Theory of Demand

It shows the relationship between consumer demand for goods and services and their prices. Demand theory forms the basis for the demand curve, which relates consumer desire to the amount of goods available.

1. Theory of Demand

2. Meaning of demand The individuals demand for a commodity: is the amount of a commodity which the consumer is willing to purchase at any given price over a specified period of time. The individual's demand for a commodity varies inversely price ceteris paribus.

3. Individual demand schedule It means the units of good or service that the individual is willing and able to purchase at alternative prices during a given period of time. Market demand schedule: It is showing total demand of a commodity by all households in the market of a commodity. The market curve is the summation of all individual household demand curves.

4. For Example There are only two consumers, Person A and Person B. Person A is buying 10 of this quantity and Person B is buying 15 units when the price is 3$. Thus, at a price of 3$ the total quantity demanded in the market is 25 units ( 10+15 ) of this commodity.

5. Individual and Market demand curve

6. Law of the Demand Assumptions of law of demand There are three main assumptions of the Law: There should not be any change in the tastes of the consumers for goods. The purchasing power of the typical consumer must remain constant. The price of all other commodities should not vary.

7. Law of demand The law of demand states that other factors being constant ( cetris peribus ), price and quantity demand of any good and service are inversely related to each other. When the price of a product increases, the demand for the same product will fall.

8. Numerical Example and Graph of Demand Curve Price of Good Quantity demanded of Good 5 10 4 20 3 30 2 40 1 50

9. Change in demand vs. change in quantity demanded Change in demand: Occurs when the entire demand curve shift either to the right or the left, that demand has changed.

10. A change in demand means that at constant price OP O more OQ, is demanded. This is illustrated by a shift of the demand curve either to the right (increase in demand) or to the left (a decrease in demand).

11. Quantity demanded: It means total number of units of a good that buyers are willing and able to buy at a particular price is called quantity demanded as shown in graphic bellow:

12. An increase in the amount of the commodity demanded is concerned with the movement along the demand curve, downwards and it is due to a fall in the price of the commodity. At OP 2 price, the amount demanded is OQ 2 and when prices reduce to OP 1 , more of the commodity OQ, is demanded. If the price increases from OP 1 to OP 2 , the amount demanded reduces from OQ 1 to OQ 2

13. . Change in quantity demanded It designates the movement from one point to another point (from one price-quantity combination to another price-quantity combination) on a fixed demanded curve.

14. Shifts in demand curve Demand, as we know, is determined by many factors. When there is a change in demand due to one or more than one factors other than price, results in the shift of demand curve. For Example : if the level of income in community raises, other factors remaining the same, the demand for the goods increases. Consumers demand more goods at each price per period of me (rise or Increase in demand). The demand curve shifts upward from the original demand curve indicating that consumers at each price purchase more units of commodity per unit of time.

15. If there is a fall in the disposable income of the consumers or rise in the prices of close substitute of a good or decline in consumer taste or non-availability of good on credit, there is a reduction in demand (fall or decrease in demand). The fall or decrease in demand shifts the demand curve from the original demand curve to the left. The lower demand curve shows that consumers are able and willing to buy less of the good at each price than before.

16. P dx  ($) Q dx Rise in Q dx Fall in Q dx 12 100 300 50 6 250 500 200 4 500 600 300

17. Determinants of demand : the tastes or preferences of consumer the number of consumer in the market the incomes of consumers prices of related goods consumers expectations about future prices and income

18. Tastes and preferences : Taxes and preferences depend on habit, age, sex, education, time, religion etc. When they are favorable to the commodity, its quantity demanded increases, and when they are unfavorable quantity demanded falls. For example, During the winter season, quantity demanded of woolen clothes increases and falls during the summer season. In Christmas time, the quantity demanded of Christmas cards increased.

19. The number of consumer in the market An increase in the number of consumers in a market will increase demand. Fewer consumers will be reflected by a decrease in demand. The income of consumers : There are two goods: Normal goods and Inferior goods Normal goods : A rise in income will cause an increase in demand is called normal goods. The demand for a normal good rises as income rises and falls as income falls. The demand for a normal good and income are directly related.

20. Graph of Normal Goods

21. Inferior Goods : A good the demand for which falls as income rises. The demand for an inferior good and income are inversely related. The demand for an inferior good falls as income rises and rises as income falls.

22. Prices of related goods : Whether a given change in the price of a related good will increase or decrease the demand for a product will depend on the related good is a substitute for it or complement to it. Substitutes : A substitutes is a good which can be used in place of another good. In other words, where two commodities can be used to satisfy the same demand. For example, Tea & Coffee, Butter & Margarine, Chicken & Beef. Substitute’s goods if an increase in the price of one good result in an increase in the demand for the others.

23. For Example Price of Tea Quantity demanded of Tea Price of Coffee Quantity demanded of Coffee 300 Rwf 10 Kg. 300 Rwf 15 Kg. 350 8 300 20 400 6 300 25 450 4 300 30

24. Complements : Where commodities are jointly demanded is called complements. For example, Cars & petrol, Cameras & film, CDs & CD Player etc. Complementary goods if an increases in the price of one result in a reduction in the demand for the others.

25. For example Price of Cars Quantity demanded of Cars Price of Petrol Quantity demanded of Petrol 5000$ 50 2$ 900Lit 6000$ 40 2$ 800 7000$ 35 2$ 700 8000$ 30 2$ 600

26. Abnormal demand curve Abnormal demand curves violate (to break) the Law of demand. These are also called regressive demand. The demand curve is abnormal at high price level. These curves arise in the following circumstances: Articles of ostentation: Some goods are luxuries items where satisfaction comes from knowing the price of the good. For example, luxurious cars (Land cruiser), Designer clothes, Jewelry etc. These are luxurious items. When their prices increase people buy more of them because people on high incomes. They can pay easily for all these articles.

27. Price expectation: When prices are expected to increase, consumer buy more commodities as price increase because they expect further price increase. Seller also increases prices because demand is increasing. For example, War expectations. When people expect that after some time there is a possibility of war. Giffen goods : These are highly inferior goods that people on low incomes spend a high proportion (A part of the income) of their income on. When prices fall, they are able to discard the consumption of these goods (having already satisfied their demand) and move on to other better goods. Demand may fall when the price falls. These trends to be very basic foods such as rice and potatoes. When its price increases, one tends to buy more of it and less when the price falls. When the price of such a commodity increases, the consumers gives up other commodities and buy this commodity when its price falls the consumer buy less of it and spends on commodities he had previously given up. The demand curve of given good is abnormal at low price levels.

28. Effect of depression : A depression is a period of low prices, low incomes, low purchasing power and low economic activity. During such a period, prices are low while demand is also low.