THEORY OF DEMAND

Meaning of Demand
Demand means desire/want for something ,but in
economics demand refers to effective demand ie; the
amount buyers are willing to purchase at a given price
over a given period of time.
Demand is -:
•Demand is desire/want backed by money
(Demand=desire+ ability to pay+ will to pay)
•Demand is always related to price and time (example
:demand for oranges by a household at a price of Rs.50/kg
is 5kg oranges /week)
•Demand maybe viewed as Ex Ante (intended/potential
demand)or Ex Post (amt actual purchased/actual
quantity demanded)
Definition of demand
The demand for a product refers to the amount of it which
 Individual demand/Market demand
Individual demand :It refers to demand from the individuals /family/house-
hold. It is a single consuming entity’s demand.

Market demand: It refers to the total demand of all buyers ,taken together.
It is the aggregate of the quantities of a product demanded by all the
individuals buyers at a given price over a given period of time-it is the sum
total of individual demand function

Market demand is more important from the business point of view, sales
depends on market demand ,so does planning future marketing strategy
Prices are determined on the basis of demand for the product etc.

The following table shows individual demands for eggs and how the market
demand eggs at various prices is derived from it :
Price A B C D E Total dd
/doz Rs for eggs

10 1 3 0 0 0 4

9 2 4 1 0 0 7
8 3 5 3 1 0 12
7 4 6 5 2 1 18

6 5 7 6 3 2 23
5 6 8 7 4 3 28
4 7 9 8 5 4 33
 Determinants of Demand
INDIVIDUAL DEMAND
• Price of the products
• Income
• Tastes, Habits, Preferences
• Relative price of other
goods-substitutes and
complementary goods
• •
Consumers Expectations
• Advertisement Effect
MARKET DEMAND
• Price of the product
• Distribution of wealth and
income in the community
• Community’s common habits
and scale of preferences
• General standard of living and
spending habits of the people
• Growth of the population
Age structure/sex ratio of the
population
• Future Expectations
• Level of taxation and tax
structure
• Fashions/inventions/innovations/
customs/weather/climate
• Advertisement/sales
propaganda
DEMAND FUNCTION
At any point of time, the quantity of a given product(good/service)
that will be purchased by the consumers depends on a number
of key variables/determinants.
The most important variables are listed below:
• The ‘own price’ of the product (P)
• The price of the substitute and complementary goods(Ps or Pc)
• The level of disposable income(Yd) with the buyers(ie; income
left after direct taxes)
• Change in the buyers’ taste and preferences(T)
• The advertisement effect measured through the level of
advertising expenditure(A)
• Changes in the population number or number of buyers(N)
 Using the symbolic notations, the demand function can expressed
as follows:

D x =f (Px, Ps, Pc, Yd, T, A, N, u)

Where x –commodity
Dx - the amount demanded of the commodity
Px- price of x
u- other unspecified determinants of the
demand for
commodity x
it can also be expressed as
Q d= f(P,X1,X2…………..Xn)
Where, Qd –quantity demanded
P –price
X1,X2………..Xn –other determinants of demand
In economics ,a very simple statement of demand function is adopted
where all variables, that determine demand are held to be
constant ,expect for price.
So demand function is denoted as
Dx= f(Px)
this denotes that demand for commodity x is the
function
of its price.

Demand Equation
A linear demand function may be stated as
D = a – bP
Where, D –amount demanded
a - is a constant parameter which signifies
initial price
irrespective of price
b- denotes functional relationship b/w (P)
&(D)
 b – having a minus sign denotes a negative function, ie; demand
for a commodity is a decreasing function of its price.
To illustrate a demand equation & the computation of demand schedule
assuming estimated demand functions, as Dx = 20 - 2Px, where
Dx = Amount demanded for the commodity X
Px = Price of X
Suppose, the given prices per unit of the commodity X are: Rs.1,2,3,4 and 5
alternatively.
In relation to these prices, a demand schedule may be constructed as below

Demand schedule for commodity X

Price per unit Rs. (Px) Units Demanded (Dx)

1 18
2 16
3 14
4 12
5 10
LAW OF DEMAND
The law of demand expresses the nature of functional
relationship b/w two variables of the demand relation viz; the
price and the quantity demanded.
It simply states that demand varies inversely to change in price.
Statement of law of demand
Ceteris paribus, the higher the price of a commodity the
smaller is the quantity demanded and lower the price ,larger
the quantity demanded
Other things remaining unchanged ,demand varies inversely
with price

so, D= f (P)
 Price of commodity X Quantity demanded
(in Rs) (units per week)
5 100
4 200
3 300
2 400
1 500

The schedule for commodity X, as price falls demand raises so there is an inverse
relationship b/w price and quantity demanded.
Assumptions of law of demand
The law of demand is based on certain assumptions
• No change in consumer’s income
• No change in consumer’s preferences
• No change in fashion
• No change in the price of related goods
• No expectation of future price changes or shortages
• No change in government policy etc.
Exceptions to the law of demand
The upward sloping curve is contrary to the law of demand, where there is
a direct relationship b/w price and demand (as shown in fig-2)
These exceptional cases can be listed as
• Giffen goods : In the case of certain inferior goods called Giffen
goods(named after Sir Robert Giffen), in spite of price rise, demand will
also rise. It was seen in Ireland in 19th . Century people were so poor
that they spent a major part of income on potatoes and a small part on
meat, as price of potatoes, rose the demand also rose since they could
not substitute it for meat which was very expensive. Giffen’s paradox is
seen the case of inferior goods like potatoes, cheap bread etc.
• Speculation : when people speculate about prices on the commodity in
the future they may not act according to the laws of demand.
Speculating the prices of the commodity will further increase they will
demand more of the commodity for hoarding etc. In the stock market,
people tend to buy more shares when prices are rising in the hope of bull
runs in anticipation of future profits.
• Article of snob appeal : Certain commodities are demanded
because they happen to be expensive or prestige goods or
snob value having a status symbol. So increase in price will
lead to increase in demand for such goods. E.g.
Diamonds ,exclusive cars etc.
• Consumer psychological Bias: when a customer is wrongly
biased against quality of a commodity a fall in price may
not lead to an increase in demand example clearance of
stock , discounted sale , etc.
 Extension and contraction of demand

• A variation in demand implies extension or contraction of demand.

A change in demand due to change in price is called extension or
contraction of demand.
• It is a movement along the same demand curve due to changes in
price.
• In the following diagram , demand increases from a to b and then
decreases to point c indicating various changes to demand due to
price change.
 Increase and decrease in demand
Changes in demand are a result of the change in the conditions /
factors determining demand other than price.
Change in demand thus implies an increase or decrease in
demand with price remaining constant.
An increase /decrease signifies either more or less will be
demanded at a given price. This is represented graphically by
movement of the demand curve upwards (in case of increase in
demand) and downward movement of demand curve incase of
decrease in demand.
Reasons for change in Demand:
 Changes in income
 Changes in taste, habits and preferences
 Change in distribution of wealth and population
 Change in demand of complimentary / substitute goods
 Change in tax structure
 Change in value of money
 Effect of advertisement and publicity
 Network externalities in market demand
It is assumed that individual demands are independent so the
market demand function is obtained simply by summing all
individual buyers’ demand
Individual demand maybe interdependent on the demands of
other buyers in the case of some goods, this situation is
described as ‘network externalities’.
• Bandwagon Effect
• Veblen Effect

Bandwagon Effect
The demand for certain goods are determined not
by their usefulness/utility but mostly on account of the
bandwagon/ demonstration effect.
The demand of individuals is conditioned by the
consumption of others in the community (trendsetters/film
stars/models/friends/etc)
 The figure shows the bandwagon effect and how due to this
the demand curve shifts to the right

The initial demand curve is DD based on the utility of the

product, in this case if there is a price cut to the extent of
PP ,due to the price reduction the quantity demanded will
1

increase to QQ in the absence of bandwagon effect.

1

The marketing strategy is to create a bandwagon effect for

these goods through the media- advertising, fashion shows,
promotional drives etc.
It amounts to manipulating the market demand ,to create
demand for a product. Examples- Branded jeans, branded
shoes, Barbie dolls, new released music CD’s
This effect is associated with crazes ,fads and stylishness of
people as more people are drawn to use the product due to
the demonstration effect.
Veblen Effect
The snob effect refers to the desire of a person (usually rich
people) to own exclusive or unique product – Veblen goods/snob
good
These goods serve as a status symbol ,so the supplier has to
restrict its supply so as to maintain its exclusivity .
According to Torstein Veblen the rich class demonstrate their
superior of ‘high class’ by spending on prestige goods like
diamonds, antiques, rare paintings limited edition cars etc.
In this case if the price of the goods increase the snob value
increases so demand also increases ,if prices fall the snob value
decreases so the demand from the affluent class decreases.
A snob good loses its appeal once it is no longer exclusive ,and it
becomes a commonly used product.
The Veblen effect is of snob appeal is exploited in certain industries
like in the airlines industry- the business class fares. In the 5-star
hotels the special rates for the suites/deluxe rooms
Veblen Effect Paradox
The figure explains the concept of an inherent paradox in the so called
snob goods
Some goods are initially sold as exclusive goods for the rich strata of
society, so its adheres to the Veblen effect ie; at high prices there is
a limited ,but high demand from the richer section of the buyers
Once these goods are massed produced, their prices fall and they
start appealing to the higher middle class groups, while the rich will
switch to more exclusive brands.
Any further increase in output will lead to further price reduction ,but
at this price demand tends to fall on account of the loss of
exclusivity. At any point below this price the product will be bought
on account of its functional utility
So in the case of Veblen Paradox, the demand curve is Z –shaped
In the diagram, DD has changing slopes at pt a & b
At P1 demand is Q1 when price is lowered to P2 demandQ3 if price is
lowered to P3,demand drops to Q2 as brand loses its exclusivity after
this point the demand depends on the utility of the product
Types of demand
The demand behavior of the consumer differs with different types of demand
in the study of managerial economics it is important to distinguish these
types of demand
• Demand for consumers’ goods and producers’ goods
Goods /services that are demanded by the consumer for direct
satisfaction of their wants ie; for consumption purpose- food, clothes,
services of doctors ,maids, teachers
Goods that demanded by producers in the process of production are called
production goods eg; tools and equipment, machinery, raw material,
factory building, offices
Demand for consumer goods is direct /autonomous ,whereas demand for
producer goods is derived ie; based on demand for output
Demand for consumer goods is based on marginal utility, whereas the
demand for producer goods is based on marginal productivity of the
factors of production
Dean (1976) explained this distinctive demand behavior for
producer goods in the economy.
Buyers of producers goods are professionals /experts, so they
are less likely to be influenced by sales promotion.
Producer buyers are more sensitive to factor price differences
and substitutes. The motive of the producers are purely
economic and capital goods are bought on account of profit
prospective. The demand of producers goods is derived from
consumption demand, so there are frequent fluctuations in
demand levels.
• Demand for perishable and durable goods:
Perishable goods have no durability , they cannot be stored for
a long period of time eg. Fish, egg, vegetables etc.
Durable good have a long shelf life and can be stored example
furniture , car etc.
Perishable goods give a one shot service whereas durable goods
can be used for several years.
Demand for perishable goods depends on convenience, style & income of the
consumer. This demand is always immediate.
Demand for durable goods depends on product design, current trends, income
levels, price etc. this demand is postponable.
• Autonomous and derived demand:
Spontaneous demand for goods is based on a urge to satisfy some want
directly, such a demand is called Autonomous demand. Demand for consumer
goods is autonomous. It is a direct demand, it is a final demand .
“When the demand of the product depends on the demand of some other
product, it is called derived demand. When the demand of the product is tied to
the purchase of some parent product its demand is called derived”(Dean 1976).
Eg. Demand for doors derived from demand from houses., demand for bulbs
derive from demand for lamps.
Demand for dependent product is caused by complementary consumption.
Example demand for sugar emerges from demand for tea.
Demand for all capital goods are derived. Nowadays it is rare to see demand
for goods to be wholly dependent of all other demands. Most demands are
derived demands.
Example demand for car by an individual is derived from
demand of transportation service.
This distinction between two types of demand is a matter of
degree.

• Industry demand and firm / company demand :

A firm is a business unit , where as industry is a group of
closely competitive firms.
A firms/company’s demand relates to the market demand for
the firm’s output. An industry’s refers to the to the total
demand for a commodity produced by a particular industry
eg; Car industry, Sugar industry etc.
The basic relationship of a firm’s demand and industry/market
depends on the market structure whether perfect
competition, monopoly or monopolistic competition. The
elasticity of the demand curve will vary accordingly.
• Short run demand and Long run demand
“Short run demand refers to existing demand with its immediate reaction to price
changes ,income fluctuations etc., whereas long run demand is that which will ultimately
exist as a result of the changes in pricing, promotion or product improvement ,after time
is allowed to let market adjust itself to the new situations” (Dean 1976)

Y In the short run the demand is not elastic

(not very responsive to change) due to the
following reasons
D’ * Cultural lags in information/experience
D X * Capital investment required of buyers
to shift consumption patterns
*Time adjustment involved-to change consumption patterns, habits, arrange for finance.
• Joint demand and composite demand
There are certain commodities the demand for which are
interrelated. There are two types of interrelationships for
such commodities.
(1)Joint or complimentary: two goods that are demanded in
conjunction with one another at the same time to satisfy
the same want, such goods are said to be complimentary in
nature. Eg. Bread / butter, cars/fuel, pen/ink, key/lock.
(2)Composite demand: A commodity is said to be in composite
demand when it is wanted for several different uses. Eg.
Steel needed for cars, building,railways etc., Coal for
factories, railways etc., wool for carpet, clothing etc.,
electricity for tv, radio etc. sugar for sweets, preservatives
etc.
A change in demand for the commodity by one user will
affect its supplies to others and will bring about a change in
its price and hence alter its demand pattern
Price demand, income demand, and cross demand.
Price demand refers to the various quantities of a product purchased by a
consumer at alternate prices
D= f (p)
where D-demand, f-functional relationship p- price of product

Income demand refers to various quantities of a commodity demanded

by the consumer at alternative levels of changing money income
D = f (M) Where M –income varible

Cross demand refers to the various quantities of a commodity (X)

purchased by a consumer in relation to changes in price of a related
commodity(Y), which maybe a substitute/complimentary product

D x = f (P y)
Where Dx –demand for X and Py –price of commodity Y