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Demand

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In economics, demand is the desire to own anything and the ability to pay for it and willingness to pay (see also supply and demand). The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time. Demand is also defined elsewhere as a measure of preferences that is weighted by income.

Economists record demand on a demand schedule and plot it on a graph as an inverse (downward sloping) demand curve. The inverse curve reflects the relationship between price and quantity demanded: as price decreases, quantity demanded increases. The demand curve is equal to the marginal utility (benefit) curve. If there are no externalities, the demand curve is also equal to the social utility (benefit) curve.

Demand schedule

The demand schedule shows the quantity of goods that a consumer would be willing and able to buy at specific prices under the existing circumstances. Some of the more important factors affecting demand are the price of the good, the price of related goods, tastes and preferences, income, and consumer expectations.

Factors affecting demand

• Innumerable factors and circumstances could affect a buyer's willingness or ability to buy a good. Some of the more common factors are:

Good's own price:The basic demand relationship is between the price of a good and the quantity supplied. Generally the relationship is negative or inverse 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 an inverse relationship is reasonable and intuitive. If the price of a new novel is high, a person might decide to borrow the book from the public library rather than buy it. Or if the price of a new equipment is high a firm may decide to repair existing equipment rather than replacing it.

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. Close 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 complementary good would have a negative coefficient. For example, Qd = P - Pg where Q is 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 substitute and the good in question is negative. If the price of the substitute goes down the demand for the good in question goes up,

Income: The more money you have the more likely you are to buy a good.

Taste or preferences:The greater the desire to own a good the more likely you are to buy the good. There is a basic distinction between desire and demand. Desire is a measure of the willingness to buy a good. Demand is the willingness and ability to affect one's desires. It is assumed that tastes and preferences are relatively constant.

Consumer expectations about future prices and income: If a consumer believes that the price of the good will be higher in the future he is more likely to purchase the good now. If the consumer expects that her income will be higher in the future the consumer may buy the good now. In other words positive expectations about future income may encourage present consumption (Demand increases).

• 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/equation

The demand function is the mathematical expression of the relationship between demand and those factors that affect the willingness and ability of a consumer to buy goods. For example, Qd = f( P,⎮ Prg Y ) is a demand function where P equals price of the good Prg equals the price of related goods and Y equals income. The vertical bar means that the variables to the right are being held constant. The demand equation is the explicit mathematical expression of the functional relationship. For example, Qd = 325 + P - 30 Prg + 1.5Y. 325 is x-intercept; it is the repository of all non-specified factors that affect demand for the product. P is the price of the own good. The coefficient is negative in accordance with the law of demand. Prg may be either a complement or substitute. If a complement, the term would be negative. If a substitute the term 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.

Demand curve

The relationship of price and quantity demanded can be exhibited graphically as the demand curve. The curve is generally negatively sloped. The curve is two dimensional and depicts the relationship between two variables only; price and quantity demanded. All other factors affecting demand are held constant. However, these factors are part of the demand curve and are present in the intercept. Economics puts the independent variable on the y-axis and the dependent variable on the x=axis. Consequently, the graphical presentation is of the inverse demand function = P = f(Q).

Discrete goods

In some cases it is impractical to represent the relationship between price and demand with a continuous curve because of small quantities demanded. Goods and services measured in small units are best represented with a smooth curve. Examples include food measured in calories and leisure measured in minutes. However, when the price of a good is very high in proportion to a consumer's budget there is a need to incorporate this limitation in both the mathematical analysis and the graph representing the relationship. While cars and houses are discrete goods for most people, cheaper goods such as glasses and bicycles are discrete goods only for the very poor. On the national level, nuclear power plants or space stations may be considered discrete goods. The concept is more useful at the individual consumer's level than at the consumers' aggregate level.

Equation and curve

The price where the consumer is indifferent between buying an extra unit and not buying an extra unit is called the reservation price (r) after the same term used in auctions. If p is the price of the good and n units of the good are demanded, then r_n>=p>=r_n+1. For example, John is considering whether to buy a car or not (n=0 or n=1). The price of the car is $15,000 (p=15,000). The determining factor in John's consumption choice is his reservation price, r, simply the maximum price he is willing to pay for the car, reflecting his preferences. If John purchases this car and only this car then r₁>=15,000>=r₂ but if he does not purchase the car then r₀>=15,000>=₁.

As with other demand curves, discrete demand curves are usually downward sloping and convex, but in the case of discrete goods the curve is shaped like a staircase, reflecting the properties of goods which can only be consumed in qualities of integers. The horizontal lines represent a price at which the consumer is indifferent between buying an extra unit or not. The vertical lines represent a range of prices where the quantity demanded does not vary. Nevertheless, as prices change within these ranges, the consumer surplus may change.

Movements versus shifts

The demand curve is a two dimensional depiction of the relationship between price and quantity demanded. Movements along the curve occur only if there is a change in quantity demanded caused by a change in the goods own price. A shift in the demand curve, referred to as a change in demand, occurs only if a non-price determinant of demand changes. For example, if the price of a complement were to increase, the demand curve would shift in reflecting a decrease in demand. The shifted demand curve is a new demand equation. For example assume the demand for livermush in Western North Carolina is Q = 225 - P + 20Ps - 30Pc + 0.90 Pop + 1.5Y and assume that the price of cornbread increases 40% inducing the demand for livermush to shift 30% to the left. The new demand equation will be Q = .70(225 - P + 20Ps - 30Pc + 0.90 Pop + 1.5Y) = 157.5 = .7P + 14Ps - 21Pc + 0.63 Pop + 1.05Y. Contrast this situation with a change in the goods own price. If the price of livermush increased by 0.25 per kg. quantity demanded would decrease by 0.25 units. The change in price of the good would not affect demand.

From individual to market demand curve

The market demand curve is the horizontal summation of individual consumer demand curves. Aggregation introduces three additional non price determinants of demand - (1) the number of consumers (2) "the distribution of tastes among the consumers" and (3) "the distribution of incomes among consumers of different taste." Thus if the population of consumers increases ceteris paribus the demand curve will shift out. If the proportion of consumers with a strong preference for a good increases certeris paribus the demand for the good will change.Finally if the distribution of income changes is favor of those consumer with a strong preference for the good in question the demand will shift out. factors that affect individual demand can also affect aggregate demand. However, net effects must be considered. For example, a good that is a complement for one person is not necessarily a complement for another. Further the strength of the relationship would vary among persons.

Price elasticity of demand (PED)

PED is a measure of the sensitivity of the quantity variable, Q, to changes in the price variable, P. Elasticity answers the question of how much the quantity will change in percentage terms for a 1% change in the price. The formula for calculating PED is :(∂Q/∂P) (P/Q).

Determinants of PED

The overriding factor in determining PED is the willingness and ability of consumers after a price changes to postpone immediate consumption decisions concerning the good and to search for substitutes (wait and look). The greater the incentive the consumer has to delay consumption and search for substitutes and the more readily available substitutes are the more elastic the demand will be. Specific factors are:

Availability of Substitutes: The more choices that are available, the more elastic is the demand for a good. If the price of Pepsi goes up by 20%, one can always purchase Coke, 7-Up, Dr. Pepper and so forth. One's willingness and ability to postpone the consumption of Pepsi and get by with a "lesser brand" makes the PED of Pepsi relatively elastic.

Necessity: With a true necessity a consumer has neither the willingness nor the ability to postpone consumption. There are few or no satisfactory substitutes. Insulin is the ultimate necessity.

Importance is terms of proportion of Income Spent on a Good: Most consumers have both the willingness and ability to postpone the purchase of big ticket items. If an item constitutes a significant portion of one's income, it is worth one's time to search for substitutes. A consumer will give more time and thought to the purchase of a $3000 television than a $1 candy bar.

Duration: The more time a consumer has to search for substitute goods, the more elastic the demand.

Breadth of definition: How specifically the good is defined. For example, the demand for automobiles is more elastic than the demand for Toyotas which is in turn greater than the demand for Red Toyota Priuses.

Availability of Information Concerning Substitute Goods: The easier it is for a consumer to locate the substitute goods, the more willing he will be to undertake the search.

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. At the point the demand curve intersects the y axis PED is infinitely elastic. At the point the demand curve intersects the x axis PED is zero. 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. Below, is the inelastic range. The decline in elasticity as one moves down the curve is due to the falling P/Q ratio.

Market structure and the demand curve

In perfectly competitive markets demand, average revenue, marginal revenue and price are equal. (D = AR = MR = P). 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 PC firm's decisions are limited to whether to produce and if so, how much. In non-competitive markets the demand curve is negatively sloped and there is a separate marginal revenue curve. A firm in a non-competitive market is a price maker. The firm can decide how much to produce or what price to charge.

Inverse demand function

In it standard form the demand equation is q = f(p). That is, quantity demanded is a function of price. The inverse demand equation, or price equation, treats price as a function of quantity demanded - p = f(q). To compute the inverse demand function, simply solve for P in the demand function. For example, if the demand function is Q = 240 - 2P then the inverse demand function would be P = 120 - .5Q.

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 or MR = 120 - Q. Note that the MR function has the same y-intercept as the inverse demand function, the x-intercept of the MR function is one-half the value 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 conditions for firms regardless of market structure is to produce where marginal revenue equals marginal cost. 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[3] 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.

References and Notes

See also

• Demand curve
• Demand schedule
• Derived demand
• Law of demand
• Law of supply
• Supply (economics)
• Supply and demand
• Utility

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