ECONOMICS 1

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 t have
demand
the consume must possess 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.
The amount of a product that consumers wish to purchase is called the
quantity demanded. Quantity demanded is a desired quantity. It is how much
consumer’s wish to purchase, not necessarily how much they actually succeed in
purchasing.

Demand function:

An equation which shows the mathematical relationship between the quantity

demanded of a good and the values of the various determinants of demand. Demand
function is an algebraic expression of the demand schedule expressed either in general
terms or with specific numerical values expressed for the various parameters, and
usually including all factors affecting demand. In other words demand function shows
the functional relationship between quantity demanded of a commodity and the
factors influence the demand for that commodity. The demand function can be
expressed as

Q XD = ( Px, P1 ------Pn, Y, T, S)

Where
Q XD = Quantity demanded X (X=any commodity)
Px = Price of X
P1----Pn = Prices of related commodities
Y = Consumer’s income and wealth.
T = Consumer’s taste
S = Various sociological factors.

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Demand schedule and demand curve:

A demand schedule is one way of showing the relationship between quantity
demanded and price. It is a numerical tabulation that lists some selected prices and
shows the quantity that will be demanded at each.
The following table is an individuals hypothetical demand schedule for
carrots. It shows the quantity of carrots that the individual would demand at six
selected prices.
An individual consumer’s demand schedule for carrots:

Reference letter Price (Tk per kg) Quantity demanded

(Kg per month)
A 1 80
B 2 60
C 3 40
D 4 30
E 5 20
F 6 10

For example, at price Tk 4 per kg, the quantity demanded is 30 kg per month. Each of
the price-quantity combination in the table is given a letter for easy references.
Demand curve: A graph showing the relationship between the price of a good and
the quantity of the good demanded over a given time period. Price is measured on the
vertical axis; quantity demanded is measured on the horizontal axis. On the other
hand, a demand curve is the graphical representation of the demand schedule.

6 F

5 E

D
Price

4
C
3
B
2
A
1
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10 20 30 40 50 60 70 80

Quantity demanded
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The above curve shows the quantity of carrots that the consumer would like to buy at
every possible price; Its negative slope indicates that the quantity demanded increases
as the price falls.
A single point on the demand curve indicates a single price-quantity relation.
The whole demand curve shows the complete relation between quantity demanded
and price.
Law of demand:
A basic economic hypothesis is that the lower the price of a product, the larger
the quantity that will be demanded, other things being equal.
The quantity of a good demanded per period of time will fall as price rises and
will rise as price falls, other things being equal. (ceteris paribus)

Determinations of demand:

Factors which determine the level of demand for any commodity are as follows:

1. Price: The higher the price of a commodity the lower the quantity demanded.
The lower the price the higher the quantity demanded.
2. Taste: The more desirable people find the good, the more they will demand.
Tastes are affected by advertising, by fashion, by observing other consumers,
by considerations of health and by the experience from consuming the good on
previous occasions.
3. The number and price of substitute goods: The higher the price of substitute
goods. the higher will be the demand for this good, as people switch from the
substitutes. For example the demand for tea will depend upon the price of
coffer. If the price of coffee goes up the demand for tea will rise.
4. The number and price of complementary goods: Complementary goods are
those that are consumed together: Cars and petrol, shoes and polish, fish and
chips. The higher the price of complementary goods, the fewer of them will be
bought and hence the less will be the demand for these goods. For example,
the demand for matches will depend on the price of cigarettes. If the price of
cigarettes goes up, so that fewer are bought, the demand for matches will fall.

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5. Income: As people’s income rise, their demand for most goods will rise. Such
goods are called normal goods. As people get richer, they spend less on
inferior goods, such as cheap margarine, and switch to better quality goods.
A rise in consumer’s income shifts the demand curve for normal products to
the right and for inferior goods to the lift.
6. Distribution of income: If national income were redistributed from the poor
to the rich, the demand for luxury goods will rise. At the same time, as the
poor got poorer, they might have to turn to buying inferior goods, whose
demand would thus rise too.
7. Expectation of future price change: If people think that prices are going to
rise in the future, they are likely to buy more now before the price does go up.
8. Advertising: Advertising is a powerful instrument affecting demand in many
markets. In highly competitive markets, a successful advertising campaign
will move the products demand curve to the right.
9. The availability of credit: If developed countries the demand for many
durable consumer goods depend very much on the provision of credit
facilities. Any changes in the terms on which this type of finance can be
obtained will have a marked effect on the demand for such things as motor
cars, electrical appliances, furniture, and other types of household equipment.
A similar situation applies in the housing market since the overwhelming
majority of houses purchased with borrowed funds.
10. Changes in population: The influence of this factor is of a longer term nature
unless the change comes about by large-scale migration. Changes in the total
population and changes in the age distribution will affect both the total
demand for goods and services and the composition of that demand. For
instance, a fall in the death rate will increase demand for residential homes, for
greater health care for the elderly, etc.

11. Sociological variables: Changes in the many sociological variables that

influence demand will cause demand curve to shift. For example, a reduction
in the typical number of children per consumer, as happened in this century,
will reduce the demands for many of the things used by children. If the typical
age of retirement falls significantly, there will be a rise in the demands for

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goods consumed during leisure time and a fall in the demands for goods
required while working.

Shifts in the demand curve:

An increase in demand means that the whole demand curve has shifted to the
right; A decrease in demand means that the whole demand curve has shifted to the
left.

D1
Do
D2
Price

O
Quantity

A shift in the demand curve from Do to D1 indicates an increase in demand, a shift

from Do to D2 indicates a decrease in demand.
An increase in demand means that more is demanded at each price. Such a rightward
shift can be cause by
1. a rise in the price of a substitute
2. a fall in the price of a complement
3. i) a rise in income, for normal goods
ii) income declines, for inferior goods,
4. a redistribution of income toward groups who favor the commodity.
5. a change in taste that favors the commodity.
6. The number of buyers increases.
7. Income or price expectation decreases.

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A decrease in demand means that less is demanded at each price. Such a leftward shift
can be caused by
(1) a fall in the price of a substitute
(2) a rise in the price of a complement.
(3) i) a fall in income, for normal goods
ii) a rise in income for inferior goods
(4) a distribution of income away from groups who favor the commodity.
(5) a change in taste that disfavors the commodity.
(6) the number of buyers decreases.
(7) income or price expectations increases.

Change in quantity demanded:

Movements along a demand curve can be referred to as extensions and contractions in
demand or changes in quantity demanded.
Price

A
P
B
P1

O Q Q1 Quantity demanded

In the above figure an extension in demand from OQ to OQ1, results from a decrease
in price from OP to OP1. This can also be referred to as an increase in the quantity
demanded.
Price

P1
A
P

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O
Q1 Q
Quantity demanded
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The above figure shows a contraction in demand from OQ to OQ 1 due to rise in price
from OP to OP1.
A movement down a demand curve is called an increase in the quantity
demanded. a movement up the demand curve is called a decrease in the quantity
demanded.

Movements along demand curves versus shifts:

P3
Price

P2 C
A B
Po

D1
Do

O q3 qo q2 q1
Quantity

A rise in demand means that more will be bought at each price, but it does not mean
that more will be bought under all circumstance. The demand curve is originally D o
and price is Po, at which qo is bought (Point A). Demand then increase to D1. At the
old price of Po, the quantity demanded in now q1 (Point B). Assume that, the price
rises to above Po. This causes the quantity demanded to be reduced to below q 1. The
net effect of these two shifts can be either an increase or decrease in the quantity
demanded. If the price rises to P2, the quantity demanded of q2 still exceeds the
original quantity qo (point C); while a rise in price to P3 leaves the final quantity of q3
(Point D) below the original quantity of qo.

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

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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 in 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
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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 hut 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 people will use power for cooking, fans, lighting,
but if the charges are reduced, people will use power cooking, fans, heaters, etc.

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.
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 less. This is because of the lack of purchasing power with
consumers.
(iii) Habit: if someone is habituated in consuming any commodity and the price
of that product goes up, he doesn’t reduce the consumption.
(iv) Gffen 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

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consume more of it. The Marshallian example is applicable to developed economies.

It the case of an underdeveloped economy, 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 Gffen Paradox which makes the demand curve to have a positive
slope.
(v) Demonstration Effect. If consumers are affected 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.
(vi) 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.

(vii) Speculation. Marshall mentions speculation as one of the important

exceptions to the downward sloping demand 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.
(viii) Very rich people: Law of demand does not work for the very rich people
because he can purchase whatever he wants. A millionaire doesn’t have any effect on
the increase in the price rice or any commodity

Market demand:

The market demand for a commodity gives the alternative amounts of the
commodity demanded per time period, at various alternative prices, by all the
individuals in the market. The market demand for a commodity thus depends on all
the factors that determine the individuals demand and in addition, on the number of
buyers of the commodity in the market. Geometrically the market demand curve for a
commodity is obtained by the horizontal summation of all the individuals demand
curves for the commodity.
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Suppose there are three individuals A, B and C in a market who purchase the
commodity. The demand schedule for the commodity in depicted in the following
table.

Market demand schedule:

Prices per Quantity demanded (Per unit of time)

kg (Tk) Individual A Individual B Individual C Total Demand
(1) (2) (3) (4) (5)
6 9 18 30 57
5 10 20 32 62
4 12 24 36 72
3 16 30 45 91
2 22 40 60 122
1 30 60 110 200

The last column (5) of the table represents the market demand of the commodity at
various prices. It is arrived at by adding columns (2), (3) and (4) representing the
demand of consumer A, B and C respectively. The relation between column (1) and
(5) shows the market demand schedules. When the price is 6tk per kg then the market
demand for the commodity is 57 kgs. As price falls demand increases. When the price
is 1 Tk per kg the market demand is 200 kgs. This is shown in figure below.

6 . . . .
. . . .
5
4 . . . .
3 . . . .
2 . . . .
1 .D .D
A
. D
B C
.D X =DA+ DB +DC

. . . . . . . . . .
0 20 40 60 80 100 120 140 160 180 200
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Demand equations:
We can represent the market demand for a good and the determinants of
demand in the form of an equation. This is called a demand function.
Demand equations are often used to relate quantity demanded to just one
determinant. Thus an equation relating quantity demanded to price could be in the
form: Qd = a – bP
For example, the actual equation might be for commodity X is –
Q XD = 8 − PX , (ceteris paribus.)
By substituting various prices of X into this demand function we get individuals
demand schedule shown in table below

PX 8 7 6 5 4 3 2 1 0
QXD 0 1 2 3 4 5 6 7 8
Plotting each pair of values as a point on a graph and joining the resulting points, we
get the individuals demand curve for commodity X. as shown in figure below.

PX

0 8 QX

If there are 1000 identical individuals in the market each with the demand for
commodity x given by Q dX = 8 − PX ceteris paribus, the market demand schedule and

the market demand curve for commodity X are obtained as follows.

Q dX = 8 − PX cet. par. (individual’s dx)

QDx = 1000 ( QDX ) cet. par. (Market DX)

QDx = 8000-1000 Px

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PX 8 7 6 5 4 3 2 1 0
QXD 0 1000 2000 3000 4000 5000 6000 7000 8000

PX

0 400 800 QXD

Estimated demand equations:

Using statistical techniques called regression analysis, a demand equation can
be estimated. Assume that the demand for butter (measured in 250g units) depended
on its price (Pb), the price of margarine (Pm) and total annual consumer income (Y).
The estimated weekly demand equation may than be something like.
Qd = 2000000 − 50000 Pb + 20,000 Pm 0.01 Y
If price of butter were 50 p, the price of margarine were 35 p and consumer income
were α 200 million and Pb and Pm were measured in pence and Y were measured in
pounds. then the demand for butter would be
Qd = 2000000 − (50000  50) + (20,000  35) + 0.01 20000000
= 2000000 − 2500000 + 700000 + 2000000
= 2200000

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Demand for butter:

Let us look at how the demand for butter is affected by the other factors –
 taste: if it is heavily advertised, demand is likely to rise, on the other hand, if there
is a cholesterol scarce people may demand less for health reason.
 Substitute: If the price of margarine goes up, the demand fro butter is likely to rise
as people switch from one to other.
 Complement: If the price of bread goes up, people will buy less bread and hence
less butter to spread on it.
 Income: if peoples income rises, they may well turn to consuming butter rather
than margarine or feel that they can afford to spread butter more thickly on bread.
 Income distribution: If income is redistributed away from the poor, they may have
to give up consuming butter and buy cheaper margarine instead, or simply buy less
butter and be more economical with the amount they use.
 Expectation: if it is announced in the news that butter prices are expected to rise in
the near future, people are likely to buy more now and stock up their freezer while
current prices last.

A real-world demand function:

The following is an estimate of the UK’s market demand curve for butter. It
has been estimated from actual data for the years 1969-91.
Qd = 283.8 – 35.4 Pb + 89.1 Pm – 1.96 Y

Where
Qd = quantity of butter sold in grams per person per week
Pb = real price of butter i.e. the price of butter in pence per kg, divided by the
real
price index (RPI) (1980 = 100)
Y = real personal disposable income of household that other determinants of
demand have not changed. But one of the other factor did change. This was taste –
during 1970s and 1980s there was a massive shift in demand from butter to
margarine,
- perhaps for health reason
- perhaps because of the advent of ‘easy to spread’ margarines.

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- perhaps because of an improvement in the flavour of margarines

The following table shows this shift.
Consumption of butter, margarine and spreads.
(grams per person per week)
Butter Margarine Low-fat spreads
1969 174 79 --
1987 61 113 31
1994 39 43 74

Assuming that this shift in taste took place steadily over time, a new demand equation
was estimated for the same years.
Qd = 321.4 – 38.5 Pb + 16.1 Pm – 0.38 Y – 5.21 TIME
Where the TIME term is as follows: 1969 = 1, 1970 = 2, 1971 = 3 etc.
It mid 1980s a new substitute entered the market: low-fat spreads. These have not
been on the market long enough to estimate a new demand equation, but clearly they
have shifted the demand curve for butter.
* Here they assume that

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