Demand

Meaning of Demand u Demand in economics means a desire to possess a good supported by willingness and ability to pay for it. u If you have a desire to buy a certain commodity, say, a tractor, but do not have the adequate means to pay for it, it will simply be a wish, a desire or a want and not demand.

Demand, cont. Meaning of Demand u In the other words, "Demand means the various quantities of a good that would be purchased per unit of time at different prices in a given market.”

Demand, cont. There are three main characteristics of demand in economics. i. Willingness and ability to pay. u Demand is the amount of a commodity for which a consumer has the willingness and also the ability to buy.

Demand, cont. ii. Demand is always at a price. u If we talk of demand without reference to price, it will be meaningless. The consumer must know both the price and the commodity. He will then be able to tell the quantity demanded by him. iii. Demand is always per unit of time. u The time may be a day, a week, a month, or a year.

Demand, cont. Individual's Demand for a commodity: u The individual’s demand for a commodity is the amount of a commodity which the consumer is willing to purchase at any given price over a specified period of time. u The individual's demand for a commodity varies inversely with price ceteris paribus. As the price of a good rises, other things remaining the same, the quantity demanded decreases and as the price falls, the quantity demanded increases.

Demand, cont. The Market Demand for a Commodity: u The market demand for a commodity is obtained by adding up the total quantity demanded at various prices by all the individuals over a specified period of time in the market.

The Demand Curve Price Quantity demanded per unit of time Demand Curve

Demand, cont. u Two types of demand: 1) Derived demand. Derived demand refers to demand for goods which are needed for further production. It is the demand for producer’s goods like industrial raw material, machine tools and equipment.

Demand, cont. 2) Autonomous demand u Autonomous demand is independent of the other product or main product. It is not linked or tie-up with the other goods or commodity. u eg: food articles, clothes.

Demand, cont. u Price Demand : It refers to various quantities of a good or service that a consumer would be willing to purchase at all possible prices in a given market at a given point in time, ceteris paribus.

Demand, cont. u Income Demand : It refers to various quantities of a good or service that a consumer would be willing to purchase at different levels of income, ceteris paribus.

Demand, cont. u Cross Demand : It refers to various quantities of a good or service that a consumer would be willing to purchase due to changes in the price of related commodity. For example: Demand for pork is more not because price of pork has fallen but because price of beaf has risen. Thus demand for substitutes take the form of cross demand.

Surplus and Shortage u We could have a surplus and still have a scarce commodity, RIGHT?

Surplus

A SURPLUS u P e and Q e represent the market clearing price and quantity. u Assume the government sets a price at P 1 : 1. There is a surplus of goods. 2. Price must fall for the market to clear.

Shortage

A SHORTAGE u Assume the government sets a price at P 2 : 1. There is a shortage of goods. 2. Price must rise for the market to clear.

Law of Demand Principle stating that as the price of a commodity increases, the less consumers will purchase per unit of time, ceteris paribus. As price decreases, the quantity demanded increases per unit of time, ceteris paribus.

Law of Demand  P   Q d   P   Q d

Law of Demand u As price falls from P1 to P2 the quantity demanded increases from Q1 to Q2. This is a negative relation between price and quantity, hence the negative slope of the demand schedule; as predicted by the law of demand.

Change in Demand u Changes in demand for a commodity can be shown through the demand curve in two ways: (1) Movement along the demand curve (Extension and contraction) (2) Shifts of the demand curve (Increase and decrease).

Change in Demand, cont. (1) Movement along the demand curve: u A movement along a demand curve is defined as a change in the quantity demanded due to changes in the price of a good will result in a movement along the demand curve.

Law of Demand

Change in Demand, cont. 2) Shifts in the demand curve: u A shift of the demand curve is referred to as a change in demand due any factor other than price.

Change in Demand, cont. u A demand curve will shift if any of these occurs: 1.Change in the price of other goods (complements and substitutes) 2.Change in the income level 3.Change in consumers’ tastes and preferences…

Determinants of demand u Movements along a demand curve is the result of increase or decrease of the price of the good, while the demand curve shifts when any demand determinant other than price changes.

Determinants of demand u These other determinants, in addition to the commodity's own price are: a. Consumer disposable income. b. Price of substitutes. c. Price of complements. d. Consumer preferences. e. Expectations about the future.

Determinants of demand f. Changes in the population. g. Length of adjustment period. h. Availability of substitutes. i. The proportion of the consumers budget a good or service represent

A. Consumer’s Disposable Income 1. If we increase consumer's disposable income, ceteris paribus, what happens? He/she is able to purchase more at all price levels.

2. The demand curve shifts to the right. Price D 1 D 0 Quantity

3. If we decrease the consumer's disposable income ceteris paribus, what happens ? · The consumer cannot purchase the same amount of the commodity as before, over the entire range of prices.

4. The demand curve is said to shift to the left. Price D 0 D 1 Quantity

5. Associated with this income effect, we can create another sub-classification for commodities:

Normal Goods or Services An Increase in disposable income, shifts Demand curve right.  Id  Demand

Price D 1 D 0 Quantity

Normal Goods or Services A Decrease in disposable income shifts Demand curve left  Id  Demand

Price D 0 D 1 Quantity

Inferior Good or Service An Increase in disposable income shifts curve left.  Id  Demand

Price D 0 D 1 Quantity

Inferior Good or Service A Decrease in disposable income shifts curve right.  Id  Demand

Price D 1 D 0 Quantity

Inferior Good or Service Examples: u potatoes, u and rice

B. Change in the price of substitutes, ceteris paribus: An increase in the price of a substitute will result in an increase in the demand of the commodity of interest (COI) (demand shifts right).

For example, lets look at beef while considering pork as a substitute: Let the quantity of pork available become restricted. What happens? · There is an increase in the price of pork.

Increase in price of pork due to a decrease in Supply of pork: Price S 1 S 0 Pork Market P 1 P 0 D Q 1 Q 0 Qd of pork

There is an increase in the demand for beef (COI) because of the increase in the price of pork (SUBSTITUTE). Price S 0 Beef Market P 1 P 0 D 1 D 0 Q 0 Qd of beef

Substitutes: Therefore, an increase in the price of a substitute will shift the entire demand curve of the commodity of interest to the right.

Substitutes: A decrease in the price of a substitute will shift the entire demand curve of the commodity of interest to the left.

Substitutes  P sub  D COI AND  P sub  D COI

C. Change in the price of a complement, ceteris paribus: Complements are goods that go together, such as: u left and right shoes, u gas and cars, u milk and cereal, u Gasoline and bio-gas u etc.

Compliments: If the price of a complement increases, then the demand for the COI decreases.  P comp    D COI

Compliments: Price Let the price of gasoline increase. Since bio-gas is a complement of gasoline, its demand will decrease. D 0 D 1 Qd

Compliments: If the price of a complement decreases, the demand for the COI increases.  P comp  D COI

Compliments: Price Let the price of gasoline decrease. Since bio-gas is a complement of gasoline, its demand will increase. D 1 D 0 Qd

D. Consumer preferences and taste As preferences change the demand curve will also change. For example: What would be the result of the following statements, if true, on the demand curve for each commodity ?

Animal fat leads to a higher risk of heart attacks. Price Result:  Demand for red meat D 0 D 1 Qd

Increasing fiber in the diet reduces the chance of getting colon cancer. Price D 1 D 0 Quantity / unit of time Result:  Demand for high fiber cereals and popcorn.

E. Expectations about the future The peanut butter scare: a news release said that the peanut crop would be short that year and peanut butter prices were expected to double.

Expectations about the future Result: People bought 3 kg. of peanut butter that month instead of 1 kg.  Demand for peanut butter. Due to Expectations of higher Price.

Since consumers expect prices to increase, they all run out to buy NOW. This causes demand to increase, and prices are pushed up very quickly!

Graphically Speaking: Price $2.00 D 1 D kg. per month

F. Changes in the population of consumers Price D 1 D 0 Quantitiy/unit time Increase in population will result in increase in Demand for G&S.

Changes in the population of consumers Price D 0 D 1 Quantitiy/unit time Decrease in population will result in decrease in Demand for G&S.

G. Length of the Adjustment Period This is tied to, or related to the availability of substitutes. Price Short Run: Consumers have little time to find suitable substitutes. D Quantity per Unit of Time Demand is not very sensitive to price changes, c.p. We say demand is relatively inelastic

Length of the Adjustment Period Price D Quantity Demanded per Unit of Time Long Run: Consumers have time to find suitable substitutes. Demand becomes more sensitive to prices changes as time progresses, c.p. We say demand is relatively elastic.

An Example: Demand for Gasoline If the price of gas increases from $1.20 per gallon to $2.20 per gallon, how will consumers respond? First: Are we asking how consumers will respond over the next day, week, month, year, etc.

It makes a difference! Demand for gas will be different for different time periods The longer the time period considered, the flatter the demand curve becomes; or the more elastic it becomes.

What occurred in the 1970’s? What was a simplified sequence of events that occurred when gas prices at the pump increased so dramatically in the 1970's?

The Sequence of Events: (1) People griped. (2) Car pools formed, and bus usage increased. (3) Big cars were replaced with small ones. (4) Some people moved closer to work. (5) New technology that decreased fuel consumption was developed.

What was the result of this sequence of events on Demand? Price Quantity demanded $1.20 $2.20 Q1Q1 Q0Q0 In Short Run, the very large increase in gas price resulted in a very small decrease in consumption of gasoline. D Consumption of gas will not be very responsive to the increase in price. We say demand is relatively inelastic

As time progressed: Price Quantity demanded $1.20 $2.20 Q1Q1 Q0Q0 In Long Run, consumers have time to find substitutes, and the very large increase in gas price will eventually result in a significant decrease in consumption of gasoline. This of course assumes that consumers perceive the increased price of gas to be persistent, not just a temporary price increase. D

H. The Availability of Substitutes D Price Quantity/unit time If a commodity has FEW substitutes, demand for the commodity will tend to be more inelastic or less responsive to price changes. P0P0 P1P1 Q1Q1 Q0Q0 Demand curve will tend to have a very steep slope.

D Price Qd/unit time If a commodity has MANY substitutes, demand for the commodity will tend to be more elastic or more responsive to price changes. P0P0 P1P1 Q1Q1 Q0Q0 The Availability of Substitutes Demand will tend to have a very flat slope.

I. Proportion of the Consumers Budget a Good or Service Represents D Price Qd/u.t. Salt $.50 $1.00 Q0Q0 Q1Q1 If the price of SALT doubles, how much will this price increase affect the consumption of salt? Why?

Proportion of the Consumers Budget a Good or Service Represents The less of a consumers budget a commodity represents, the more inelastic the demand curve will tend to be. The price of salt is such a small percentage of our budgets, that consumption of salt will not be affected very much by a price increase.

Proportion of the Consumers Budget a Good or Service Represents D Price Qd/u.t. Automobile $20,000 $40,000 Q0Q0 Q1Q1 If the average price of an AUTO doubles, how much will this price increase affect the consumption of Automobiles? Why?

Proportion of the Consumers Budget a Good or Service Represents The more of a consumers budget a commodity represents, the more elastic the demand curve will tend to be. The price of an automobile is such a large percentage of our budgets, that consumption of automobiles will be affected very much by a price increase.

Exceptions to the law of demand u Few exceptions of the law of demand are as follows: 1. These are those inferior goods whose quantity demanded decreases with decrease in price of the good. 2. Commodities which are regarded as status symbols: Expensive commodities like jewelry, AC cars, etc., are used to define status and to display one’s wealth. 3. Expectation of change in the price of the goods in future: if a consumer expects the price of a good to increase in future, it may start accumulating greater amount of the goods for future consumption even at the presently increased price.