BBA I Semester Managerial Economics Demand Analysis Study Material Notes
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BBA I Semester Managerial Economics Demand Analysis Study Material Notes: Meaning of Demand Types of Demand Short Run Demand and Lon run demand Joint demand and Composite demand Derived and Auoomous demand Industry and Firm Demand Sectoral Demand and market Demand An Individuals Demand Schedule and Curve The Market Demand Schedule and Curve The Law of Demand Extenstion and Contractor in demand Cross demand of Substitute and Complementary Goods :
MCom I Semester Managerial Economics Profit Study Material notes
DEMAND ANALYSIS
In this chapter, we shall study the law of demand and in the next the elasticity of demand. But before we analyze them, it is essential to understand the nature of the term demand’ in economics.
MEANING OF DEMAND
The demand for a commodity is its quantity which consumers are able and willing to buy at various prices during a given period of time. So, for a commodity to have demand, the consumer must possess a willingness to buy it, the ability or means to buy it, and it must be related to per unit of time i.e. per day, per week, per month or per year. According to Prof. Bober, “By demand, we mean the various quantities of a given commodity or service which consumers would buy in one market in a given period of time at various prices or at various incomes or at various prices of related goods.”
Demand Functions
The demand function is an algebraic expression of the relationship between demand for a commodity and its various determinants that affect this quantity.
There are two types of demand functions:
(i) Individual Demand Function. An individual’s demand function refers to the quantities of a commodity demanded at various prices, given his income, prices of related goods and tastes. It is expressed as
D=f(P)
(ii) Market Demand Function. An individual demand function is the basis of demand theory. But it is the market demand function that is main interest to managers. It refers to the total demand for a good or service of all the buyers taken together. The market demand function may be expressed mathematically thus
Dx=f(Px, Py, M, T, A, U)
Where
Dx = Quantity demanded for commodity x
f=functional relation
Px= Price of commodity
Pr=Prices of related commodities i.e. substitutes and complementaries M= The money income of the consumer
T = The taste of the consumer
A=The advertisement effect
U=Unknown variables
By demand function, economists mean the entire functional relationship. This means the whole range of price quantity relationship and not just the quantity demanded at a given price per unit of time. The demand function expressed above is really just a listing of variables that affect the demand. The demand function must be made explicit and clear for use in managerial decision making. The industry must have reasonably good knowledge and information about its demand function to formulate effective long run planning decisions and short run operating decisions.
The basic assumption in demand schedule and demand curve has been the relationship between price and quantity of a commodity signifying a change in price to bring a change in quantity demanded with all other variables assumed constant and unchanged. In demand function this assumption is relaxed and it is held emphatically that besides change in price there are other variables which influence the demand for a particular commodity.
Classical economists were aware of the fact that the price is not the only factor which determines sales but that other factors, too, have an inportant effect on them. These other factors are the income of the consumer, their tastes, habits, preferences, etc. When these factors influence the demand the demand is said to shift. But their price-demand relationship is not as important to the management as the shift in demand, which constitutes the demand function. Shifting of demand curve renders the demand analysis difficult. Therefore, demand fuction makes use of mathematical formulation to arrive at correct results. Recenty more sophisticated methods have been developed for the study like simultaneous equation and mathematical programming which helps in arriving at precise results.
TYPES OF DEMAND
Managerial decisions require the knowledge of various types of demand. We explain below a few important types.
Demand for Consumers’ Goods and Producers’ Goods
Consumers’ goods are those final goods which directly satisfy the wants of consumers. Such goods are bread, milk, pen, clothes, furniture, etc. Producers’ goods are those goods which help in the production of other goods that satisfy the wants of the consumers directly or indirectly, such as machines, plants, agricultural and industrial raw material, etc. The demand for consumers’ goods is known as direct or autonomous demand. The demand for producers’ goods is derived demand because they are demanded not for final consumption but for the production of other goods.
Joel Dean gives the following reasons of the demand for producers’ goods:
(1) Buyers are professionals, and hence more expert, price-wise and sensitive to substitutes.
(2) Their motives are purely economic: products are bought, not for themselves alone, but for their profit prospects.
(3) Demand, being derived from consumption demand, fluctuates differently and generally more violently.
The distintion between consumers’ goods and producers’ goods is based on the uses to which these goods are put. There are many goods such as electricity, coal, etc. which are used both as consumers’ goods and pro appropriate demand analysis.
Demand for Perishable (Non-Durable) and Durable Goods
consumers’ and producer’s goods have been classified further into perishable and de goods. In economics, perishable goods are the goods which are used up in a single act of consumption while durable goods are the goods which can be used time and again for a considerable period of time. In other words, perishable goods are consumed automatically while only services of durable goods are consumed. Thus, perishable goods include all types of services, foodstuffs, raw materials, etc. On the other hand, durable goods consist of buildings, machines, furnitures, etc. This distinction has great importance because in the demand analysis durable goods create more complex problems than non-durable goods. Non-durable goods are often sold to meet the current demand which is based on existing conditions. On the other hand, the sale of durable goods increases the stock of available goods whose services are consumed over a period of time. The demand for perishable goods is more elastic while the demand for non-durable goods is less elastic in the short-run and their demand tends to be more elastic in the long run. According to J.Dean, the demand for durable goods is more unstable in relation to the business conditions. Postponement, replacement, storage and expansions are inter-related problems which are included in the determination of demand for durable goods.
Derived and Autonomous Demand
When the demand for a particular product is dependent upon the demand for some other goods, it is called derived demand. In many cases, derived demand of a product is due to its being a component part of the parent product. For example, demand for cement is dependent upon the demand for houses. The inputs or commodities demanded for further production have derived demand. The demand for raw materials, machines, etc. do not fulfil any direct consumption need of the buyer but they are needed for the production of goods having direct demand. Therefore, they fall in the category of derived demand. If demand for final product increases, the derived demand for related product also increases. If demand for the former falls, the demand for the latter also decreases.
On the other hand, when demand for a particular product is independent of the demand for other products, such a demand is called autonomous demand. The demand for consumer goods is autonomous. It is the one where a commodity is demanded because it is needed for direct consumption. For example, T.V., furniture, etc.
To distinguish between derived demand and autonomous demand is not an easy job. There is a thin line of demarcation between the two. In fact, mostly demand is derived demand. For example, even the demand for a car by a household is derived from the demand for transport service. Thus, the distinction between the two is rather arbitrary and a matter of degree.
Derived demand is generally less price elastic that the autonomous demand. In the pase of derived demand, the impact of price on demand gets diluted by other components in production whose prices are sticky.
Industry and Firm (Company) Demand
Industry demand refers to the total demand for the products of a particular industry That is the demand for the products of a particular firm, that is, the demand for paper in the country. On the other hand, company demand Arup Paper Mills. Industry demand covers the demand of all firms producing similar products which are close substitutes to each other irrespective of differences in trade names, such as Close-up, Colgate, Peps dent, etc.
Industry demand is less price elastic than company demand. However, the structure of the market decides the degree of price-demand relationship of the company demand:
(i) In the case of perfect competition the degree of substitutability being perfect, the company demand for the product tends to be perfectly elastic.
(in) In monopoly market, there is only one firm and the firm is itself an industry. In such a case, the company demand curve is the same as that of the industry demand curve.
(iii) In homogeneous oligopoly, business is highly transferable among rivals. The company demand curve remains uncertain because it depends upon what its rivals do. Usually, the sellers charge the same price to stay in the market.
(vi) in differentiated oligopoly, the company demand is less closely related to the industry demand. Sellers try to differentiate their products from each other. Hence, the price competition is lower than the homogeneous oligopoly market.
(v) If there is monopolistic competition, the company demand curve is more price elastic than the industry demand curve.
Short-run Demand and Long-run Demand
In the case of perishable commodities such as vegetables, fruit, milk, etc., the change in quantity demanded to a change in price occurs quickly. For such commodities, there is a single demand curve with the usual negative slope. But in the case of durable commodities such as equipments, machines, clothes, and others, a change in price will not have its ultimate effect on the quantity demanded until the existing stock of the commodity is adjusted which may take a long time. A short-run demand curve shows the change in quantity demanded to a change in price, given the existing stock of the durable commodity and the supplies of its substitutes. On the other hand, the long-run demand curve shows the change in quantity demanded to a change in price after all adjustments have been made in the longrun. According to Joel Dean, “Short-run demand refers to existing demand with its immediate reaction to price changes, income fluctuation, etc., whereas long-run demand is that which will ultimately exist as a result of the changes in pricing, promotion or product improvement, after enough time is allowed to let the market adjust itself to the new situation.”
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Joint Demand and Composite Demand
When two or more goods are jointly demanded at the same time to satisfy a single want it is called joint or complementary demand.
Joint demand refers to the relationship between two or more commodities or services when they are demanded together. There is joint demand for cars and petrol, pens and ink, tea and sugar, etc. Jointly demanded goods are complementary. A rise in the price of one leads to a fall in the demand for the other and vice-versa. For example, a rise in the price of cars will bring a fall in their demand together with the demand for petrol and lower its price, if the supply of petrol remains unchanged. On the contrary, a fall in the price of cars, as a result of a fall in the cost of production of cars, will increase their demand, and therefore increase the demand for petrol and raise its price, if available supplies of petrol are unchanged.
A commodity is said to have composite demand when it can be put to several alternative uses. This is not only peculiar to commodities like leather, steel, coal, paper, etc. but also to factors of production like land, labour and capital. For example, coal is demanded by railways, by factories, by households, etc. There is competition among the different uses of a commodity in composite demand. Hence, each use of the commodity is the rival of the other uses. So it! is also called rival demand. Any change in the demand for a commodity by a user will affect the supply of the other users which will change their prices.
Sectoral Demand and Market Demand
Market demand refers to the total demand for a particular commodity. For instance, the market demand for toilet soaps includes all brands of toilet soaps. Sectoral demand refers to the part of the total market such as foreign market, local market, regional market and national market for a product. It is also known as market segment demand which may also be of substitutes and sub-products of a commodity. Thus market demand includes the sectoral or market segment demand of product.
When demand forecasting is made, the total market is taken into consideration. But in the case of pricing, distribution and promotion of a product, its sectoral or segment market demand is taken. Each of its segments may differ in price, packaging, promotion, etc.
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AN INDIVIDUAL’S DEMAND SCHEDULE AND CURVE
An individual consumer’s demand refers to the quantities of a commodity demanded by him at various prices, other things remaining equal Xpr and !). An individual’s demand for a commodity is shown on the demand schedule and on the demand curve. A demand schedule is a list of prices and quantities and its graphic representation is a demand curve.
The demand schedule reveals that when the price is Rs 5, the quantity demanded is 5 nits. If the price happens to be Rs 4, the quantity demanded is 10 units, and ultimately the ice being Re. 1,25 units are demanded. In Figure 1. DD is the demand curve drawn on the Basis of the above demand schedule. The dotted points P,Q,R,S and T show the various entity combinations. Marshall call them “demand points”. The first combination is recanted by the first dot and the remaining price-quantity combinations move to the right towards D,
THE MARKET DEMAND SCHEDULE AND CURVE
market, there is not one consumer but many consumers of a commodity. The demand of a commodity is depicted on a demand schedule and a demand curve. now the sum total of various quantities demanded by all the individuals at various prices. Suppose there are two individuals A and B in a market who purchase the commodity. The demand schedule for the commodity is depicted in Table 2
The Table represents the market demand of orange at various prices. It is arrived at by adding the demand of consumers A and B. When the price is very high, Rs 5 per unit, the market demand for orange is 15 units. As the price falls, the demand increases. When the price is the lowest, Re. I per unit, the market demand is 75 units.
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Table 2
Market Demand Schedule
From Table 2 we draw the market demand curve in Figure 2. D. is the market demand curve which is the horizontal summation of the two individual demand curves D. +D.. The market demand for a commodity depends on all factors that determine an individual’s demand.
But a better way of drawing a market demand curve is to add together sideways (lat Demand individual demand curves. In Curve this case, the different quantities demanded by consumers at one price are represented on each individual demand curve and then a lateral summation is done, as shown in Figure 3. Suppose there are three individuals Quantity Demanded OB and OC quantities of the commodity at the price OP, as
1 This is a detailed method. For a simple exposition, students may attempt the method given below. Show Panels (A),(B) and (C) respectively in Figure3. In the market, OQ quantity will be
which is made up by adding together the quantities OA, OB and OC. The market demand curve, D. is obtained by the lateral summation of the individual demand curves D. D. and Din panel
CHANGES IN DEMAND
Changes in demand take place in two ways: (1) increase and decrease in demand; and (2) extension and contraction in demand.
(1) Increase and Decrease in Demand
An individual’s demand curve is drawn on the assumption that factors such as prices of other commodities, income and tastes influencing his demand remain constant. What happens to an individual’s demand curve if there is a change in any one of the factors affecting his demand, the other factors remaining constant? When any one of the factors changes, the entire demand curve shifts either to the right or to the left when the consumer buys more of the commodity at the same price, it is increase in demand. When his money income rises, other factors remaining constant, his demand curve for a commodity will shift to the right. This is shown in Figure 4. Before the rise in his income, the consumer is buying O quantity at OP price on the DD demand curve. With the increase in income, his demand curve shifts to the right as D.D. He now buys more quantity 09, at the same price OP. On the contrary, if his income falls, his demand curve will shift to the left. He will buy less of the commodity at the same price, as shown in Figure 5. Before the fall in his income, the consumer is on the demand curve D, D, where he is buying 0g, of the commodity at OP price.
He now buys less quantity 09, at the given price OP. When the consumer buys less of the commodity at a given price, this is called the decrease in demand.
Demand curves are thus not stationary. Rather, they shift to the right or left due to a number of causes. There are changes in tastes, habits and customers of the consumers: changes in income and expenditure; changes in the prices of substitutes and complements; expectations about future in prices and incomes and changes in the age and composition of the population, etc
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(2) Extension and Contraction in Demand
A movement along a demand curve takes place D when there is a change in the quantity demanded due to a change in the commodity’s own price and not due to P
A Extension any other factor. This is illustrated in Figure 6. Which in Demand shows that when the price is OP, the quantity demanded is og. With the fall in price, there has been a downward movement along the same demand curve D D from point A to B. This is known as extension in demnad. On the
Contraction contrary, if we take B as the original price-demand point, in Demand then a rise in the price from OP, to OP leads to a fall in the quantity demanded from 0 to 00. The consumer O Q moves upwards along the same demand curve D.D. from Quantity Demanded point B to A. This is known as contraction in demand.
THE LAW OF DEMAND
The law of demand expresses a relationship between the quantity demanded and its price. It may be defined in Marshall’s words as the amount demanded increases with a fall in price, and diminishes with a rise in price”. Thus it expresses an inverse relation between price and demand. The law refers to the direction in which quantity demanded changes with a change in price. On the figure, it is represented by the slope of the demand curve which is normally negative throughout its length. The inverse price-demand relationship is based on other things remaining equal. This phrase points towards certain important assumptions on which this law is based.
Its Assumptions
These assumptions are:
(i) there is no change in the tastes and preferences of the consumer:
(ii) the income of the consumer remains constant:
(iii) there is no change in customs;
(iv) the commodity to be used should not confer distinction on the consumer:
(v) there should not be any substitutes of the commodity:
(vi) there should not be any change in the prices of other products:
(vii) there should not be any possibility of change in the price of the product being used;
(viil) there should not be any change in the quality of the product; and
(ix) the habits of the consumers should remain unchanged. Given these conditions. the law of demand operates. If there is change even in one of these conditions it will stop operating,
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Given these assumptions, the law of demand is explained in terms of Table 3 and Figure 7.
The above table shows that when the price of say, orange, is Rs. 5 per unit, 100 units are demanded. If the price falls to Rs.4, the demand increases to 200 units. Similarly, when the price declines to Re.1, the demand increases to 600 units. On the contrary, as the price increases from Re. 1, the demand continues to decline from 600 units.
In the figure, point P of the demand curve DD, shows demand for 100 units at the Rs. 5. As the price falls to Rs. 4, Rs. 3, Rs. 2 and Re. 1, the demand rises to 200, 300, 400 and 600 units respectively. This is clear from points Q, R, S, and T. Thus, the demand curve DD, shows increase in demand of orange when its price falls. This indicates the inverse relation between price and demand.
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Causes of Downward Sloping Demand Curve
Why does a demand curve slope downward from left to right? The reasons for this also clarify the working of the law of demand. The following are the main reasons for the downward sloping demand curve.
(1) The law of demand is based on the law of Diminishing Marginal Utility. According to this law, when a consumer buys more units of a commodity, the marginal utility of that commodity continues to decline. Therefore, the consumer will buy more units of that commodity only when its price falls. When less units are available, utility will be high and the consumer will be prepared to pay more for the commodity. This proves that the demand will be more at a lower price and it will be less at a higher price. That is why the demand curve is downward sloping.
(2) Every commodity has certain consumers but when its price falls, new consumers start consuming it, as a result demand increases. On the contrary, with the increase in the price of the product, many consumers will either reduce or stop its consumption and the demand will be reduced. Thus, due to the price effect when consumers consume more or less of the commodity, the demand curve slopes downward.
(3) When the price of a commodity falls, the real income of the consumer increases because he has to spend less in order to buy the same quantity. On the contrary, with the rise in the price of the commodity, the real income of the consumer falls. This is called the income effect. Under the influence of this effect, with the fall in the price of the commodity the consumer buys more of it and also spends a portion of the increased income in buying other commodities. For instance, with the fall in the price of milk, he will buy more of it but at the same time, he will increase the demand for other commodities. On the other hand, with the increase in the price of milk he will reduce its demand. The income effect of a change in the price of an ordinary commodity being positive, the demand curve slopes downward.
(4) The other effect of change of the price of the commodity is the substitution effect. With the fall in the price of a commodity, the prices of its substitutes remaining the same, consumers will buy more of this commodity rather than the substitutes. As a result, its demand will increase. On the contrary, with the rise in the price of the commodity (under consideration) its demand will fall, given the prices of the substitutes. For instance, with the fall in the price of tea, the price of coffee being unchanged, the demand for tea will rise, and contrariwise, with the increase in the price of tea, its demand will fall.
(5) There are persons in different income groups in every society but the majority is in low income group. The downward sloping demand curve depends upon this group. Ordinary people buy more when price falls and less when price rises. The rich do not have any effect on the demand curve because they are capable of buying the same quantity even at a higher price.
(6) There are different uses of certain commodities and services that are responsible for the negative slope of the demand curve. With the increase in the price of such products, they will be used only for more important uses and their demand will fall. On the contrary, with the fall in price, they will be put to various uses and their demand will rise. For instance, with the increase in the electricity charges, power will be used primarily for domestic lighting, but if the charges are reduced, people will use power for cooking, fans, heaters, etc.
(7) There is a tendency to satisfy unsatisfied wants. Each person has some unsatisfied wants. When the price of a good such as apple falls, he wants to satisfy his unsatisfied wants which leads him to increase its demand. Because of this tendency of human beings, the demand curve slopes downwards to the right.
Exceptions to the Law of Demand
In certain cases, the demand curve slopes up from left to right, i.e., it has a positive slope. Under certain circumstances, consumers buy more when the price of a commodity rises, and less when price falls, as shown by the D curve in Figure 8. Many causes are attributed to an upward sloping demand curve.
(i) War. If shortage is feared in anticipation of war, people may start buying for building stocks or for hoarding even when the price rises.
(ii) Depression. During a depression, the prices of commodities are very low and the demand for them is also This is because of the lack of purchasing power with consumers.
(iii) Giffen Paradox. If a commodity happens to be a necessity of life like wheat and its price goes up, consumers are forced to curtail the consumption of more expensive foods like meat and fish, and wheat being still the cheapest food they will consume more of it. The Marshalling example is applicable to developed economies. In the case of an underdeveloped with the fall in the price of an inferior commodity like maize, consumers will start consuming more of the superior commodity like wheat. As a result, the demand for maize will fall. This is what Marshall called the Giffen Paradox which makes the demand curve to have a positive slope.
(iv) Demonstration Effect. If consumers are affectd by the principle of conspicuous consumption or demonstration effect, they will like to buy more of those commodities which confer distinction on the possessor, when their prices rise. On the other hand, with the fall in the prices of such articles, their demand falls, as is the case with diamonds.
(v) Ignorance Effect. Consumers buy more at a higher price under the influence of the “ignorance effect”, where a commodity may be mistaken for some other commodity, due to deceptive packing, label, etc.
(vi) Speculation. Marshall mentions speculation as one of the important exceptions to the downward sloping clemand curve. According to him, the law of demand does not apply to the demand in a campaign between groups of speculators. When a group unloads a great quantity of a thing on to the market, the price falls and the other group begins buying it. When it has raised the price of the thing, it arranges to sell a great deal quietly. Thus when price rises, demand also increases.
(vii) Necessities of Life. Normally, the law of demand does not apply on necessities of life such as food, cloth etc. Even the price of these goods increases, the consumer does not reduce their demand. Rather, he purchases them even the prices of these goods increase often by reducing the demand for comfortable goods. This is also a reason that the demand curve slopes upwards to the right.
INCOME DEMAND
We have so far studied price demand in its various aspects, keeping other things constant. Let us now study income demand which indicates the relationship between income and the quantity of commodity demanded. It relates to the various quantities of a commodity or service that will be bought by the consumer at various levels of income in a given period of time, other things being equal. Things that are assumed to remain equal are the price of the commodity in question, the prices of related commodities, and the tastes, perferences and habits of the consunr ier for it. The incomedemand function for a commodity 0 0 0 0 is written as D=f(). The income demand relationship is usually Tlne demand for the commodity increases with the rise in income and decreases with in income, as shown in Figure 9. When income is Ol, the quantity demanded is oo han income rises to OI, the quantity demanded also increases to 00.. The reverse aIso be shown likewise. Thus, the income demand curve ID has a positive slope But this slope is in the case of normal goods. take the case of a consumer who is in the habit of consuming an inferior good. his income remains below a particular level of his minimum subsistence, he will continue to buy more of this inferior good even when his income increase by small increments.
So Long his income starts rising above that level. he reduces his demand for the inferior good. In Figure 9(B), Ol is the minimum subsistence level of income where he buys IQ of the commodity. Upto this level, this commodity is a normal good for him so that he increases its consumption when his income rises gradually from OI, to Ol. As his income rises above OI, he starts buying less of the commodity. For instance, at Ol, income level, he buys/, which is less than IQ. Thus, in the case of inferior foods, the income demand curve ID is backward sloping.
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CROSS DEMAND OF SUBSTITUTE AND COMPLEMENTARY GOODS
Let us now take the case of related goods and how the change in the price of one affects the demand of the other. This is known as cross demand and is written as D=f(pr). Related goods are of two types, substitutes and complementary. In the case of substitute or competitive goods, a rise in the price of one good A raises the demand for the other good B, the remaining the same. The opposite holds in the case of a fall in the price of A when the demand o A, for B falls. Figure 10 (A) illustrates it. When the price of good A increases from OA to OA, the quantity of good B also increases from OB to OB. The cross demand 0 B B. O B R > curve CD for substitutes is posititively sloping. For with the rise in the price of A, the consumers will shift their demand to B since the price of B remains unchanged. It is also assumed here that the incomes, tastes, preferences, etc. of the consumers do not change.
In case the two goods are complementary or jointly demanded, a rise in the price of one good A will bring a fall in the demand for good B. Conversely, a fall in the price of A will raise the demand for B. This is illustrated in Figure 10 (B) where when the price of A falls from OA, to OA, the demand for B increases from OB to OB. The demand curve in the case of complementary goods is negatively sloping like the ordinary demand curve.
If, however, the two goods are independent, a change in the price of A will have no effect on the demand for B. We seldom study the relation between two unrelated goods like wheat and chairs. Mostly as consumers, we are concerned with the price-demand relation of substitutes and complementary goods.
DEMAND DETERMINANTS
The demand for the product is mainly the attitude of consumers towards the product. The attitude of consumers gives rise to actions in buying different products at different prices. The demand for a product is determined by different factors. The main demand determinants are price, income, price of related goods and advertising. Therefore, demand is a multivariate relationship, i.e. it is determined by many factors simultaneously.
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(A) Determinants of Individual Demand
Let us discuss the variables which influence individual demand.
1 Price of the Commodity
This is the basic factor influencing the demand. There is a close relationship between the quantity demanded and the price of the product. Normally a larger quantity is demanded at a lower price that at a higher price. There is inverse relationship between the price and quantity demanded. This is called the law of demand.
2. Income of the Consumer
The income of the consumer is another important variable which influences demand. The ability to buy a commodity depends upon the income of the consumer. When the income of the consumers increases, they buy more and when income falls they buy less. A rich consumer demands more and more goods because his purchasing power is high.
3. Tastes and Preferences
The demand for a product depends upon tastes and preferences of the consumers. If the consumers develop taste for a commodity they buy whatever may be the price. A favourable change in consumer preference will cause the demand to increase. Likewise an unfavourable change in consumer preferences will cause the demand to decrease.
4. Prices of Related Goods
The related goods are generally substitutes and complementary goods. The demand for a product is also influenced by the prices of substitutes and complements. When a want can be satisfied by alternative similar goods they are called substitutes, such as coffee and tea. Whenever the price of one good and the demand for another are inversely related then the goods are said to be complementary, such as car and petrol.
5. Advertisement and Sales Propaganda
In modern times, the preferences of consumers can be altered by advertisement and sales propaganda. Advertisement helps in increasing demand by informing the potential consumers about the availability of the product, by showing the superiority of the product, and by influencing consumer choice against the rival products. The demand for products like detergents and cosmetics is mainly caused by advertisement.
6. Consumer’s Expectation
A consumer’s expectation about the future changes in price and income may also affect his demand. If a consumer expects a rise in prices he may buy large quantities of that particular commodity. Similarly, if he expects its prices to fall in future, he will tend to buy less at presnt. Similarly, expectation of rising income may induce him to increase his current consumption.
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(B) Determinants of Market Demand
Market demand for a product refers to the total demand of all the buyers taken together. How much quantity the consumers in general would buy at a given period of time constitutes the total market demand for the product. The following factors affect the market demand pattern of a commodity:
1 Price of the Product. The law of demand states that if other things remain the same when price falls, demand increases and vice-versa.
2. Standard of Living and Spending Habits. When people are accustomed to high standard of living their spending on comforts and luxuries also increase, that automatically increase the demand.
3. Distribution of Income Pattern. If the distribution pattern of income is fair and equal the market demand for essential items tends to be greater.
4. The Scale of Preferences. The market demand for a product is also affected by the scale of preference of buyers. If there is a shift in consumers’ preference from x to y, the demand for y tends to increase.
5. The Growth of Population. The growth of population is also another important factor that affects the market demand. With the increase in population, people naturally demand more goods for their survival.
6. Social Customs and Ceremonies. Social customs and ceremonies are usually celebrated collectively. They involve extra expenditure on certain items and thereby increase the demand.
7. Future Expectation. People are not sure about their future, because future is uncertain. If the consumers expect a rise in prices of products, they buy more at present and preserve the same for the future, thereby the market demand would be affected.
8. Tax Rate. The tax rate also affects the demand. High tax rate would generally mean a low demand for the goods. At certain times the government restricts the consumption of a commodity and use the tax as a weapon. A highly taxed commodity will have a lower demand.
9. Inventions and Innovations. Inventions and innovations introduce new goods in the market. The consumers will have a strong tendency to purchase the new product. The preference over the new goods adversely affects the demand for the existing goods in the market
10. Weather Conditions. Seasonal factors also affect the demand. The demand for certain items purely depends on climatic and weather conditions. For example, the growing demand for cold drinks during the summer season and the demand for sweaters during the winter season.
11. Availability of Credit. The purchasing power is influenced by the availability of credit. If there is the availability of cheap credit, the consumers try to spend more on consumer durables thereby the demand for certain products increase.
12. The pattern of Saving. Demand is also influenced by the pattern of saving. If people begin to save more, their demand will decrease. It means the disposable income will be less to purchase the goods and services. On the contrary, if saving is less their demand will increase.
13. Demonstration Effect. The demonstration effect helps to increase human wants. In underdeveloped countries, there is a desire in the minds of the people to imitate other people for conspicuous consumption and that is why they are not able to save. This change in the saving habits of the people is due to “contact effect”. The demonstration effect has a positive effect on the demand for comforts and luxury goods.
14. Circulation of Money. An expansion or a contraction in the quantity of money will affect demand. When more money circulates among the people, more of a thing is demanded by the people because they have more purchasing power, and vice versa.
Demand Analysis Study Material
IMPORTANCE OF DEMAND IN MANAGEMENT
The concept of demand is of much significance in business management. It is the demand for a firm’s product that determines its market. In fact, it is the extent of demand for a product being produced by an industry consisting of several firms that determines the size of its market. The larger the demand, the more will be the profits. Therefore, firms make efforts in increasing the demand for their products. For this, they study the behaviour of consumers and competitors towards their products. On the basis of their analysis, they plan and adopt such measures as advertisements, improving the quality of products, etc. To increase the sales revenue and profits, they estimate their present demand and forecast the future demand. Thus the entire business depends upon the size and structure of demand for their products.
In the case of substitute or complementary goods, demand depands on the change in the price of the other good. A firm producing a similar or competitive product will thus influence the demand for the products of other firms by reducing or raising the price of its own product. Moreover, the producers of complementary goods will be influenced by the demand for the main good. When the demand for the main good increases, the demand for the complementary goods will also increase in the market. The increase in the demand and sales of both the main and complementary goods will increase the business of such firms. These will further increase the demand for sales agencies, representatives and various persons associated with these products.
The income demand of the people also influences the business of a firm producing a product. When the income of people increases, their demand for variety of products also increases depending on the level of their incomes. Persons with higher incomes will demand better quality and high price goods then others. This will lead to the expansion of firms producing low priced and high priced goods of different varieties and qualities.
Demand Analysis Study Material
EXERCISES
1 What do you mean by the term “demand” ? Discuss different types of demand.
2. Explain the main determinants of demand.
3. What are the demand function, demand schedule and demand curve?
4. Examine critically the law of demand. What are its exceptions? Why does a demand curve always slope downwards to the right?
5. Distinguish between :
6 Consumer goods and producer goods demand.
(ii) Derived demand and autonomous demand.
(iii) Firm demand and industry demand.
(iv) Demand schedule and demand curve.
(v) Sectoral demand and market demand. plain the market demand function. What is the importance of demand in management?
