Demand

Concept of Demand 

• In economics, demand = quantity of a good or service that consumers are willing and able to buy at various prices during a given period (not mere desire).

• Demand exists only when there is:

  • Desire for the good

  • Purchasing power (income/credit)

  • Willingness to spend that income on the good.

• Alfred Marshall: “Amount of a commodity that will be bought at a given price in a given period.” Emphasises price–quantity relation and time period.

• Paul Samuelson: “Demand is a schedule of quantities that will be purchased at various prices at a given time.” Forms the basis of demand schedule and demand curve.

Individual vs Market Demand

• Individual demand

  • Quantity of a commodity a single consumer is willing and able to buy at various prices in a given period, ceteris paribus.

  • Individual demand curve: shows inverse relation between price and quantity demanded for one consumer; usually downward sloping.

• Market demand

  • Total quantity of a commodity that all consumers in the market are willing and able to buy at various prices in a given period.

  • Market demand curve: obtained by horizontal summation of all individual demand curves (add quantities at each price).

Demand Function (Individual and Market)

• General form

  • Demand function expresses functional relation between quantity demanded and its determinants:

    • Qd=f(P,Y,Ps,Pc,T,N,E) where

      • P = own price, Y = income, Ps= price of substitutes, Pc​ = price of complements, T = tastes, N = number of consumers, $E$ = expectations.

• Individual demand function

  • Relates quantity demanded by a single consumer to own price and his/her income, tastes, expectations etc., e.g. qi=f(P,Yi,Ps,Pc,Ti,Ei)

• Market demand function

  • Functional relation between market quantity demanded and its determinants; aggregate of individual demand functions, Q=∑qi

• Movement vs shift

  • Change in own price → movement along given demand curve (expansion/contraction of demand).

  • Change in other determinants (income, tastes etc.) → shift of entire demand curve right (increase) or left (decrease).

Law of Demand

• Statement

  • Other things remaining constant (ceteris paribus), quantity demanded of a commodity varies inversely with its price:

    • Price ↑ → quantity demanded ↓

    • Price ↓ → quantity demanded ↑.

• Graphical representation

  • Demand curve: downward sloping from left to right in price–quantity diagram (price on vertical, quantity on horizontal).

• Assumptions (ceteris paribus)

  • Income of consumers remains constant.

  • Tastes and preferences unchanged.

  • Prices of related goods (substitutes/complements) constant.

  • No change in future price expectations.

  • Size and composition of population constant.

• Reasons for downward slope

  • Substitution effect: When price of a good falls, it becomes relatively cheaper than substitutes; consumers substitute towards it, increasing demand.

  • Income effect: Fall in price raises real income (purchasing power); consumers can buy more, so quantity demanded increases.

  • Law of diminishing marginal utility: Additional units give less utility, so consumers are willing to buy more only at lower prices (conceptually consistent though not always explicitly tested).

Exceptions to the Law of Demand

• Giffen goods

  • Special type of inferior goods (staple items making large share of poor consumers’ budget: coarse grains, low‑quality rice etc.).

  • Price ↑ → real income falls sharply; consumers cut down on costlier foods and buy more of the inferior staple, so quantity demanded rises with price.

• Veblen or conspicuous consumption goods

  • Prestige/luxury goods bought for status: diamonds, designer clothes, high‑end cars etc.

  • Higher price itself increases snob appeal; some consumers buy more at higher price (Veblen effect).

• Necessities of life

  • Essential goods: basic food items, salt, life‑saving drugs, electricity, water etc.

  • Demand is almost fixed within a range; even if price rises, quantity demanded does not fall appreciably (very inelastic).

• Future price expectations

  • If consumers expect future price rise, they may buy more now despite rising current prices.

  • If they expect future price fall, they may postpone purchase, reducing demand even at lower current prices.

• Speculative goods

  • Shares, real estate, other speculative assets: rising price may attract more buyers hoping for capital gains, so demand increases with price.

• Ignorance and irrationality

  • Consumers may be ignorant of ruling price or behave irrationally (fashion, habits, impulse buying), sometimes buying more at higher prices.

Determinants of Demand

• Price of the commodity (P)

  • Core determinant; higher price → lower quantity demanded; lower price → higher quantity demanded (law of demand).

• Income of consumers (Y)

  • Normal goods: income ↑ → demand ↑. Ex. Mobile phones, TVs, laptops

  • Inferior goods: income ↑ → demand ↓ (consumers shift to superior goods). Ex. Kerosene, low grade grains etc

• Prices of related goods

  • Substitutes (tea–coffee, Pepsi–Coke): price of tea ↑ → demand for coffee ↑ (cross‑price positive).

  • Complements (car–petrol, printer–ink): price of petrol ↑ → demand for cars ↓ (cross‑price negative).

• Tastes, preferences and fashion

  • Favourable change (trend, advertising, lifestyle) → demand curve shifts right.

  • Unfavourable change (change in fashion, health concerns) → demand curve shifts left.

• Size and composition of population

  • Larger population → higher market demand for many goods.

  • Demographic composition (age structure, urbanisation etc.) affects pattern of demand (e.g., more youth → higher demand for education, mobile phones).

• Expectations about future prices and incomes

  • Expected future price rise or income rise → current demand ↑.

  • Expected future price fall → current demand ↓.

• Government policy and taxation

  • Indirect taxes raise effective price → demand tends to fall.

  • Subsidies lower effective price → demand tends to rise.

Types of Demand (Conceptual)

• Price demand

  • Demand viewed as a function of own price, holding other factors constant (standard demand curve).

• Income demand

  • Demand as a function of income;

  • Normal goods: positive relation; inferior goods: negative relation.

• Cross demand

  • Demand for a good as a function of price of related goods (substitutes/complements).

• Joint demand

  • Demand for two or more complementary goods used together (car and fuel, pen and ink); demand for one implies demand for the other.

• Composite demand

  • Demand for a good that has multiple uses (electricity for lighting, heating, industry etc.). Total demand is sum of demands for all uses.

• Derived demand

  • Demand for a factor or intermediate good arising from demand for final goods (e.g., demand for steel derived from demand for cars and construction).

Elasticity of Demand – Concept

• Law of demand shows direction of change but not magnitude. Elasticity measures how much quantity responds to changes in determinants.

• Elasticity of demand = degree of responsiveness of quantity demanded to change in one determinant (price, income or price of related goods).

• Price Elasticity of Demand (PED)

  • Measures responsiveness of quantity demanded to change in own price.

  • Defined as:

    • PED = Percentage change in quantity demanded /Percentage change in price.

• Other major types (for syllabus linkage):

  • Income Elasticity of Demand (YED): response of quantity demanded to change in income.

  • Cross Elasticity of Demand (XED): response of quantity demanded of one good to change in price of another good (substitute/compliment).

1. Price Elasticity of Demand (PED)

This is the most important type.

Types with Examples

(a) Elastic Demand (PED > 1)

• Quantity changes more than proportionately to price.
• Example: Luxury items like branded shoes
  If price drops 10%, demand may increase 25%.

👉 People are sensitive to price changes.

(b) Inelastic Demand (PED < 1)

• Quantity changes less than proportionately to price.
• Example: Petrol or medicines
  Even if prices rise, demand doesn’t fall much.

👉 People must buy these goods.

(c) Perfectly Elastic Demand (PED = ∞)

• A tiny price increase leads to zero demand.
• Example: Identical products in perfect competition (like grains in wholesale markets).

(d) Perfectly Inelastic Demand (PED = 0)

• Demand remains constant regardless of price.
• Example: Life-saving drugs (e.g., insulin).

(e) Unitary Elastic Demand (PED = 1)

• Proportionate change in price = change in demand.
• Example: Some household goods in stable conditions.

2. Income Elasticity of Demand (YED)

Types:

• Normal Goods (YED > 0): Demand rises with income
  Example: Clothes, electronics
• Inferior Goods (YED < 0): Demand falls as income rises
  Example: Cheap street food

3. Cross Elasticity of Demand (XED)

Types:

• Substitutes (XED > 0):
  Example: Tea and coffee
  If tea price rises → coffee demand increases
• Complements (XED < 0):
  Example: Car and petrol
  If petrol price rises → car demand falls

Factors Affecting Elasticity

• Availability of substitutes
• Nature of the good (luxury vs necessity)
• Income level
• Time period (long run = more elastic)
• Habit-forming goods (less elastic)

Real-Life Insight

• Companies like Apple keep premium pricing because their customers show inelastic demand (brand loyalty).
• Discount sales in supermarkets work because many goods have elastic demand.

Why Elasticity Matters

• Pricing strategy: Helps firms decide price changes
• Tax policy: Governments tax inelastic goods (like petrol)
• Business forecasting: Predicts revenue changes

Factors Affecting Price Elasticity of Demand

• Nature of the commodity

  • Necessities (salt, staple food, essential medicines) → inelastic demand.

  • Comforts and luxuries (ACs, jewellery, expensive cars) → more elastic demand.

• Availability of close substitutes

  • More/closer substitutes → easier to switch → demand more elastic.

  • No close substitutes (e.g., salt) → demand highly inelastic.

• Proportion of income spent on the commodity

  • Small share of income (needles, matchboxes, salt) → price change hardly affects budget → inelastic demand.

  • Large share (housing, major durables) → consumers react strongly to price change → elastic demand.

• Time period

  • Short run: adjustment difficult, habits fixed → demand more inelastic.

  • Long run: consumers can adjust habits, find substitutes, change technology → demand becomes more elastic.

• Possibility of postponement

  • Purchases that can be postponed (car, furniture, luxury travel) → elastic demand.

  • Non‑postponable items (food grains, basic medicines) → inelastic demand.

• Habit‑forming nature

  • Habitual/ addictive goods (cigarettes, alcohol, some beverages) → consumers less responsive to price → relatively inelastic demand.

• Range of price and level of income

  • At very low or very high prices, additional price changes may not induce much quantity response → inelastic.

  • Very high‑income consumers may not react strongly to price changes for many goods, reducing elasticity.

Read more: INDIAN ECONOMY