Theory of Demand

Meanings and Definition of Demand:

The word 'demand' is so common and familiar with every one of us that it seems superfluous to define it. The need for precise definition arises simply because it is sometimes confused with other words such as desire, wish, want, etc.

Demand in economics means a desire to possess a good supported by willingness and ability to pay for it. If your have a desire to buy a certain commodity, say a car, but you 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 is an effective desire, i.e., a desire which is backed by willingness and ability to pay for a commodity in order to obtain it. In the words of Prof. Hibdon:

"Demand means the various quantities of goods that would be purchased per time period at different prices in a given market".

Characteristics of Demand:

There are thus three main characteristic's of demand in economics.

(i) Willingness and ability to pay. Demand is the amount of a commodity for which a consumer has the willingness and also the ability to buy.

(ii) Demand is always at a price. 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. The time may be a day, a week, a month, or a year.

Example:

For instance, when the milk is selling at the rate of $15.0 per liter, the demand of a buyer for milk is 10 liters a day. If we do not mention the period of time, nobody can guess as to how much milk we consume? It is just possible we may be consuming ten liters of milk a week, a month or a year.

Summing up, we can say that by demand is meant the amount of the commodity that buyers are able and willing to purchase at any given price over some given period of time. Demand is also described as a schedule of how much a good people will purchase at any price during a specified period of time.

Law of Demand:

Definition and Explanation of the Law:

We have stated earlier that demand for a commodity is related to price per unit of time. It is the experience of every consumer that when the prices of the commodities fall, they are tempted to purchase more. Commodities and when the prices rise, the quantity demanded decreases. There is, thus, inverse relationship between the price of the product and the quantity demanded. The economists have named this inverse relationship between demand and price as the law of demand.

Statement of the Law:

Some well known statements of the law of demand are as under:

According to Prof. Samuelson:

"The law of demand states that people will buy more at lower prices and buy less at higher prices, other things remaining the same".

E. Miller writes:

"Other things remaining the same, the quantity demanded of a commodity will be smaller at higher market prices and larger at lower market prices".

"Other things remaining  the same, the quantity demanded increases with every fall in the price and decreases with every rise in the price".

In simple we can say that when the price of a commodity rises, people buy less of that commodity and when the price falls, people buy more of it ceteris paribus (other things remaining the same). Or we can say that the quantity varies inversely with its price. There is no doubt that demand responds to price in the reverse direction but it has got no uniform relation between them. If the price of a commodity falls by 1%, it is not necessary that may also increase by 1%. The demand can increase by 1%, 2%, 10%, 15%,  as the situation demands. The functional relationship between demanded and the price of the commodity can be expressed in simple mathematical language as under:

Formula For Law of Demand:

Qd^x = f (P^x, M, P^o, T,..........)

Here:

Qd^x = A quantity demanded of commodity x.

f = A function of independent variables contained within the parenthesis.

P^x = Price of commodity x.

P^o = Price of the other commodities.

T = Taste of the household.

The bar on the top of M, P^o, and T means that they are kept constant. The demand function can also be symbolized as under:

Qd^x = f (P^x) ceteris paribus

Ceteris Paribus. In economics, the term is used as a shorthand for indicating the effect of one economic variable on another, holding constant all other variables that may affect the second variable.

Schedule of Law of Demand:

The demand schedule of an individual for a commodity is a Iist or table of the different amounts of the commodity that are purchased the market at different prices per unit of time. An individual demand schedule for a good say shirts is presented in the table below:

Individual Demand Schedule for Shirts:

(In Dollars)

Price per shirt	100	80	60	40	20	10
Quantity demanded per year Qdx	5	7	10	15	20	30

According to this demand schedule, an individual buys 5 shirts at $100 per shirt and 30 shirts at $10 per shirt in a year.

 

Law of Demand Curve/Diagram:

Demand curve is a graphic representation of the demand schedule. According toLipsey:

"This curve, which shows the relation between the price of a commodity and the amount of that commodity the consumer wishes to purchase is called demand curve".

It is a graphical representation of the demand schedule.

In the figure (4.1), the quantity. demanded of shirts in plotted on horizontal axis OX and "price is measured on vertical axis OY. Each price- quantity combination is plotted as a point on this graph. If we join the price quantity points a, b, c, d, e and f, we get the individual demand curve for shirts. The DD^/ demand curve slopes downward from left to right. It has a negative slope showing that the two variables price and quantity work in opposite direction. When the price of a good rises, the quantity demanded decreases and when its price decreases, quantity demanded increases, ceteris paribus.

           

Assumptions of Law of Demand:

According to Prof. Stigler and Boulding:

There are three main assumptions of the Law:

        

(i) There should not be any change in the tastes of the consumers for goods (T).

(ii) The purchasing power of the typical consumer must remain constant (M).

(iii) The price of all other commodities should not vary (P^o).

Example of Law of Demand:

If there is a change, in the above and other assumptions, the law may not hold true. For example, according to the law of demand, other things being equal quantity demanded increases with a fall in price and diminishes with rise to price. Now let us suppose that price of tea comes down from $40 per pound to $20 per pound. The demand for tea may not increase, because there has taken place a change in the taste of consumers or the price of coffee has fallen down as compared to tea or the purchasing power of the consumers has decreased, etc., etc. From this we find that demand responds to price inversely only, if other thing remains constant. Otherwise, the chances are that, the quantity demanded may not increase with a fall in price or vice-versa.

Demand, thus, is a negative relationship between price and quantity.

In the words of Bilas:

"Other things being equal, the quantity demanded per unit of time will be greater, lower the price, and smaller, higher the price".

Limitations/Exceptions of Law of Demand:

Though as a rule when the prices of normal goods rise, the demand them decreases but there may be a few cases where the law may not operate.

(i) Prestige goods: There are certain commodities like diamond, sports cars etc., which are purchased as a mark of distinction in society. If the price of these goods rise, the demand for them may increase instead of  falling. 

(ii) Price expectations: If people expect a further rise in the price particular commodity, they may buy more in spite of rise in price. The violation of the law in this case is only temporary.

(3) Ignorance of the consumer: If the consumer is ignorant about the rise in price of goods, he may buy more at a higher price.

(iv) Giffen goods: If the prices of basic goods, (potatoes, sugar, etc) on which the poor spend a large part of their incomes declines, the poor increase the demand for superior goods, hence when the price of Giffen good falls, its demand also falls. There is a positive price effect in case of Giffen goods.

Importance of Law of Demand:

(i) Determination of price. The study of law of demand is helpful for a trader to fix the price of a commodity. He knows how much demand will fall by increase in price to a particular level and how much it will rise by decrease in price of the commodity. The schedule of market demand can provide the information about total market demand at different prices. It helps the management in deciding whether how much increase or decrease in the price of commodity is desirable.

(ii) Importance to Finance Minister. The study of this law is of great advantage to the finance minister. If by raising the tax the price increases to such an extend than the demand is reduced considerably. And then it is of no use to raise the tax, because revenue will almost remain the same. The tax will be levied at a higher rate only on those goods whose demand is not likely to fall substantially with the increase in price.
 

(iii) Importance to the Farmers. Goods or bad crop affects the economic condition of the farmers. If a goods crop fails to increase the demand, the price of the crop will fall heavily. The farmer will have no advantage of the good crop and vice-versa.

Summing up we can say that the limitations or exceptions of the law of demand stated above do not falsify the general law. It must operate.

Movement Vs Shifts of Demand Curve:

Changes in demand for a commodity can be shown through the demand curve in two ways:

(1) Movement Along the Demand Curve and (2) Shifts of the Demand Curve.

    

(1) Movement Along the Demand Curve:

Demand is a multivariable function. If income and other determinants of demand such as tastes of the consumers, changes in prices of related goods, income distribution, etc., remain constant and there is a change only in price of the commodity, then we move along the same demand curve.

In this case, the demand curve remains unchanged. When, as a result of change in price, the quantity demanded increases or decreases, it is technically called extension and contraction in demand.

The demand curve, which represents various price quantity has a negative slope. Whenever there is a change in the quantity demanded of a good due to change, in its price, there is a movement from one point price quantity combination to another on the

same demand curve. Such a movement from one point price quantity combination to another along the same demand curve is shown in figure (4.3).

Diagram/Figure:

Here the price of a commodity falls from $8 to $2. As a result, therefore, the quantity demanded increases from 100 units to 400 units per unit of time. There is extension in demand by 300 units. This movement is from one point price quantity combination (a) to another point (b) along a given demand curve. On the other hand, if the price of a good rises from $2 to $8, there is contraction in demand by 300 units.

We, thus, see that as a result of change in the price of a good, the consumer moves along the given demand curve. The demand curve remains the same and does not change its position. The movement along the demand curve is designated as change in quantity demanded.

(2) Shifts in Demand Curve:

 

Demand, as we know, is determined by many factors. When there is a change in demand due to one or more than one factors other than price, results in the shift of demand curve.

For example, if the level of income in community rises, other factors remaining the same, the demand for the goods increases. Consumers demand more goods at each price per period of me (rise or Increase in demand). The demand curve shifts upward from he original demand curve indicating that consumers at each price purchase more units of commodity per unit of time.

If there is a fall in the disposable income of the consumers or rise in the prices of close substitute of a good or decline in consumer taste or non-availability of good on credit, etc, etc., there is a reduction in demand (fall or decrease in demand). The fall or decrease in demand shifts the demand curve from the original demand curve to the left. The lower demand curve shows that consumers are able and willing to buy less of the good at each price than before.

Schedule:

                 

Pdx  ($)	Qdx	Rise in Qdx	Fall in Qdx
12	100	300	50
6	250	500	200
4	500	600	300

Diagram/Figure:

In this figure, (4.4) the original demand curve is DD^/.

At a price of $12 per unit, consumers purchase 100 units. When price falls to$4 per unit, the quantity demanded increases to 500 units per unit of time. Let us assume now that level of income increases in a community. Now consumers demand 300 units of the commodity at price of $12 per unit and 600 at price of $4 per unit.

As a result, there is an upward shift of the demand curve DD². In case the community income falls, there is then decrease in demand at price of $12 per unit. The quantity demanded of a good falls to 50 units. It is 300 units at price of $4 unit per period of time. There is a downward shift of the demand to the left of the original demand curve.

Summing Up: 

(i) Extension in demand is due to reduction in price.

(ii) Increase in demand occurs due to changes in factors other than price.

(iii) Contraction in demand is the result of a rise in the price commodity.

(iv) A decrease in demand follows a change in factors other than price.

(v) Changes in demand both increase and decrease are represent shifts in the demand curve.

(vi) Changes in the quantity demanded are represented by move along the same demand curve.