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Demand (economics)

In economics, demand is the desire to own anything and the ability to pay for it and willingness to pay.
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 demand: as price
decreases, demand 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 pretezels, 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 subsitute. 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 rn>=p>=rn+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 Westen 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 stong preference for a good increases
certeris paribus the demand for the good will change. Finally if the diistributuo of income changes is
favor of those consumer with a strong preference for the good in quesiton 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.