THEORY OF DEMAND

DEMAND is the amount of goods or services that consumers are willing and able to buy at a given
price over a specified period of time.

From the above definition it is important to observe and note the following :

 dd refers to quantity.
 dd is done by consumers
 dd is not only desire or willingness rather it is desire backed by the ability to pay for the
goods or services.
 This kind of dd is reffered to as effective demand.
Effective Demand =willingness + ability
 Demand is different at each price level.
 Demand refers to a flow of goods – quantities that move over a specified period of time.

Latent Demand

 It refers to the way dd is defined from a layman’s point of view.

 It is defined as willingness to have a good / services not supported by the ability to pay
for it. Latent demand = willingness only.
 Many people have a desire for many goods and services which they are not able to pay.
 THUS kind of dd is not important at all to economist and therefore not included in the
business definition of dd.

QUANTITY DEMANDED

 Quantity demanded (qd) is the amount of a good or service consumers are willing and able to
buy at a given price.

LAW OF DEMAND

 States that there is an inverse relationship between the price of goods or service and quantity.
 It means more goods are demanded at lower price than a higher prices other things being
equal.
 Law of demand states that, “other things being equal, more will be demanded at a lower price
than at a higher price”.
 This describes a negative or inverse relationship between price and quantity demanded.

Other things being equal (ceteris Paribas)

 It is a phrase that is used as an economic tool to make an economic analysis and relationships
simple and easier to comprehend.
 It means when one factor is under consideration other factors are assumed to remain
unchanged.
 It therefore means one factor’s effect on another variable is analysed at a time e.g. if we want
to analyse the effect of a price change on qd we assume the other determinants of dd remain
unchanged.
 The objection is to analyse the effect of one factor in isolation.
Demand Schedule

It is the representation of the relationship between qd and the price of a commodity by use of a table.

Price $ $10 $12 $14 $16 $18

Quantity demanded (qd) 100 80 60 40 20
Units

Demand Curve

 It is a graphical explanation of the relationship between qd of a good and its price.

 A normal dd curve is downward sloping.
 It has a negative slope because of a negative relationship between price and qd.
 As price falls, the quantity demanded rises.
 Conversely, as the price increases the corresponding quantity demanded falls.
 In other words, the demand curve is down sloping from left to right indicating that as price
falls more will be demanded.

 The down sloping demand curve implies that a fall in price from $15 to $12 will lead to an
increase in the number of units demanded from 5 units to 10 units.

Why the demand curve is downsloping

More is demanded at a lower price than a higher price because:-

1. Consumers prefer cheaper products to dearer ones.

2. At a lower price more goods will be purchased than at a higher price for instance at $15 one can
get 5 cds while at a reduced price of say $5 can get 25 cds. Thus the purchasing power of money
increases as prices go down. This purchasing power can be equated to an increase in real income
and hence is seen as the income effect of a price fall.
3. Consumers tend to substitute cheap products for dear products. For example a fall in price of
butter will provide an incentive to substitute butter for margarine which is relatively expensive.
 Purchase of butter will increase as a result and this is referred to as the substitution effect of a fall
in price.
4. Law of diminishing marginal utility / Utility satisfication derived from the consumption or use of
the product. As consumers consume additional units of a product the additional satisfication
derived from that consumption declines. Thus consumption is subject to diminishing marginal
utility hence consumers will only buy additional units if price is reduced.

Factors that determine level of demand / Factors affecting the demand curve / shifters of
demand

The level of demand of a particular good or service is influenced by a quite a number of factors.

 The following are some of the factors that determine dd of a good or service:-

1. The price of a good (Px)

- The price of the good itself (Px).
- Basically the higher the price law of dd says the higher the price the lower the quantity
demanded and vice versa.
2. Income effect / changes in household disposable income
- If the price of a good changes the purchasing power of consumers is affected and
therefore the quantity demanded changes.
- Purchasing power (pp) is called real income.
- E.g. if the price falls it means less money is spent on good than before.
- Consumers are therefore with more real income (purchasing power) can buy more of the
good.
- Even non users (those who were not able to buy) can now afford to buy the good.
- A fall in prices increases the real income/ pp of the consumers
- On the other hand a rise in the price decrease real income / pp and the quantity demanded
(qd) falls.
3. Substitution effect
- There are so many ways of satisfying a want or a need.
- e.g. a desire for vegetables can be satisfied by a cabbage, rape, spinach.
- E.g.a desire to quench thirst can be met by water, soft drink etc.
- It there means that for every good has its own substitutes, thus change in price of a good
will make consumers make comparisons.
- Consumers normally opt for cheaper goods.
- A fall in price of a good will make the good a cheaper way of satisfying a need or want
compared to the substitutes, its dd will increase and the reverse is true.
4. Price of other goods (price of related goods)
- Goods are related.
- In economics there are two important relationships between goods, goods are either
substitutes or compliments.
- Substitutes are good that can be used interchangeably.
- They compete for the same consumer income.
- It means when a consumer buys will forgo the other.
- E.g washing powder and soap, peanut butter and margarine, bread and rice, etc.
- If the price of the one increases its dd will fall because it is an expensive way of satisfying
a need/want as compared to its substitutes.
 - The substitutes good’s demand will increase thus in the case of substitute goods the price
of one good and quantity demanded of the other move in the same direction.
- There is a positive relationship between the two goods.
- Complimentary Goods are goods that are jointly demanded.
- They are goods that are used at the same time.
- They do not compete for the same income but rather are needed to save the same need
and want at the same time.
- E.g. camera and film, cellphone and sim card, car and fuel, etc.
- If the price of one increases its demand will fall and negatively affect the demand of the
complimentary good.
- Thus the price of one good move in the opposite direction with quantity demanded of the
other good.
- There is a negative relationship between price of one good and quantity demanded of the
other good.
5. Consumer’s Income and wealth
- Income and wealth of the consumers determine the consumer’s purchasing power.
- The greater the size of income and wealth the more consumers can demand a particular
good or service.
6. Consumer’s tastes and preferences
- Consumers can have tastes for or prefer a good thus taste in favour of a good increases
the demand of that particular good.
- On the other hand, tastes can be against a good.
- Taste against a good reduces the demand of the good or service.
- Changing preferences will affect your demand for a product regardless of its price.
7. Population size and structure
- Population size refers to the number of consumers in a given market.
- A high population size is likely to bring more consumers of a given good or service than a
low population size ceteris Paribas.
- Quite obviously, a significant rise in the number of people in a given area or country will
affect the demand for a whole host of goods and services.
- There is a positive relationship between the population size and the quantity demanded.

- The structure of the population is important as well.

- It refers to the sex or age composition of a given population.
- Population structure determines the units of a commodity to be demanded in many ways.
- e.g. a population mainly made of middle aged group has a high marginal propensity to
spend than the one mainly made of senior citizens (old aged).
- Note that a change in the structure of the population (we have an ageing population) will
increase the demand for some goods but reduce the demand for others.
8. Expectations of future prices.
- If you think that the price for CDs is likely to fall in the near future, perhaps because of
reduced production costs or competition from the US, you may delay some purchases
which will reduce demand in the current time period.
- Alternatively, you may feel that CD prices are likely to rise in the near future, perhaps
due to the lack of competition in the retail market, so you may increase your demand in
the current time period.
OTHER factors

9. Weather or climatic factors.

10. Government policy.
11. Advertising
12. Customs
13. Religion
14. Interest rates

PRICE CHANGES AND QUANTITY DEMANDED

 A change in the price of a good increases or decreases quantity demanded.

 For any product a change in quantity demanded is always caused by a change in price.
 A change in quantity demanded refers to a movement along the existing demand curve.
 This is in line with the law of demand.

NB. Changes in quantity demanded are shown as movements along the same demanded curve as
shown above e.g. movement from point C to A along the same demand curve is described as a change
in quantity demanded.

Increase in quantity demanded

- It is reflected by movements down the curve e.g from C, A to B.

- It is caused only by a fall in the price of the good concerned.
- An increase in demand means that more is now demanded at each and every price than
before.

Decrease in quantity demanded

- Is shown by movements up the curve e.g. from B, A to C.

- It is caused by a rise in the price of the good concerned.
- A fall in demand means that less is demanded at each and every price than before.
SHIFTS OF THE DEMAND CURVE

- The demand (dd) curve is drawn on the assumption that it is the price that only affect
quantity demanded (qd/dd).
- However there are many other factors that can change and affect dd for a product.
- A change in one of the other determinants of dd, cause the whole dd curve to shift to the
left or right.

Shift to the right

- If the dd curve shifts to the right it is called an increase in dd that is a shift from D 1 to D2.
- It reflects an increase in qd at each and every price level.

Reasons for the shift to the right

- Increase in consumer disposable income

- Increasing in or population growth
- Change in tastes and preferences in favour of the good
 - Change in season which favours the dd of the good.
- Government policy which support a good or service
- Increace in the price of the substitute.
- Fall in price of complimentary goods.

Shift to the left

- If the dd curve shifts to the left it is called a decrease in dd that a shift from D 1 to D3.
- It reflects a decrease in qd at each and every price level.

Reasons for the shift to the left

- Decrease in consumer disposable income

- Fall or decreasing in population size or structure.
- Change in tastes and preferences against dd of a good
- Change in season which does not favours the dd of the good.
- Government policy against consumption of a good or service
- decrease in the price of the substitute.
- Increase in price of complimentary goods.

Exceptions of law of demand

 Refers to situation or circumstance that violates the law of demand.

 Exceptional demand curve do not confirm with the law of demand.
 They have a positive slope that is the slope slopes upwards from left to right as follows.

Exceptional demand curve

1. The case of Giffen goods

 Giffen goods are special kind of a good with a snob appeal.
  It means a good that is associated with high status, uniqueness or high prestige.
 The price of the good makes it unique, thus the higher the price the higher the good is
demanded by the targeted customers.
 If the price falls, the good became affordable by majority, unique and status disappears and
the dd of the good decreases.
 The giffen goods have an upward sloping dd curve as shown above.
 Example of giffen goods are poshy cars, jewellery and deodorants.

2.Speculative Demand
 Sometimes the law of demand does not hold the truth.
 When people’s dd is determined by speculation.
 Consumers tend to buy more of a product as the price increases if they foresee an even higher
price in the future.
 Eg. If the price of sugar is going up and consumers anticipate an even higher price they
increase the purchase of sugar in order to avoid the higher price in future.

3. Occasional Demand
 Refers to the demand of a product that respects time of the year or events or occasions more than
the price of the good itself.
 It means people buy a good or service because of the event or occasion taking place they therefore
ignore the direction of change in price.
 E.g. valentine, Christmas, easter.

Questions