Ch-2 Demand

Definition of DemandDefinition of DemandThe demand for a product refers

to the amount of it which will be bought per unit of time at a particular price

Demand = Desire + Ability to pay (i.e., Money or Purchasing Power) + Will to spend

The Concept of The Concept of Demand. . .Demand. . .

Quantity Demanded refers to the amount (quantity) of a good that buyers are willing to purchase at alternative prices for a given period.

P

Q

Unwilling to buy

Willing to buy

Types of DemandTypes of Demand1. Demand for consumers’ goods and

producers’ goods2. Demand for perishable and durable

goods3. Autonomous (direct) and derived

(indirect) demand.4. Individual buyer’s demand and all

buyers’ (aggregate / market) demand.

5. Firm and Industry demand6. Demand by market segments and

by total market

Consumers’ Goods and Producers’ Consumers’ Goods and Producers’ GoodsGoods

Goods and Services used for final consumption are called consumers’ goods.

These include those consumed by human-beings (e.g. food items, clothes, kitchen tools, residential houses, medicines, and services of teachers, doctors, lawyers, washer men and shoe-makers), animals (e.g. dog food and fish food), birds (e.g. grains), etc.

Producers’ goods refer to the goods used for production of other goods.

Thus, producers’ goods consist of plant and machines, factory buildings, services of business employees, raw-materials, etc.

The distinction is somewhat arbitrary. This is because, whether a good is consumers’ or producers’ depends on its use.

For ex., if a sofa set is used in the drawing room of a house - it is a consumers’ good; while if is a used in the reception room of a business house – it is a producers’ good.

But, the distinction is useful for a proper demand analysis for while the demand for consumers’ goods depends on households’ income, that for producers’ goods varies with the production level, among other things.

Perishable and durable Perishable and durable goodsgoodsBoth consumers’ and producers’

goods are further classified into perishable (non-durable) and durable goods.

In laymen’s language, perishable goods are those which perish or become unusable after sometime, the rest are durable goods.

In economics, perishable goods refer to those goods which can be consumed only once while in case of durable goods, their services only are consumed.

Perishable goods include all services (e.g. services of teachers and doctors), food items, raw-materials, coal, and electricity, while durable goods include plant and machinery, buildings, furniture, automobiles, refrigerators, and fans.

Durable goods pose more complicated problems for demand analysis than do non-durables.

Sales of non-durables are made largely to meet current demands which depends on current conditions.

In contrast, sales of durable goods go partly to satisfy new demand and partly to replace old items.

Further, the letter set of goods are generally more expensive than the former set, and their demand alone is subject to preponment and postponement, depending on current market conditions vis-à-vis expected market conditions in future.

Autonomous (direct) and Autonomous (direct) and Derived (Indirect) DemandDerived (Indirect) Demand

The goods whose demand is not tied with the demand for some other goods are said to have autonomous demand, while the rest have derived demand.

Thus, the demands for all producers’ goods are derived demands, for they are needed in order to obtain consumers or producers goods.

Thus, the demand for goods which fulfill our basic Physiological requirements, are generally included in autonomous demand.

For example; Demand for soap, clothing etc

While the demand for goods for the production of other goods and services are included in derived.

For example; Demand for raw material like steel, cement, plant and machinery etc,

Demand for money which is needed not for its own sake but for its purchasing power, which can buy goods and services.

Similarly, demand for car’s battery or petrol is a derived demand, for it is linked to the demand for a car.

There is hardly anything whose demand is totally independent of any other demand.

But the degree of this dependence varies widely from product to product.

For ex: Demand for petrol is totally linked to the demand for petrol driven vehicles, while the demand for sugar is only loosely linked with the demand for milk.

Goods that are demanded for their own sake have direct demand while goods that are needed in order to obtain some other goods possess indirect demand.

In this sense, all consumers’ goods have direct demands while all producers’ goods, including money, have indirect demand.

Individual’s Demand and Individual’s Demand and Market DemandMarket Demand

The demand for a goods by an individual buyer is called individual’s demand while the demand for a goods by all buyers in a market is called market demand.

For ex, if the ice-cream cones market consisted of, say, only two buyers, then individuals and market demand (daily) could be as follows.

Individual firm Demand Individual firm Demand Amul’s Demand: Ice Cream Amul’s Demand: Ice Cream

ConesConesPrice/cones

Daily quantity_________________________________Rs10.00 12Rs15.00 10Rs20.00 8Rs25.00 6Rs30.00 4

Industry DemandIndustry DemandMarket demand is the sum of all individual demands at each possible price.

Assume the ice cream market has two buyers as follows:

Price Per Cone Amul Vadilal Market Demand

Rs10.00 12 + 7 = 19 Rs15.00 10 + 6 = 16 Rs20.00 8 + 5 = 13 Rs25.00 6 + 4 = 10 Rs30.00 4 + 3 = 7

Market Demand CurveMarket Demand CurveAll BuyersAll Buyers

PRs Per Cone

Q # Cones Per Day

Rs30.00

Rs25.00

Rs20.00

7 10 13

Firm and Industry Firm and Industry DemandDemand

Most goods today are produced by more than one firm and so there is a difference between the demand facing an individual firm and that facing an industry (all firms producing a particular good constitute an industry engaged in the production of that good).

For ex: Cars in India are manufactured by Maruti Udyog, Hindustan Motors, Premier Automobiles, and Standard Motor Products of India.

Demand for Maruti car alone is a firm’s (company) demand where as demand for all kinds of cars is industry’s demand.

Similarly, demand for Godrej refrigerators is a firm’s demand while that for all brands of refrigerators is the industry’s demand.

Demand by Market Demand by Market Segments and by Total Segments and by Total

MarketMarket

The market demand is the total demand for the product in the market. It is the sum (total) of the demand of a product by all the consumers in the market. In managerial economic the total market demand concept is having very less importance.

On the other hand demand by segment is the entire market is divided into different groups on the basic of location, demography, life style and behavior of the consumers in the classification is more meaningful in managerial economics.

The demand condition in each segment is different from other, which provides better guidance for the manager in understanding the different class of consumers.

Demand FunctionDemand FunctionA function is that which describes the

relationship between a variable (dependent variable) and its determinants (independent variables).

Thus, the demand function for a good relates the quantities of a goods which consumers demand during some specific period to the factors which influence that demand.

Mathematically, the demand function for a goods x can be expressed as follows:

Demand functionDemand functionDx= f (Y, Px, Ps, Pc, T; Ep, Ey, N, D, u)

Dx =Demand of goods x Y =Income of consumers Px =Price of x Ps =Price of substitute of x Pc =Price of complements of x T =Taste of consumers Ep =Consumers’ expectations about future price Ey = Consumers’ expectations about future

income N =No. of consumers D =Distribution of consumers

The first five determinants affect the demand for all goods, the next two are influence mainly on the demand for durable and expensive goods, and the next tow are arguments only in the demand functions for a group of consumers.

The impact of these determinants on Demand is

1) Price effect on demand: Demand for x is inversely related to its own price.

2) Substitution effect on demand: If y is a substitute of x, then as price of y increases, demand for x also increases.

3) Complementary effect on demand: If z is a complement of x, then as the price of z falls, the demand for z goes up and thus the demand for x also tends to rise.

4)Price expectation effect on demand: Here the relation may not be definite as the psychology of the consumer comes into play.

5) Income effect on demand: As income rises, consumers buy more of normal goods (positive effect) and less of inferior goods (negative effect).

6) Promotional effect on demand: Advertisement increases the sale of a firm up to a point.

Socio-psychological determinants of demand like tastes and preferences, custom, habits, etc.

Demand CurveDemand CurveDemand curve considers only the

price demand relation, other factors remaining the same.

An individual’s demand schedule for commodity x

Price x (per unit) Quantity of x demanded (in

units)2.0 1.0

1.5 2.0 1.0 3.0 0.5 4.5

The demand curve is negatively sloped, indicating that the individual purchases more of the commodity per time period at lower prices.

The inverse relationship between the price of the commodity and the quantity demanded per time period is referred to as the law of demand.

A fall in Px leads to an increase in Dx because of the substitution effect and income effect.

Determinants of Determinants of DemandDemand

Product’s Own PriceConsumer IncomePrices of Related GoodsTastes & preferencesExpectations about future price & income

Number of Consumers & their Distribution

Demand Determinants

For all demands For durable and/or expensive goods

For aggregate demand

No. of Consumers

Distribution of consumers

Consumers’ expectations about

Future Incomes

Future Prices

Consumer’s Income

Own price Consumer’s taste & preference

Prices of related goods

Substitute goods prices

Complementary goods’ prices

Consumers’ Income and Consumers’ Income and DemandDemandIncome acts as a variable to take care

of the ability to pay requirement in the demand function.

Economists classify goods into normal or superior goods and inferior goods.

By defination, the former are those whose demand varies directly with income while the latter are those whose demand varies inversely with income.

For example : milk, refrigerator, television, education, and the good quality of

Food grains and clothes are superior goods while the poor quality of food grains and clothes are inferior goods.

The relationship between demand and income is of this type because as the consumer’s income increases, his purchasing power goes up and therefore he increases his consumption of superior goods, and if he was consuming some inferior items earlier, he would give them up either totally or partially in favor of superior items.

Engel was the first person to study this relationship systematically and the curve reflecting the relationship between demand and income, is known as the Engel’s curve.

The curvature of the Engel curve depends on the degree of the superiority or inferiority of the good in question. Thus, the curve be linear (straight line), convex or even concave.

Engel SchedulesFor Superior Goods For Inferior

GoodsIncome Demand Income

Demand100150200250

5 81011

100150200250

10 9 7 4

Income

Demand

Own Price and DemandOwn Price and DemandThe demand for a goods varies

inversely with its own priceThus, as the price of the Maruti car

goes up, the demand for Maruti car goes down. This is known as Law of Demand.

The Law which describe the inverse relationship between quantity demanded and price.

The price effect (PE) is divided into income effect(IE) and substitution effect(SE). i.e. PE = IE + SE.

Prices of Related Goods and Prices of Related Goods and DemandDemand

Consumers’ goods may have either of the two kinds of relationships: Substitutes and complements.

For ex: tea and coffee , car and scooters are substitutes goods.

The degree of substitution might vary from product to product.

For ex: Maruti car and Honda car is a close substitution while car and scooter is a poor substitution.

Thus, increase in the price of a substitute good would lead to an increase in the demand for the good.

When the price of complementary goods goes down, the demand for its parent good goes up.

Ex : Car and Petrol Petrol is complementary good

Consumers’ Testes and Consumers’ Testes and Preferences, and DemandPreferences, and DemandConsumers’ testes and

preferences are an important determinant of the demands for all consumers’ good.

If a product goes out of fashion, or taste, its demand goes down. On the other hand, if an item becomes popular its demand goes up.

Producers’ spend a lot of money on advertising their products primarily

Because they can influence the tastes and preferences of the consumers in their favour, and thereby achieve an increase in the demand for their own products.

Consumers’ expectations Consumers’ expectations and demand and demand The expectations’ variable plays

a more significant role in the case of demand for durable and expensive items.

Generally, expectations’ variables are often left out from the list of demand determinants for non-durable and cheap goods.

Number of Consumers, their Number of Consumers, their distribution and demanddistribution and demandThe aggregate demand for a

good obviously depends also on the number of consumers.

The larger the number of consumers, the greater is the demand, and vice versa.