DEMAND THEORY

DEFINITIONS

Demand is the desire backed by the ability to pay a given amount of money for a particular amount of a commodity in a given period of time.

OR

Demand is the amount of a good that a consumer is willing and able to buy at a given price in a given period of time.

Market demand is the total demand for a commodity in the market by all consumers at a given price in a given period of time.

Effective demand is the actual buying of goods and services at a given time.

TYPES OF DEMAND

1.     Joint/ complementary demand.

This is the demand for commodities which are used together; an increase in the demand for one commodity leads to an increase in the demand for the other commodity.

Examples of joint demand include;

Ø Demand for cars and fuel

Ø Demand for books and pens

Ø Demand for DVD players and DVDs.

Ø Demand for guns and bullets

Ø Demand for cameras and films

Ø Etc

2.     Competitive demand.

This is the demand for commodities which serve the same purpose; an increase in the demand for one commodity leads to a decrease in the demand for the other commodity.

Examples of competitive demand include;

Ø Demand for butter and honey

Ø Demand for bread and cakes

Ø Demand for tea and coffee

Ø Demand for Omo and Nomi

Ø Demand for close up and fresh up

Ø Demand for beans and peas

Ø Etc

3.     Independent demand.

This refers to demand for commodities which are not related such that the demand for one commodity does not directly affect the demand for another commodity.

Examples of independent demand include;

Ø Demand for clothes and food

Ø Demand for a car and a pen

Ø Etc

4.     Composite demand

This is the total demand for a commodity which has several/ many uses.

Examples of composite demand include;

Ø Demand for electricity (for lighting, ironing, cooking, etc)

Ø Demand for water (for cooking, bathing, etc)

Ø Demand for timber (for construction, furniture making, manufacturing, etc)

Ø Demand for cotton wool (for cloth making, cushioning, cleaning, etc)

Ø Demand for steel (for manufacturing machines, motor cars, roofing, etc)

Ø Demand for clay (for making pots, bricks, cups, etc)

Ø Demand for an axe (for splitting wood, tool of defence, etc)

Ø Demand for skins and hides (for making shoes, bags, belts, etc)

Ø Demand for paper (for making books, bank notes, envelopes, toilet paper, etc)

Ø Demand for cloth (for adornment, protection, etc)

Ø Etc.

5.     Derived demand.

This is the demand for a commodity not for its own sake but for the sake of what it helps to produce.

OR

It is the demand for a commodity due to the demand for the commodity that it helps to produce.

Examples of derived demand include;

Ø Demand for land

Ø Demand for labour

Ø Demand for capital

Ø Demand for entrepreneurship

Ø Demand for organisation.

ASSIGNMENT

1.     a) What is composite demand?                                                                    (01 mark)

b) State any three examples of commodities with composite demand in your country.

                                                                                                                       (03 marks)

THE DEMAND SCHEDULE

This is a table showing the amount of a commodity demanded at various prices by a consumer or groups of consumers during a particular period of time. This schedule can be compiled either for an individual or for all individuals in the market.

INDIVIDUAL AND MARKET DEMAND SCHEDULES

The market demand schedule is derived by horizontal summation of the quantities purchased at each price by all the individuals / consumers in the market. The quantities in the market schedule are larger than those of the individuals demand schedule.

One major characteristic of a demand schedule is that the higher the price the lower the quantity demanded and the lower the price the higher the quantity demanded of the commodity in question other factors being constant.

The information tabulated in a demand schedule can be summarized or represented graphically on a curve

THE DEMAND CURVE

The demand curve is a graphical representation of the demand schedule.

The demand curve is a locus of points showing the quantities demanded of a commodity at various prices in a given period of time.

Price is represented on the vertical axis while quantity demanded is on the horizontal axis.

From the above table, an individual demand curve (Consumer A) can be drawn as shown below.

A normal demand curve is downward sloping from left to right, that is it has a negative slope meaning that there is an inverse relationship between price and quantity demanded. (As the price increases, quantity demanded decreases and vice versa).

QUALITIES OF A NORMAL DEMAND CURVE

1.     It must be downward sloping from left to right.

2.     It should not touch either of the axes. If it touches the Y-axis, it implies that a consumer incurs a cost for a commodity which has not been obtained. (He pays a price at zero quantity). If it touches the X-axis, it implies that the consumer is buying a commodity at zero prices.

THE LAW OF DEMAND

The law of demand states that “the higher the price of a commodity, the lower the quantity demanded and the lower the price of a commodity, the higher the quantity demanded holding other factors constant (Ceteris paribus).

REASONS WHY THE DEMAND CURVE SLOPES DOWNWARDS FROM LEFT TO RIGHT (EXPLAINING THE LAW OF DEMAND)

A normal demand curve is one that slopes downwards from left to right following the law of demand. The following reasons explain why the demand curve slopes downwards from left to right.

1.     The law of diminishing marginal utility

According to this law, when a consumer buys more units of the commodity, the marginal utility of that commodity continues to decline; and therefore the consumer will buy more units of the commodity only when the price reduces. When fewer units are available, utility will be high and the consumer will be prepared to pay more for that commodity. This proves that demand will be low at a higher price and that is why the demand curve is downward sloping.

2.     The substitution effect of a price change.

When the price of the commodity falls, the price of substitutes remaining the same, a consumer reduces the quantities of other substitute goods whose prices now appear relatively high and increases the quantity of the commodity whose price has fallen. When the price of the commodity under consideration increases, the consumer leaves the commodity and buys the substitutes, given constant prices of substitutes hence the downward sloping demand curve.

3.     The income effect of a price change. (Real income effect)

When an individual has a fixed income and the price of the commodity reduces, his real income increases and hence he can buy more units of the commodity with his fixed income. On the other hand when the price increases, the consumer’s real income decreases and hence he buys less units of the commodity hence the downward sloping demand curve.

4.     The total effect of a price change.

This is the combination of the substitution and income effects. When the price of the commodity falls, the quantity demanded increases because many new buyers are attracted while an increase in price leads to a decrease in demand because it scares away buyers hence the inverse relationship between price and quantity demanded which produces a downward sloping demand curve.

5.     Behaviour/presence of low income earners.

The demand curve depends upon the behaviour of low income earners. They buy more when price reduces and less when the price increases. This leads to a downward sloping demand curve. (The rich do not have effect on the demand curve because they are capable of buying the same quantity even at a higher price)

6.     Different/various uses of certain commodities.

Some goods have more than one use e.g. water, electricity, etc such that when the price of the commodity increases, consumers tend to use it for essential purposes only hence reducing on its demand. On the other hand when the price reduces, the consumers put the commodity to many uses thereby increasing quantity demanded hence a downward sloping curve.

DETERMINANTS/ FACTORS INFLUENCING/ AFFECTING DEMAND.

1.     Price of the commodity in question.

A high price leads to low demand because it scares away some buyers. However, a low price attracts new buyers hence high commodity demand.

2.     Price of substitutes.

A high price of substitutes leads to high commodity demand because the commodity appears relatively cheaper. On the other hand, a low price of substitutes leads to low commodity demand because the commodity appears to be relatively expensive.

3.     Price of complements.

A high price of a complement leads to low commodity demand because it is expensive to use both goods together. On the other hand a low price of a complement leads to high commodity demand because it is cheap to use both goods together.

4.     Level of consumer’s income.

High level of consumer’s income leads to high purchasing power hence high commodity demand. However, low level of consumer’s income leads to low purchasing power hence low commodity demand.

5.     Tastes and preferences of consumers.

Favourable tastes and preferences result in high commodity demand because they are able to raise the consumer’s interest in the commodity. However, unfavorable tastes and preferences result into low commodity demand because they make the consumer to develop bias against the commodity.

6.     Population size.

A large population size creates high commodity demand because it is associated with many buyers. However, a small population size leads to low commodity demand because it has few buyers.

7.     Nature of income distribution.

A fair distribution of income leads to high commodity demand because many people can afford to purchase a commodity. However, high level of income inequality between individuals and different groups of people leads to low commodity demand because there are few people who can afford to purchase the commodity.

8.     Future price expectation.

Expectation of a high price in the nearby future leads to high commodity demand currently because buyers stock more goods to avoid the higher prices in the future. However, expectation of a low price in the nearby future leads to low commodity demand currently because the buyer reserve some money so as to buy more when the price falls.

9.     Government policy on taxation.

High level of direct taxation leads to low commodity demand because people have low disposable income while low level of direct taxation leads to high commodity demand because people have high disposable income.

10. Seasonal factors.

Certain commodities are demanded in particular seasons. Favourable season leads to high commodity demand and unfavourable season leads to low commodity demand. It is common to see vendors selling success cards during examination periods, Christmas cards in Christmas period and Easter cards in the Easter period. However outside those periods, one can hardly find them on the market because no one is willing to purchase them.

11. Level of advertising.

A high level of advertising leads to high commodity demand because it results into high level of awareness of the consumers about the availability of the commodity. On the other hand, low level of advertising leads to low commodity demand because it leads to low level of awareness of the consumers about the availability of the commodity.

12. The prevailing economic conditions in an economy.

Commodity demand tends to be high during periods of economic prosperity (boom) because during such times, people are employed and earn fair income to purchase the commodity. However, commodity demand is low during periods of economic depression because many people have no jobs and thus have no income to purchase the commodity.

13. Quality of the commodity.

A high quality of the commodity encourages people to buy hence high commodity demand while a low quality of the commodity forces people to abandon it hence low commodity demand.

14. Availability of credit facilities.

Commodity demand is high when consumers are allowed to take goods on credit because many consumers without immediate cash are able to buy the commodity. However, commodity demand is low when consumers are not allowed to buy goods on credit because the few buyers with cash are the only ones who buy.

15. The law of diminishing marginal utility.

With high marginal utility, commodity demand is high because the commodity is highly enjoyable and satisfying to the buyer. However at low marginal utility, commodity demand is low because the commodity is less enjoyable and satisfying to the buyer.

16. Socio-economic factors.

These include age, sex, religion, culture etc. One or a combination of these factors to some extent influence demand for a commodity. For instance demand for pork is low in places where there are many Muslims as compared to places where there are many Christians especially Catholics and Pentecostals.

ASSIGNMENT

1.     Explain the factors that lead to high demand of a commodity.

2.     Explain the factors that lead to low demand of a commodity.