In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given period of time. The relationship between price and quantity demanded is also known as the demand curve. Preferences which underlie demand, are influenced by cost, benefit, odds and other variables.
Factors influencing demand
Innumerable factors and circumstances affect a buyer’s willingness or ability to buy a good. Some of the common factors are:
Good’s own price: The basic demand relationship is between potential prices of a good and the quantities that would be purchased at those prices. Generally the relationship is negative meaning that an increase in price will induce a decrease in the quantity demanded. This negative relationship is embodied in the downward slope of the consumer demand curve. The assumption of a negative relationship is reasonable and intuitive. For example, if the price of a gallon of milk rose from $5 to a price of $15, this is a big price increase. This significant price increase causes the consumer to demand less of that product at the price of $15 because not only is it more expensive, but the new price is very unreasonable for a gallon of milk.
Price of related goods: The principal related goods are complements and substitutes. A complement is a good that is used with the primary good. Examples include hotdogs and mustard, beer and pretzels, automobiles and gasoline. (Perfect complements behave as a single good.) If the price of the complement goes up the quantity demanded of the other good goes down.
Mathematically, the variable representing the price of the complementary good would have a negative coefficient in the demand function. For example, Qd = a – P – Pg where Q is the quantity of automobiles demanded, P is the price of automobiles and Pg is the price of gasoline. The other main category of related goods are substitutes. Substitutes are goods that can be used in place of the primary good. The mathematical relationship between the price of the substitute and the demand for the good in question is positive. If the price of the substitute goes down the demand for the good in question goes down.
Personal Disposable Income: In most cases, the more disposable income (income after tax and receipt of benefits) a person has, the more likely that person is to buy.
Tastes or preferences: The greater the desire to own a good the more likely one is to buy the good. There is a basic distinction between desire and demand. Desire is a measure of the willingness to buy a good based on its intrinsic qualities. Demand is the willingness and ability to put one’s desires into effect. It is assumed that tastes and preferences are relatively constant.
Consumer expectations about future prices, income and availability: If a consumer believes that the price of the good will be higher in the future, he/she is more likely to purchase the good now. If the consumer expects that his/her income will be higher in the future, the consumer may buy the good now. Availability (supply side) as well as predicted or expected availability also affects both price and demand.
Population: If the population grows this means that demand will also increase.
Nature of the good: If the good is a basic commodity, it will lead to a higher demand
This list is not exhaustive. All facts and circumstances that a buyer finds relevant to his willingness or ability to buy goods can affect demand. For example, a person caught in an unexpected storm is more likely to buy an umbrella than if the weather were bright and sunny.
Demand function and equation and curve
The demand equation is the mathematical expression of the relationship between the quantity of a good demanded and those factors that affect the willingness and ability of a consumer to buy the good. For example, Qd = f(P; Prg, Y) is a demand equation where Qd is the quantity of a good demanded, P is the price of the good, Prg is the price of a related good, and Y is income; the function on the right side of the equation is called the demand function. The semi-colon in the list of arguments in the demand function means that the variables to the right are being held constant as one plots the demand curve in (quantity, price) space. A simple example of a demand equation is Qd = 325 – P – 30Prg + 1.4Y. Here 325 is the repository of all relevant non-specified factors that affect demand for the product. P is the price of the good. The coefficient is negative in accordance with the law of demand. The related good may be either a complement or a substitute. If it is a complement, the coefficient of its price would be negative as in this example. If it is a substitute, the coefficient of its price would be positive. Income, Y, has a positive coefficient indicating that the good is a normal good. If the coefficient was negative the good in question would be an inferior good meaning that the demand for the good would fall as the consumer’s income increased. Specifying values for the non price determinants, Prg = 4.00 and Y = 50, results in the demand equation Q = 325 – P – 30(4) +1.4(50) or Q = 275 – P. If income were to increase to 55 the new demand equation would be Q = 282 – P. Graphically this change in a non price determinant of demand would be reflected in an outward shift of the demand function caused by a change in the x intercept.
In economics the demand curve is the graphical representation of the relationship between the price and the quantity that consumers are willing to purchase. The curve shows how the price of a commodity or service changes as the quantity demanded increases. Every point on the curve is an amount of consumer demand and the corresponding market price. The graph shows the law of demand, which states that people will buy less of something if the price goes up and vice versa.
Price elasticity of demand (PED)
Main article: Price elasticity of demand
PED is a measure of the sensitivity of the quantity variable, Q, to changes in the price variable, P. Elasticity answers the question of the percent by which the quantity demanded will change relative to (divided by) a given percentage change in the price. For infinitesimal changes the formula for calculating PED is the absolute value of (∂Q/∂P)×(P/Q).
Elasticity along linear demand curve
The slope of a linear demand curve is constant. The elasticity of demand changes continuously as one moves down the demand curve because the ratio of price to quantity continuously falls. At the point the demand curve intersects the y-axis PED is infinitely elastic, because the variable Q appearing in the denominator of the elasticity formula is zero there. At the point the demand curve intersects the x-axis PED is zero, because the variable P appearing in the numerator of the elasticity formula is zero there. At one point on the demand curve PED is unitary elastic: PED equals one. Above the point of unitary elasticity is the elastic range of the demand curve (meaning that the elasticity is greater than one). Below is the inelastic range, in which the elasticity is less than one. The decline in elasticity as one moves down the curve is due to the falling P/Q ratio.
Perfectly inelastic demand
Perfectly inelastic demand is represented by a vertical demand curve. Under perfect price inelasticity of demand, the price has no effect on the quantity demanded. The demand for the good remains the same regardless of how low or high the price. Goods with (nearly) perfectly inelastic demand are typically goods with no substitutes. For instance, insulin is nearly perfectly inelastic. Diabetics need insulin to survive so a change in price would not effect the quantity demanded.
Market structure and the demand curve
In perfectly competitive markets the demand curve, the average revenue curve, and the marginal revenue curve all coincide and are horizontal at the market-given price. The demand curve is perfectly elastic and coincides with the average and marginal revenue curves. Economic actors are price-takers. Perfectly competitive firms have zero market power; that is, they have no ability to affect the terms and conditions of exchange. A perfectly competitive firm’s decisions are limited to whether to produce and if so, how much. In less than perfectly competitive markets the demand curve is negatively sloped and there is a separate marginal revenue curve. A firm in a less than perfectly competitive market is a price-setter. The firm can decide how much to produce or what price to charge. In deciding one variable the firm is necessarily determining the other variable
Inverse demand function
In its standard form a linear demand equation is Q = a – bP. That is, quantity demanded is a function of price. The inverse demand equation, or price equation, treats price as a function g of quantity demanded: P = f(Q). To compute the inverse demand equation, simply solve for P from the demand equation. For example, if the demand equation is Q = 240 – 2P then the inverse demand equation would be P = 120 – .5Q, the right side of which is the inverse demand function.
The inverse demand function is useful in deriving the total and marginal revenue functions. Total revenue equals price, P, times quantity, Q, or TR = P×Q. Multiply the inverse demand function by Q to derive the total revenue function: TR = (120 – .5Q) × Q = 120Q – 0.5Q². The marginal revenue function is the first derivative of the total revenue function; here MR = 120 – Q. Note that the MR function has the same y-intercept as the inverse demand function in this linear example; the x-intercept of the MR function is one-half the value of that of the demand function, and the slope of the MR function is twice that of the inverse demand function. This relationship holds true for all linear demand equations. The importance of being able to quickly calculate MR is that the profit-maximizing condition for firms regardless of market structure is to produce where marginal revenue equals marginal cost (MC). To derive MC the first derivative of the total cost function is taken. For example, assume cost, C, equals 420 + 60Q + Q2. Then MC = 60 + 2Q. Equating MR to MC and solving for Q gives Q = 20. So 20 is the profit maximizing quantity: to find the profit-maximizing price simply plug the value of Q into the inverse demand equation and solve for P.
Residual demand curve
The demand curve facing a particular firm is called the residual demand curve. The residual demand curve is the market demand that is not met by other firms in the industry at a given price. The residual demand curve is the market demand curve D(p), minus the supply of other organizations, So(p): Dr(p) = D(p) – So(p )
Demand Function and Total Revenue
If the demand curve is linear, then it has the form: p = a – b*q, where p is the price of the good and q is the quantity demanded. The intercept of the curve and the vertical axis is represented by a, meaning the price when no quantity demanded. and b is the slope of the demand function. If the demand function has the form like that, then the Total Revenue should equal quantity demanded times the price of the good, which can be represented by: TR= q*p = q(a-bq).
Is the demand curve for PC firm really flat?
Practically every introductory microeconomics text describes the demand curve facing a perfectly competitive firm as being flat or horizontal. A horizontal demand curve is perfectly elastic. If there are n identical firms in the market then the elasticity of demand PED facing any one firm is
PEDmi = nPEDm – (n – 1) PES
where PEDm is the market elasticity of demand, PES is the elasticity of supply of each of the other firms, and (n -1) is the number of other firms. This formula suggests two things. The demand curve is not perfectly elastic and if there are a large number of firms in the industry the elasticity of demand for any individual firm will be extremely high and the demand curve facing the firm will be nearly flat.
For example, assume that there are 80 firms in the industry and that the demand elasticity for industry is -1.0 and the price elasticity of supply is 3. Then
PEDmi = (80 x (-1)) – (79 x 3) = -80 – 237 = -317
That is the firm PED is 317 times as elastic as the market PED. If a firm raised its price “by one tenth of one percent demand would drop by nearly one third.” if the firm raised its price by three tenths of one percent the quantity demanded would drop by nearly 100%. Three tenths of one percent marks the effective range of pricing power the firm has because any attempt to raise prices by a higher percentage will effectively reduce quantity demanded to zero.
Demand management in economics
Demand management in economics is the art or science of controlling economic or aggregate demand to avoid a recession. Such management is inspired by Keynesian macroeconomics, and Keynesian economics is sometimes referred to as demand-side economics.
Different types of goods demand
Negative demand: If the market response to a product is negative, it shows that people are not aware of the features of the service and the benefits offered. Under such circumstances, the marketing unit of a service firm has to understand the psyche of the potential buyers and find out the prime reason for the rejection of the service. For example: if passengers refuse a bus conductor’s call to board the bus. The service firm has to come up with an appropriate strategy to remove the misunderstandings of the potential buyers. A strategy needs to be designed to transform the negative demand into a positive demand.
No demand: If people are unaware, have insufficient information about a service or due to the consumer’s indifference this type of a demand situation could occur. The marketing unit of the firm should focus on promotional campaigns and communicating reasons for potential customers to use the firm’s services. Service differentiation is one of the popular strategies used to compete in a no demand situation in the market.
Latent demand: At any given time it is impossible to have a set of services that offer total satisfaction to all the needs and wants of society. In the market there exists a gap between desirables and the availables. There is always a search on for better and newer offers to fill the gap between desirability and availability. Latent demand is a phenomenon of any economy at any given time, it should be looked upon as a business opportunity by service firms and they should orient themselves to identify and exploit such opportunities at the right time. For example, a passenger traveling in an ordinary bus dreams of traveling in a luxury bus. Therefore, latent demand is nothing but the gap between desirability and availability.
Seasonal demand:Some services do not have an all year round demand, they might be required only at a certain period of time. Seasons all over the world are very diverse. Seasonal demands create many problems to service organizations, such as:- idling the capacity, fixed cost and excess expenditure on marketing and promotions. Strategies used by firms to overcome this hurdle are like – to nurture the service consumption habit of customers so as to make the demand unseasonal, or other than that firms recognize markets elsewhere in the world during the off-season period. Hence, this presents and opportunity to target different markets with the appropriate season in different parts of the world. For example, the need for Christmas cards comes around once a year. Or the, seasonal fruits in a country.
Demand patterns need to be studied in different segments of the market. Service organizations need to constantly study changing demands related to their service offerings over various time periods. They have to develop a system to chart these demand fluctuations, which helps them in predicting the demand cycles. Demands do fluctuate randomly, therefore, they should be followed on a daily, weekly or a monthly basis.
- F. Schumacher challenges the prevailing economic assumption that fulfilling demand is the purpose of economic activity, offering a framework of what he calls “Buddhist economics” in which wise demands, fulfilling genuine human needs, are distinguished from unwise demands, arising from the five intellectual impairments recognized by Buddhism:
The cultivation and expansion of needs is the antithesis of wisdom. It is also the antithesis of freedom and peace. Every increase of needs tends to increase one’s dependence on outside forces over which one cannot have control, and therefore increases existential fear. Only by a reduction of needs can one promote a genuine reduction in those tensions which are the ultimate causes of strife and war.
Demand reduction refers to efforts aimed at reducing the public desire for illegal and illicit drugs. The drug policy is in contrast to the reduction of drug supply, but the two policies are often implemented together.
In energy conservation
Energy demand management, also known as demand-side management (DSM) or demand-side response (DSR), is the modification of consumer demand for energy through various methods such as financial incentives and behavioral change through education.
- ^O’Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey: Pearson Prentice Hall. p. 79. ISBN 9780131334830.
- ^Colander, David C. Microeconomics 7th ed. pp. 132–133. McGraw-Hill 2008.
- ^The perfectly competitive firm’s demand curve is not in fact flat. However, if there are numerous firms in the industry the demand curve of an individual firm is likely to be extremely elastic, for a discussion of residual demand curves see Perloff (2008) at pp. 245–246.
- ^The form of the inverse linear demand equation is P = a/b – 1/bQ.
- ^Samuelson, W & Marks, S. Managerial Economics 4th ed. p. 37. Wiley 2003.
- ^ Jump up to:ab c Perloff, Jeffrey M. (2008). Microeconomics. pp. 243–246.
- ^ F. Schumacher, “Buddhist Economics,” in Asia: A Handbook, Guy Wint, ed., (London: 1966).
- ^ F. Schumacher, Small is Beautiful(1973), p. 31.
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder of TBIL.co STATX Fund.