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S6 Economics

The Theory of Demand

DEMAND: 

Demand is defined as the desire for a commodity backed by the  ability to pay a certain sum of money at a given price and time OR:  Demand is the quantity of goods which the consumers are willing and able to buy at a given price over a given period of time. 

Effective Demand: 

This is the actual buying of goods and services at a given price and at a given time.  OR. It is the actual amount of goods and services purchased by the consumer at a given price and at a given time. 

AGGREGATE DEMAND : 

This is the total demand for goods and services in an economy at a given period of time. OR: It is the total amount of expenditure on goods and services by all sectors in an economy.

Components of Aggregate demand in an open economy: 

•  Consumption expenditure by households(C)

•  Investment expenditure by firms (I)

•  Government expenditure on goods and services (G)

•  Net foreign expenditure (X-M) 

Determinants of aggregate demand 

•  The income levels in the economy/amount of money in circulation.

•  The general price levels.

•  The existing stock of capital

•  The size of the population/market size.

•  Taxation and subsidization policies.

•  Availability of credit 

 

REASONS WHY PEOPLE DEMAND FOR GOODS 

1.  Functional Effect; some people buy certain goods because of the purpose they serve e.g. food for eating. 

2.   Veblem/Exclusive Consumption;  one  buys  a  commodity  because  he/she wants to be the only person identified with it i.e. the desire to be unique. 

3.  Snob effect / Conspicuous Consumption;  this is where an individual buys goods which are expensive just to show his economic power or status e.g. buying expensive designer clothes, expensive vehicle, unique phones etc. 

4.  Bandwagon  Effect;  this  is  when  a  person  buys  a  commodity  because  there  are others buying it i.e. one buys a commodity in order to emulate others who have already bought it. 

5.  Impulsive Buying; this is where an individual buys a commodity because he/she has seen  it  displayed  i.e.  the  good  is  bought  out  of  a  sudden  desire  because  the  good  is attractively displayed. 

 

TYPES OF DEMAND:  

INTER RELATED DEMAND/TYPES OF DEMAND. 

Inter related demand is a situation where demand for one commodity affects the demand of another commodity either positively or negatively. 

It includes the following. 

1.  Composite demand; this is the total demand for a good with many uses/which can be used for more than one purpose. Examples of composite demand include; 

✓  Demand for electricity used for ironing, lighting, cooking.

✓  The demand for wool for cloth making, cushioning, cleaning etc.

✓  The demand for sugar for baking, sweetening drinks, brewing etc.

✓  Demand for Iron and steel for construction, furniture making, manufacturing etc

✓  Demand for clay for making pots, bricks, cups, stoves etc

✓   Demand for skins and hides for making shoes, bags, belts etc

✓  Demand for cloth for adornment, protection, warmth etc.

✓  Demand for an axe for hewing/splitting, cutting, tool of defence 

2.  Joint/complementary demand; this is demand for commodities that are used together in the satisfaction of human wants i.e. the buying of one commodity necessities the buying of the other e.g. demand for a gun and bullets, demand for a car and fuel etc. Therefore the fall in the price of one commodity increases the quantity demanded of its complement and an increase in the price of one commodity leads to a fall in the quantity demanded of its complement. 

3.  Competitive demand; this the demand for commodities that are close substitutes which serve almost the same purpose e.g. demand for butter and blue band, the demand for tea and coffee which are substitutes to each other. A  fall  in  price  of  one  commodity  reduces  the  demand  for  another  (its  substitute).  An increase in price of one commodity increases demand for another.(its substitute) 

4.  Derived demand; this is demand for goods that are not used for the satisfaction of wants directly but rather demanded in order to produce some other goods e.g. cotton is required for cloth production. If the demand for clothes increases, then more cotton is demanded and the demand for cotton is derived from the demand for clothes. All  in  all,  demand  for  factors  of  production  is  derived  demand  i.e.  the  demand  for commodities lead to a demand for factors of production. 

5.  Independent/autonomous demand; this refers to demand for a commodity which has no effect or relationship with the demand for other commodities. 

The demand function The  demand  function  is  a  statement  which  shows  a  technical  relationship  between  quantity demanded of a commodity and factors which influence it, such as price of a commodity (p), level of consumer’s income (Y), prices of related commodities (pr), tastes and preferences (Tp) etc.i.e. Qd = f (P, Y, Pr, Tp ……….n).   

 

DEMAND SCHEDULE 

A  demand  schedule  is  a  table  showing  the  amount  of  a  commodity  which  is  demanded  by  a consumer at different price levels.

The demand schedule reflects the law of demand which states that ”the higher the price, the lower the  quantity demanded  and  the  lower  the  price  the  higher  the  quantity  demanded  holding  other factors constant”. 

An individual’s demand schedule 

The information on an individual demand schedule can be illustrated on the graph in order to come up with the demand curve 

The demand curve 

A demand is a graphical representation of quantity demanded of a commodity at different price levels. 

OR: It is a curve that shows quantity demanded of a commodity at different price levels. 

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

A typical/normal demand curve is down ward sloping from left to right. 

It  is  drawn  on  the  assumption  that  quantity  demanded  depends  on  the  price  of  the  commodity, other factors affecting demand remaining constant. 

An illustration of the demand curve 

Market demand. Market demand is the total demand of all the consumers of a given product at alternative prices in a given period of time.  If we sum up the different quantities of a commodity demanded by a number of individuals at various prices, we have a market demand schedule as shown below. 

An illustration of the Market demand curve.

THE  LAW  OF  DEMAND:  The  law  of  demand  states  that  the  higher  the  price,  the  lower  the quantity demanded of a commodity and the lower the price, the higher the quantity demanded of a commodity other factors affecting demand remaining constant/Ceteris paribus.

 

REASONS  WHY  THE  DEMAND  CURVE  SLOPES  DOWNLOADS  FROM  LEFT  TO RIGHT OR REASONS WHY  PEOPLE  DEMAND  MORE  AT  LOWER  PRICES  OR FACTORS THAT EXPLAIN THE LAW OF DEMAND: 

1. Substitution effect of a price change.  As the price of a commodity increases while prices of substitutes are constant, a commodity becomes relatively expensive in relation to its substitutes. Consumers therefore buy less of a commodity as they demand more of its substitutes which are relatively cheaper. However, as the price of a commodity decreases while prices of its substitutes remain constant, a commodity becomes relatively cheaper hence an increase in demand for it, thus leading to the downward sloping of the demand curve.  

2. Real income effect of a price change. A fall in price leads to an increase consumer’s real income. This means that the consumer can buy more units of a commodity using the same amount of income. However, as the price of a commodity increases the real income of a consumer falls hence less of a commodity is demanded.

Note :

(i) Nominal income is the income of a person expressed in monetary/money term.

(ii) Real income is the income of a person expressed in terms goods and services that the nominal income can buy OR: It is the purchasing power of the nominal income.

3. The law of diminishing marginal utility.  According to this law when one consumes more and more units of a commodity, the satisfaction he gets from each additional unit consumed diminishes/decreases. Therefore the consumer is only willing and ready to buy those extra units only when the price is reduced. This means that the consumer is willing to pay high prices for the first units of the commodity since they give higher satisfaction and pay less for the extra units to be consumed because of less satisfaction hence the downward sloping of the demand curve.

4. The price effect. A reduction in price of commodity it brings in more consumers and as a result demand increases while with an increase in price of a good, many consumers abandon that good which reduces consumption and decreases demand.

5. Different uses of a commodity. For a commodity that has many uses, an increase in price makes consumers use it for only vital purposes hence a decrease in demand. However, when the price decreases a commodity is put to various uses and its demand increases. For example, with the increase in the electricity tariffs, power is used primarily for domestic lighting, but when the tariffs are reduced, consumers use power for cooking, ironing, fans, and heaters.

6. Presence/behaviour of low income consumers. The low income earners buy more of a commodity when the price reduces because they now afford it than when the commodity’s has increased and they cannot afford it hence the downward sloping of the demand curve. 

 

ABNORMAL/REGRESSIVE /EXCEPTIONAL DEMAND CURVES 

An abnormal demand curve is one that does not conform to the law of demand. Such curves do not slope down wards from left to right because more of a commodity may be demanded at a higher price or less of a commodity may be demanded at a lower price. 

Abnormal demand curve is encountered in the following situations or circumstances. 

1.  In  case  of  goods  of  ostentation  (snob  value  goods);  these  are  goods  consumed  by  the people  as  objects  of  pride/pomp.  They  are  regarded  as  status  symbols  and  are  basically bought to impress others and therefore consumers prefer to buy them at higher prices rather than at lower prices. 

The demand curve for the goods of ostentation is regressive or backward slopping implying that more of a commodity is demanded at higher prices. 

An illustration of a regressive demand curve for goods of ostentation. 

2.  In case of giffen goods; there are normally basic commodities which are consumed by the low income earners and their demand increases when their price rise. This is because these goods consume/ take up a large proportion of the consumer’s income  when their prices rise since the consumer can no longer afford alternative goods, i.e. the consumers abandons all other goods and concentrate on giffen goods.

An illustration of the  abnormal demand curve of a giffen good: 

3.  In case of expectation of price changes; if the price of a commodity increases and there is  an  expectation  of  further  increase  in  price,  consumers  increase  the  demand  of  a commodity in order to avoid buying the commodity at an even much higher price in future, similarly when the price of the commodity decreases and there is an expectation of further decrease in price consumers buy less so that they can buy a commodity in future at an even much lower price. 

4.  In case of an effect of an economic depression; an economic depression is a period of low economic activities and during this period, prices are low and demand for the goods is correspondingly low because people have low income. 

5.  In case of ignorance effect; some consumers may mistake commodities of high prices to be  of  high  quality  which  leads  to  greater  quantities  of  a  commodity  being  demanded  at higher prices, this may be because of different packaging, designing, labelling etc. 

 

THE  FACTORS  THAT  AFFECT/INFLUENCE  /DETERMINE  THE  DEMAND  FOR  A GIVEN COMMODITY(DETERMINANTS OF QUANTITY DEMANDED): 

1.  Price of a commodity; a high price of a commodity leads to low quantity demanded of such a commodity because consumers find it expensive to buy, while low price  leads to high quantity demanded of a commodity because consumers find it cheap to buy. 

2.  The price of a substitute good. High price of a substitute good leads to high demand of the commodity in question, this is so because consumers find  it cheaper to buy that commodity in  question.  However  a  low  price  of  a  substitute  good  leads  to  low  demand  for  the commodity  in  question  since  consumers  find  it  expensive  to  buy  the  commodity  in question. 

3.  The price of complements/Price of complementary goods; High price of a complementary good  leads  to  low  demand  for  the  commodity  in  question,  this  is  so  because  less  of  the complementary good is bought which leads to low demand for the commodity in question since the two are  used together in the satisfaction of human wants. However low price of a  complementary  good  leads  to  high  demand  for    a  commodity  in  question,  this  is  so because high quantity of  a complementary good is bought since the two commodities are used together in the satisfaction of human wants. 

4.  The level of the consumer income; high level of consumer’s level of income leads to high quantity demanded of a given commodity because the consumer has the capacity/ability to purchase  the  commodity.  However  low  income  of  a  consumer  leads  to  low  quantity demanded of a given commodity because of the low purchasing power of the consumer. 

5.  Consumer’s tastes and preferences; favourable tastes and preferences lead to high  demand for  goods  because  many  people  go  for  that  commodity  while  unfavourable  tastes  and preferences leads to low demand for commodity because few people go for that commodity . 

6.  The population/the market size; A high population size leads to high market for goods thus leading to high demand for such goods because there many potential buyers for such goods. On the other hand   a low population size leads to low demand for goods because there a few potential buyers for such goods.  

7.  Government policy as regards taxation or subsidisation of  a commodity; High level of taxation  of  a  commodity  leads  to  low  demand  for  a  commodity,  this  is  so  because  high taxation makes the commodity expensive due to high price. On the other hand low level of taxation of the commodity leads to high demand for a commodity, this is so because low taxation makes the commodity cheap due to low price. 

8.  The level/nature of income distribution; even distribution of income leads to high demand for goods, this is so because of the high purchasing power of the majority of the people. However uneven distribution of income leads to low demand for goods because of the low purchasing power of the majority of the people.  

9.  Future price expectation; An expectation of high price of the commodity in future leads to a high demand for goods, this is so because consumers buy high quantity of goods currently so as to avoid buying at high prices. On expectation of a low price of a commodity in future leads to a low demand for goods, this is so because consumers buy  low quantity currently so as to buy high quantity in future at low price. 

10. Seasonal  factors;  Favourable  season  for  a  given  commodity  leads  to  high  demand  for  a given  commodity  because  there  is  apparent  need  for  it.  On  the  other  hand  unfavourable season/end of season leads to low demand for a good, this is so because there is no/limited apparent need for the commodity. 

11. The degree of advertising; A high degree of intensive  and persuasive advertising  lead to high demand for  a good  because of a high level of awareness by the consumers and being convinced  to  buy  the  good.  On  the  other  hand  a  low  degree  of  advertising  leads  to  low demand for a good, this is so because many consumers are not made aware of the existence of the good and convinced to buy.

Factors that lead to high demand for a commodity: 

  • Low price of a commodity
  • High price of a substitute good
  • Low price of a complementary good
  • High level of consumer’s income
  • High population size
  • Favourable tastes and preferences
  • Favourable season/Beginning of a season  
  • High level of advertising
  • Expectation of high future price
  • Even distribution of income among the population
  • Low level of taxation of a commodity 

Factors that lead to low demand for a commodity:

  • High price of a commodity
  • Low price of a substitute good
  • High price of a complementary good
  • Low level of consumer’s income
  • Low/small population size
  • Unfavourable tastes and preferences
  • Unfavourable season/ End of a season
  • Low level of advertising
  • Expectation of low future price
  • Uneven distribution of income
  • High level of taxation of a commodity 

WHY MAY CONSUMERS BUY LESS OF A COMMODITY WHEN IT’S PRICE FALLS? 

  • When the commodity is a giffen good.
  • When there is anticipated further price reduction in future
  • When consumers prefer goods of ostentation./Snob effect.
  • When a fall in price is associated with a fall in quality.
  • During a period of economic depression 

WHY MAY CONSUMERS BUY MORE OF A COMMODITY WHEN ITS PRICE INCREASES?

  • When the commodity is a good of ostentation.
  • When there is anticipated further increase in price in the future.
  • In case of ignorance effect
  • When there is persuasive advertising.
  • During a period of economic prosperity. 

 CHANGE IN QUATITY DEMANDED 

This refers to an increase or decrease in the amount of the commodity demanded due to changes in the price of a commodity, other factors that affect demand remaining constant. It involves movement along the same demand curve either upwards or downwards. 

A graph illustrating change in quantity demanded 

 

 

 

Extension of the demand curve (an increase in quantity demanded) 

This refers to a situation when more of a commodity is demanded due to a decrease in the price of the commodity, other factors that affect demand remaining constant. E.g. in the graph above the reduction in price from OP0 to OP2 leads to an increase in quantity demanded from OQ0  to OQ2 

Contraction of the demand curve (a decrease in quantity demanded) 

This refers to a situation when less of a commodity is demanded due to an increase in price of a commodity, other factors that affect demand remaining constant. 

 

 CHANGE IN DEMAND 

This refers to an increase or decrease in the amount of the commodity demanded due to changes in the other factors that affect demand, price remaining constant. It involves a shift of the entire demand curve either to the right or to the left.

A graph illustrating a change in demand 

In the graph above, at each possible price e.g. OP0, quantity demanded can increase or decrease due to changes in other factors that affect demand. 

An increase in demand is illustrated by the shift of the demand curve to the right i.e. D0 D0 to D2D2, quantity demanded increases from OQ0 to OQ2 at a constant price OP0.  

A decrease in demand is illustrated by the shift of the demand curve to the left. i.e. D0 Do to D1D1. Quantity demanded decreases from OQ0 to OQ1. 

 

FACTORS THAT CAUSE A CHANGE IN DEMAND FOR A COMMODITY 

A change in price of substitute commodity; An increase in the price of a substitute good leads to n increase in demand for the commodity in question; this is so because consumers find it cheaper to buy that commodity in question. On the other hand a decrease in the price of a substitute good leads to a decrease in demand for the commodity in question, this is so because consumers find it expensive to by the commodity in question  

A change in the price of a complementary good; an increase in price of a complementary good leads to a decrease in demand for the commodity in question, this is so because less of  the  complementary  good  is  bought which  leads  to  a  decrease  in  demand  for  the commodity in question since the two are   used together in the satisfaction of human wants. However a decrease in  price of a complementary good leads to  an increase in demand for  a commodity in question, this is so because more quantity of  a complementary good is bought since the two commodities are used together in the satisfaction of human wants  

Change in the level of income of the consumer; An increase in the consumer’s level of  income  leads  to  an  increase  quantity  demanded  of  a  given  commodity  because  the consumer’s increased capacity/ability to purchase the commodity. However a decrease in the income of a consumer leads to decrease in quantity demanded of a given commodity because of the reduced purchasing power of the consumer. 

A  change  in  consumer’s  tastes  and  preferences;  A  favourable  change  in  tastes  and preferences lead to an increase in  demand for a  good because more people  are now in need  of  that  commodity  while  unfavourable  change  in  tastes  and  preferences  leads  to  a decrease  in    demand  for  commodity  because  fewer    people    are  now  in  need  of    that commodity. . 

A change in population size; An increase in population size leads to an increase in the  market  for  a  good  thus  leading  to  an  increase  in  demand  for  such  a  good  because  there more potential buyers for such a good. On the other hand   a decrease in population size leads to decrease in demand for a good because there are fewer  potential buyers for such a good.

A change in the level of taxation on people’s income; An increased level of taxation on  peoples  income  leads  to a  decrease  in  demand  of  a  commodity  due  to  the  reduced purchasing power. However a decrease in the level of taxation on people’s income leads to an  increase  in  demand  of  a  commodity  due  to  the  increased  purchasing power  of  the consumer.  

Changes  in  income  distribution  among  households;  an  improved  level  of  income distribution among households leads to an increase in demand for a good, this is so because of  the  increased  purchasing  power  of  the  majority  of  the  people.  However  income distribution becoming uneven among households leads to a decrease in demand for a good because of the reduced purchasing power of the majority of the people.

Expectation of future changes in the price of the commodity;  An expectation of an increase in price of the commodity in future leads to an increase in demand for a good, this is so because consumers buy more quantity of a good currently so as to avoid buying at an increased price. On the  other hand  expectation of a decrease in price of a commodity in future leads to a  decrease in demand for a good, this is so because consumers buy  less quantity of a good  currently so as to buy more quantity in future at  a reduced price. 

A  change  in  season;  Favourable  change  in  season  for  a  given  commodity  leads  to  an increase demand for that commodity because there is increased need for it. On the other hand  unfavourable  change  in  season/  season coming  to  an  end  leads  to  a  decrease  in demand for a good, this is so because there is reduced need for the commodity. 

Change in the level advertising; an increased level   of   advertising leads to an in demand for  a  good  because  of the  increased  level  of  awareness  by  the  consumers  and  being convinced to buy the good. On the other hand a decrease in the level of advertising leads to  a decrease in demand for a good, this is so because of the reduced level of awareness among the consumers

Change in availability of credit facilities; increased accessibility to credit facilities leads to  an  increase  in  demand  of a  given  commodity,  this  is  so  because  of  the  increased purchasing  power  of  the  consumer.  On  the  other hand  reduced  accessibility  to  credit facilities leads to a decrease in demand for a commodity, this is so because of the reduced purchasing power of the consumer.  

 

AN INCREASE IN DEMAND 

This is a situation where more of the commodity is demanded due to positive/favourable changes in other factors that affect demand when price is constant. 

It is illustrated by the shift of the demand curve to the right as shown below.

A shift of the demand curve from D1D1 to D2D2 indicates an increase in demand of a commodity from Q0 to Q1 at constant price OP0.  

 

Causes of an increase in demand of commodity 

1.  An increase in the level of advertising.

2.  An increase in price of substitute a good

3.  An increase in consumer’s income.

4.  Favourable change in tastes and preferences/Tastes and preferences becoming favourable.

5.  An increase in the population size.

6.  A reduction in the level of taxation on people’s income.

7.  Increased access to credit facilities  

8.  A decrease in the price of a complementary good  

9.   Income distribution among households becoming fairer

10. Favourable change in season for a commodity 

 

A DECREASE IN DEMAND 

This  is  a  situation  where  less  of  the  commodity  is  demanded  due  to  unfavourable  changes  in other factors that affect demand when price is constant. 

It is illustrated by a shift of the demand curve to the left as shown below. 

A shift of the demand curve from D0D0 to D1D1 illustrates a decrease in demand for a commodity from Q0 to Q1 at constant price OP0. 

Causes of a decrease in demand for a commodity 

1.  A decrease in the population size.

2.  A decrease in the level of advertising

3.  An increase in the price of a complement

4.  A decrease in price of a substitute

5.  Season becoming unfavourable

6.  Decrease in consumer’s level income

7.  Tastes  and  preferences  becoming  unfavourable/Unfavourable  change  in  tastes  and preferences

8.  A decrease in access to credit facilities.

9.  An increased level of taxation on people’s income.

10. Income distribution among households becoming unfair/uneven 

Discussion

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