Demand Analysis

Concept of Demand, Types and Demand Determinants

Objective After going through this chapter, you shall be able to understand the following concepts

Concept of Demand Individual and Market Demand Individual and Market Demand Function Individual and Market Demand Curve Determinants of Individual and Market Demands Types of Demand

Introduction This chapter basically focuses on the concept of consumer demand. We all demand (need) various goods and services for the satisfaction of our wants. In this chapter, we will explore the various aspects related to demand such as what factors affect our demand for commodities and types of demand. Concept of Demand Demand for a commodity refers to the quantity of the commodity which a consumer is willing and is able to purchase at a particular price for a given period of time'. In the definition given above, the two terms ‘willing’ and ‘able to purchase’ are worth noting. In economics, mere willingness to purchase a commodity does not constitute demand. Rather, this willingness must be backed by the ability to purchase the commodity (in terms of availability of money) for it to be regarded as demand. In this regard, we can distinguish between two similar terms, desire and demand. While the desire for a commodity indicates mere willingness to purchase a commodity without sufficient purchasing power, demand for a commodity refers to the willingness to purchase which is further backed by the ability to purchase. To put in other words, it is only when a desire is backed by the sufficient purchasing power than such a desire becomes a demand. The following note further clarify this concept. Individual and Market Demand Individual demand is the demand of a particular consumer. It represents various quantities of a particular commodity that a consumer (single buyer) is willing to purchase at different possible prices at a particular point in time. On the other hand, Market demand is the aggregate (total) of the individual demands for a product by all consumers in the market at different prices. Demand Schedule  Demand Schedule is a tabular presentation of the relationship between the price of a commodity and the quantity demanded of that commodity at a particular point of time. In other words, it shows the different quantities of a commodity that a consumer is willing to purchase at different possible prices. The demand schedule can be sub-divided into the following two types.

Individual demand schedule

Market demand schedule

Individual Demand Schedule An individual demand schedule is prepared for a particular consumer. It presents the various quantities of a particular commodity that a consumer is willing to purchase at different possible prices, at a particular point of time.  Example: Consider the following demand schedule for a commodity X 

Price of Commodity X (in Rs)

Quantity Demanded of X (units)

10

100

15

50

20

25

25

15

30

5

A close analysis of the above schedule reveals that quantity demanded of a commodity holds a negative relationship with the price. In other words, it shows that at a higher price the quantity demanded of X falls and vice-versa. For example, as the price increases from Rs 10 to Rs 15, the quantity demanded falls from 100 units to 50 units. Market Demand Schedule We know that market for a commodity consists of a large number of consumers. The market demand schedule, unlike the individual demand schedule, shows the aggregate (total) demand for all the consumers in the market at different prices. Example: Consider a hypothetical market that consists of only two consumers demanding a commodity X. The market demand schedule for X can be represented as:

Price of X (Rs)

Quantity Demanded by Consumer 1 (units)

Quantity Demanded by Consumer 2 (units)

Market Demand (units)

10

5

6

5 + 6 = 11

15

4

5

4 + 5 = 9

20

3

4

3 + 4 = 7

52

2

3

2 + 3 = 5

Demand Function The demand for a commodity depends on different variables besides the price of that commodity. The relationship between these variables and the demand for a commodity can be expressed in a functional form known as demand function. The demand functions can be of following two types.

Individual demand function Market demand function

Individual Demand Function An individual demand function expresses the relationship between quantity demanded by an individual consumer and various determinants. The following are the major determinants of individual's demand for a good.

Price of the good Price of the other goods- (i.e. price of substitute and complementary goods) Income of the consumer Consumer's tastes and preferences  

Based on these factors, the individual demand function can be represented as:  

where Px represents Price of good X Dx represents Demand for good X Py represents Price of other goods Y represents Income of consumer T represents Tastes and preferences Market Demand Function Similar to individual demand function, market demand function represents the relationship between the market demand of a good and its various determinants. It can be represented in the following functional form as:

MDx = f (Px, Py, Y, T, N, Yd)

where Px represents Market Price of good X Dx represents Market Demand for good X Py represents Market Price of other goods Y represents Income of all the consumers T represents Consumers' tastes and preferences N represents Population size or number of consumers in the market Yd represents Distribution of income

Demand Curve

It is a graphical representation of demand function i.e., the graphical representation of the relationship between the demand for a good and its price for a given income, price of related goods, tastes and preferences. The relationship between the demand for a good (Dx) and its price (Px) is negative. This implies that demand will fall with the rise in price and vice-versa. A demand curve is drawn with the assumption of constant income, given taste and preference and constant price of the related goods. In other words, a demand curve helps us to study the one to one relationship between price of a good and its demand (assuming other factors to be constant). Demand curves are basically of two types. These are: 1. Individual demand 2. Market demand Individual Demand Individual demand is the demand of a particular consumer. It represents various quantities of a particular commodity that a consumer (single buyer) is willing to purchase at different possible prices at a particular point in time. Algebraically, the function form of individual demand curve is represented as:

Market Demand Curve

A market demand curve shows the aggregate quantity demanded of a commodity that all the consumers in the market are willing to purchase at different possible prices. Algebraically, a market demand curve can be represented as:

Graphically, a market demand curve is derived by horizontally summing up all the individual demand curve. Let us understand the derivation of the market demand curve by assuming that in a market of a good, there are only two consumers, Consumer 1 and Consumer 2.  

In the diagram, it can be seen that at price Rs 10, quantity demanded by Consumer 1 is 5 units and that of by the Consumer 2 at the same price is 7 units. Therefore, the market demand at price Rs 10 is 12 units i.e. 5 units + 7 units. Similarly, horizontally summing up different quantity demanded by both the consumers at different prices, we obtain the market demand in the panel (iii) of the figure.

Determinants of Individual Demand Let us discuss the relationship between quantity demanded and its various determinants in detail. 1. Price of Good X Other things remaining constant, as the price of a good rises (or falls), the quantity demanded of the good falls (or rises). Thus, price of a good and its quantity demanded share a negative relationship. 2. Price of Other Goods Quantity demanded of a good also depends on the price of other goods (i.e. related goods). Any two goods are considered to be related to each other, when the demand for one good changes in response to the change in the price of the other good. The related goods can be classified into following two categories.  (i) Substitute Goods  Substitute goods refer to those goods that can be consumed in place of each other. In other words, they can be substituted for each other. For example, tea and coffee, colgate and pepsodent, cello pens and reynolds pen, etc. In case of substitute goods, if the price of one good increases, the consumer shifts his demand to the other (substitute) good i.e. rise in the price of one good results in a rise in the demand of the other good and vice-versa.  For example, if price of tea increases, then the demand for tea will decrease. As a result, consumers will shift their consumption towards coffee and the demand for coffee will increase. (Price of tea ↑⇒ Demand for coffee ↑). It should be noted that the demand for a good moves in the same direction as that of the price of its substitute