying that demand for income-inelastic goods rises but at a
slower rate than income.
Types of Price Elasticity of Demand
Calculated Price Elasticity of Type of Result of Change in Price
Demand Elasticity

Infinity Perfectly elastic Demand declines to zero

Greater than 1 Elastic Significant change in demand

1 Unitary elasticity Equivalent percentage change in

demand

Less than 1 Inelastic Insignificant change in demand

0 Perfectly No change in demand

inelastic

If the quantity of a product demanded or purchased changes more than the price changes,
then the product is considered to be elastic. If the change in quantity purchased is the same as
the price change, then the product is said to have unit (or unitary) price elasticity. And if the
quantity purchased changes less than the price, then the product is deemed inelastic.

For example, if the price goes up by 5%, but the demand falls by 10%, the product is elastic.
If a price change of 10% creates a 10% change in demand, the product shows unitary
elasticity. And if a price increase of 10% causes demand to fall by 5%, the product is
inelastic.

Example
Suppose that the price of apples falls by 6% from $1.99 a bushel to $1.87 a bushel. In
response, grocery shoppers increase their apple purchases by 20%. The elasticity of apples is
thus: 0.20 ÷ 0.06 = 3.33. The demand for apples is elastic.