Understanding demand

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

What is meant by demand?

• Demand is the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period.
• Each of us has an individual demand for particular goods and services and our demand at each price reflects the value that we place on a product, linked usually to the enjoyment or usefulness that we expect from consuming it. Economists give this a term - utility
  

Effective demand

Demand is different to desire! Effective demand is when a desire to buy a product is backed up by an ability to pay for it

Latent Demand

Latent demand exists when there is willingness to buy among people for a good or service, but where consumers lack the purchasing power to be able to afford the product.

Derived Demand

The demand for a product X might be connected to the demand for a related product Y – giving rise to the idea of a derived demand. For example, demand for steel is strongly linked to the demand for new vehicles and other manufactured products, so that when an economy goes into a recession, so we expect the demand for steel to decline likewise.

Steel is a cyclical industry which means that market demand for steel is affected by changes in the economic cycle and also by fluctuations in the exchange rate.

The demand for new bricks is derived from the demand for the final output of the construction industry- when there is a recovery in the British building industry, so the market demand for bricks will increase

Zinc is a good example of a product with a strong derived demand. It has a wide-range of end uses such as galvanised zinc used in cars and new buildings, die-casting used in door furniture and toys, brass and bronze used in taps and pipes. And also rolled zinc (used in roofing, guttering and batteries) and in chemicals used in making tyres and zinc cream.

The Law of Demand

There is an inverse relationship between the price of a good and demand.

• As prices fall, we see an expansion of demand.
• If price rises, there will be a contraction of demand.

Ceteris paribus assumption

Many factors affect demand. When drawing a demand curve, economists assume all factors are held constant except one – the price of the product itself. Ceteris paribus allows us to isolate the effect of one variable on another variable

The Demand Curve

A demand curve shows the relationship between the price of an item and the quantity demanded over a period of time. There are two reasons why more is demanded as price falls:

The Income Effect: There is an income effect when the price of a good falls because the consumer can maintain the same consumption for less expenditure.  Provided that the good is normal, some of the resulting increase in real income is used to buy more of this product. 

The Substitution Effect: There is a substitution effect when the price of a good falls because the product is now relatively cheaper than an alternative item and some consumers switch their spending from the alternative good or service.

• As price falls, a person switches away from rival products towards the product
• As price falls, a person’s willingness and ability to buy the product increases
• As price falls, a person’s opportunity cost of purchasing the product falls
• Note: Many demand curves are drawn as straight lines to make the diagrams easier to interpret.

Tastes and preferences: A successful social media campaign increased sales of Old Spice by >100% in just one week!

 Changes in the Conditions of Demand – Shifts in the demand curve

There are two possibilities: either the demand curve shifts to the right or it shifts to the left.

• D1 – D3 would be an example of an outward shift of the demand curve (or an increase in demand). When this happens, more is demanded at each price.
• A movement from D1 – D2 would be termed an inward shift of the demand curve (or decrease in demand). When this happens, less is demanded at each price

 Remember - a change in price leads to a movement along the curve not a shift.

The conditions of demand for a product in a market can be summarised as follows:

Changing prices of a substitute good

• Substitutes are goods in competitive demand and act as replacements for another product
• For example, a rise in the price of Esso petrol should cause a substitution effect away from Esso towards competing brands such as Shell.

Changing price of a complement

Two complements are in joint demand – e.g. DVD players and DVDs, iron ore and steel.

• A rise in the price of a complement to Good X should cause a fall in demand for X. For example an increase in the cost of flights from London Heathrow to New York would cause a decrease in the demand for hotel rooms in New York and also a fall in the demand for taxi services both in London and New York.
• A fall in the price of a complement to Good Y should cause an increase in demand for Good Y. For example a reduction in the price of the new iPhone should lead to an expansion in demand for the iPhone and a complementary increase in demand for download applications.

Changes in the income of consumers

• Most of the things we buy are normal goods. When income goes up, our ability to purchase goods and services increases, and this causes an outward shift in the demand curve. But when incomes fall there will be a decrease in the demand, except for inferior goods
• Discretionary income is disposable income less essential payments like electricity & gas and mortgage repayments. An increase in interest rates often means an increase in monthly mortgage payments reducing demand. In recent years we have seen a sharp rise in the cost of utility bills with a series of hikes in the prices of gas and electricity. This has eaten into the discretionary incomes of millions of households across the UK.

The effects of advertising and marketing: Heavy spending on advertising and marketing can help to bring about changes in consumer tastes and fashions. In 2009, online advertising spending in the UK overtook television expenditure for the first time.

Interest rates and demand

• Many products are bought on credit using borrowed money, thus the demand for them may be sensitive to the rate of interest charged by the lender. Therefore if the Bank of England decides to alter interest rates – the demand for many goods and services may change.
• Examples of “interest sensitive” products include household appliances such as washing machines and fridge freezers, electronic goods, new furniture and motor vehicles. The demand for housing is affected by changes in mortgage interest rates.

Exceptions to the law of demand

There are two reasons why more might be demanded even when the price of a good or service is increasing.

Ostentatious consumption:

• A higher price may be regarded as a reflection of product quality and some consumers are prepared to pay this for the “snob value effect”. Examples might include perfumes, designer clothes, and top of the range cars.
• Goods of ostentatious consumption are known as Veblen Goods and they have a high-income elasticity of demand. That is, demand rises more than proportionately to an increase in income or an increase in price.

Speculative Demand:

• With speculative demand, a buyer hopes for a rise in price leading to a profit
• Speculative demand for housing and for shares comes into this category and we have also seen, in the last few years, strong speculative demand for many of the world’s essential commodities.
  

---

Add your comments and share this study note:

blog comments powered by Disqus

 

Search tutor2u

Any word All words Exact phrase

Order by  Relevance Date

Search tutor2u

---

Related study notes

REVISION NOTES AS Notes - Markets Economic Resources Economic systems Scarcity & Choice Opportunity Cost Production Possibility Frontier Specialisation & Trade Positive and Normative Statements Theory of Demand Consumer Rationality Theory of Supply Market Equilibrium Price Price Discrimination & Consumer Surplus Price Elasticity of Supply Income Elasticity of Demand Cross Price Elasticity of Demand Price Mechanism Price Volatility in Markets Inter-relationships Between Markets Consumer Surplus Producer Surplus Market for Oil Market for Copper Market for Cocoa Market for Coffee Market for Labour Market for Housing AS Notes - Market Failure Economies and Diseconomies of Scale Economic Efficiency Market Failure Competition & Monopoly Negative Externalities Positive Externalities Government intervention and Externalities Public Goods and Private Goods Merit Goods Demerit goods Factor Immobility Imperfect Information Poverty & Inequality Indirect Taxation Producer Subsidies Maximum Prices Minimum Prices Buffer Stock Schemes Government Failure Economics of Health Care AS Notes - Macroeconomics Interpreting Economic Data Intro to UK Economy Economic Cycle Aggregate Demand Kenesian Economics Multiplier / Accelerator Aggregate Supply Macro Equilibrium Balance of Payments Capital Investment Circular Flow of Income Consumer Spending Household Saving Economic Development Economic Growth Measuring National Income Macro Objectives Inflation Employment / Unemployment Migration Exchange Rate International Trade Fiscal Policy Monetary Policy Supply-side Policies Macro Objectives - Tradeoffs Macro Policy - Conflicts A2 Notes - Microeconomics Short Run and Long Run Production Background to Supply - Short Run Costs Economies & Diseconomies of Scale Business Revenues Profits Objectives of Businesses Divorce between Ownership and Control Technological Change, Costs & Supply in Long-run The Growth of Firms Measuring Market Concentration Perfect Competition Monopolistic Competition Dynamics of Competition Monopoly Price Discrimination Monopoly and Economic Efficiency Oligopoly Overview Oligopoly & Collusion Oligopoly - Game Theory Consumer and Producer Surplus Monopsony in Product Markets Contestable Markets Price Takers and Price Makers – Pricing Power Market Structures – A Summary Market Failure - Introduction Government Failure Externalities - Policy Options Market Failure - Public Goods Competition Policy Regulation of Prices Privatisation and Deregulation Cost Benefit Analysis Demand for Labour The Labour Force Supply of Labour to Different Markets Wages in Competitive Markets Trade Unions and Monopsony Employers Government Policies towards Poverty A2 Notes - Macroeconomics Fluctuations in Economic Activity Consumer spending and saving Capital investment spending Cyclical fluctuations The Credit Crunch Greece Debt Crisis Keynesian economics Theories of Economic Growth Competitiveness Economic Growth – Costs and Benefits National Income and Living Standards Measuring Standard of Living Unemployment Natural Rate of Unemployment Flexible Labour Markets The Phillips Curve Measuring Inflation Causes of Inflation Consequences of Inflation Deflation Monetarism and the Quantity Theory of Money Government Macroeconomic Policy Monetary Policy The Exchange Rate Exchange Rate Determination Fiscal Policy - Overview Direct and Indirect Taxation Economic Effects of Fiscal Policy Pattern of International Trade Trade and the law of Comparative Advantage Protectionism BoP - Introduction BBoP - Deficits BoP - National Income European Monetary Union A2 Notes - Development Econ Development Econ: Introduction Millenium Goals Wealth & Inequality Human Development Index Role of the Private Sector Role of State Intervention Overseas Aid, Remittances and Debt Relief Micro Finance & Fair Trade Growth Concepts: Country Cases Social & Human Capital Costs and Benefits Constraints Prebisch-Singer Hypothesis Productivity & Development Sustainable Development Competitiveness Labour Migration Globalisation: Introduction Effects ECONOMICS BLOG RESOURCES Student Support A2 Macro A2 Micro AS Macro AS Micro Economics Exam Advice Economics in News Quiz UCAS and Oxbridge Advice Economics Themes Agriculture Behavioural Economics Network Economics Game Theory Business Economics Economics of Utilities Contestable Markets Competitive Markets Economies of Scale Management Issues Monopolistic Competition Monopoly Oligopoly Price Discrimination Competition Policy Commodities Markets Emerging Economies Human Development African Economy South African Economy Kenyan Economy Development Economics Brazil Economy China Economy Indian economy Russia Economy Cost Benefit Analysis Cycles and Shocks Aggregate Demand Capital Investment Consumer Spending Saving Aggregate Supply Demography Economic History Economic Growth Competitiveness Innovation Economics of Technology Environmental Economics European Economy EU Enlargement EU Farming and Fishing Single Market The Euro Exchange Rates Money and Finance Monetarism Global Economy IMF Balance of Payments Credit Crunch International Trade Housing Economics Government Intervention Buffer Stocks Government Failure Indirect Taxes Maximum Prices Minimum Prices Regulation Subsidies Health Economics Inflation and Deflation Labour Market Trade Unions Introductory Economics Macroeconomic Policies Fiscal Policy Monetary Policy Supply-side policies Trade Policies Keynesian Economics Market Failure Externalities Factor Immobility Information Failure Merit & De-Merit Goods Public Goods Manufacturing Industry Oil and Gas OECD Economies Australia Economy French Economy German Economy Greece Economy Ireland Economy Japan Economy Poland Spain Economy US Economy Poverty and Inequality Market Equilibrium and Price Elasticity of Demand Elasticity of Supply Nature of Demand Nature of Supply Price Mechanism in Action Price Volatility Inter-related Markets Standard of Living Transport Economics UK Economy Regional Economics London Economy Recession Watch Unemployment Support for Individual Units AQA ECON 1 AQA ECON2 AQA ECON3 AQA ECON4 Edexcel Unit 1 Edexcel Unit 2 Edexcel Unit 3 Edexcel Unit 4 OCR F581 OCR F582 OCR F583 OCR F584 OCR F585

 

---