Welcome! In our Economics class today, we will be looking at the theory of demand. Do have a great moment studying with us!
Topic: Theory of Demand
Learning Objectives: At the end of the lesson, learners should be able to;
- Explain what the term demand;
- State and explain the laws of demand;
- Describe a demand schedule and demand curve;
- List and explain the different types of demand;
- State the factors that can affect demand for a commodity,
- Describe the concept of a shift in demand and also what an abnormal demand means;
- Explain the concept of price elasticity of demand and explain the various types of price elasticity with the aid of diagrams included;
- Explain how the relationship between the law of diminishing marginal utility and demand curve.
THEORY OF DEMAND
Demand may be defined as the ability and willingness to buy a specific quantity of goods and services at a given price and at a particular period of time.
In economics, demand is quite different from want or need. Want or need refers to a mere desire for a commodity but not backed up by the willingness and ability to pay for it.
In order to differentiate demand from need or want, economists usually talk about effective demand. Effective demand is defined as a desire backed up by ability and willingness to pay for specific quantities of a commodity at alternative prices and within a period of time. If Mr. Bayo has the money to purchase a brand new car and is able to pay for it, then he has the effective demand for the car. Bayo therefore demands the car. But if Mr. Okorodudu on the other hand desires to have a motorcycle and he does not have money and therefore unwilling to pay for it, he merely wants or needs the motorcycle and has no effective demand for it.
In summary, when a consumer’s demand is backed-up by the necessary ability and willingness to pay, it is said to be effective demand. But if the consumer does not have the means (money) to buy the commodity, it means he merely wants or needs or desires the commodity.
Law of Demand
The law of demand states that all things being equal, the higher the price, the lower the quantity of goods that will be demanded, or the lower the price, the higher the quantity of goods that will be demanded.
This law is often regarded as the first law of demand and suppy. It simply means that when the price of a commodity like yam, for instance,.is high in the market, very few quantities of it will be demanded by the consumer and vice versa.
All things being equal, this law will hold under the following assumptions:
i. That there will be no change in taste and preference of the consumer.
ii. That the consumers’ income remains constant.
iii. That no very close substitutes of a commodity exist.
iv. That the habits of consumers remain unchanged.
v. That there is no cheaper in the quality of the product.
Demand schedule can be defined as a table showing the relationship between prices and the quantity of that commodity demanded. In other words, a demand schedule is a table which shows the different quantities of a commodity that would be bought at various prices, at a particular time.
There are two types of demand schedule namely;
i. Individual demand schedule: This is a table which shows the different quantities of a commodity which an individual (or a consumer) would purchase at various prices and at a particular time. Let us consider a trader, Mr. Kayode, who has purchased several tins of milk at various prices as shown below:
Table 1. Individual Demand Schedule
The demand schedule above shows the relationship between the various prices of milk and the quantity which Mr. Kayode is willing to buy at each price per week. At a time when the price was #100, he was able to purchase only 10 tins of milk but as the price decreased to as low as #20.00, he was able to purchase as much as 50 tins of milk per week. It is seen from the schedule that Mr. Kayode’s demand is in consonance with the law of demand which states that the higher the price, the lower the quantity of a commodity that will be demanded and vice versa.
ii. Market demand schedule: Market demand schedule, also known as aggregate or total demand or composite demand schedule, is a schedule of all consumers of a commodity in a market. In other words, a market demand schedule is a table which shows the total quantities of a commodity which all consumers of the commodity are willing to buy at various prices, at a particular period of time.
Table 2. Market Demand Curve
In the above market demand schedule, it is measured that there are only five consumers of milk. The table also reveals the relationship between the different prices of milk and the total quantity which will be purchased by all the consumers at each price, every week. The table is also in consonance with the law of demand.
Demand curve is a graph showing the relationship between the price and quantity of a commodity demanded. In other words, a demand curve can be defined as a graphic or diagrammatic representation of a demand schedule. It should be noted that the demand curve is derived from a demand schedule.
Mr. Kayode (individual) demand curve
Fig 1: Individual demand curve
Figure 2. Market Demand Curve
As a rule and in accordance with the law of demand, demand curve normally slopes downwards from left to right, which shows that at higher price, fewer quantity of a commodity will be demanded and also at a lower price, a large quantity will be demanded.
Types of demand
1. Derived demand: Derived demand is the type of demand occurs as a result of demand for other commodities. The demand for one commodity will necessitate the demand for another commodity. For example, flour and sugar are demanded because there is demand for bread. Labour is demanded to construct the highway because there is a demand for good roads. So, labour, flour and sugar are “derived” demand commodities.
2. Joint or Complementary demand: Joint demand is a demand , which occurs when two commodities that are related to each other are demanded at the same time. These two commodities are said to be complementary to each other as a change in the demand for one commodity will bring about a similar change in the demand for the other. Examples of joint demand are bread and butter, tea and milk, can and petrol. Sometimes they are described as “joint demand goods”.
3. Competitive demand: When two commodities are fairly close substitutes to each other, they are in competitive demand. In other words, they serve the same purpose or perform a similar function such that an increase in the demand for one will result in a fall in the demand for the other. Examples of commodities that are close substitutes are Bournvita and Ovaltine, Malta Guinness and Maltina; Omo and Elephant detergents; Butter and Margarine; etc. If the price of any of these pairs of commodities is high, the consumers may switch over to the other close substitute which has a lower price.
4. Composite demand: Demand is said to be composite when a commodity is required to serve two or more purposes. For example, sugar is widely used in the home for beverages as well as in industries for making pastries and confectionery. If the industrial demand for sugar suddenly increases, it will affect the quantity of sugar demanded in the home.
Factors Affecting Demand
i. Price: The higher the price of any commodity, the lower the quantity that will be demanded and vice versa.
ii. The price of other commodities: This applies to commodities that have class substitutes. If the price of such a commodity is high, the consumer may demand for the close substitute.
iii. Income of the consumer: The higher the income of a consumer, the higher the quantity of commodities that he/she will demand and vice versa.
iv. Changes in taste of consumer: If consumers change their taste for a particular commodity, the demand for that commodity will also change.
v. Population: Increase in population in an areas will lead to high demand for commodities and vice versa.
vi. Periods of festivals: It is well known that people demand for more of a specific commodity during certain festivals.
vii. Taxation: An increase in taxation means a reduction in purchasing power of the consumers which may result in decrease in the demand for certain commodities.
Change in Quantity Demanded
A change in the quantity demanded of a commodity means a movement from one point to another on a demand curve. The cause of the change in the quantity demanded is due to changes in the price of the commodity under consideration. The quantity of a commodity demanded changes with price. More is purchased at a lower price than at a higher price.
A change in the quantity demanded is of two parts;
(a) Increase in the quantity demanded: There is an increase in the quantity demanded provided the quantity purchased increases as a result of a decrease in the price of the commodity.
Fig 3. Increase in quantity demanded
In fig 3 above, a decrease in the price of the commodity from #50 to #20 brought about an increase in the quantity purchased from 30 to 45 units.
(b) Decrease in the quantity demanded: In this case, there is a decrease in the quantity demanded if the quantity of the commodity purchased decreases as a result of an increase in price.
Fig 4: Decrease in the quantity demanded
In the figure above, an increase in the price of the commodity from #10 to #30 brought about a decrease in the quantity purchased from 50 to 20 units.
Shift of Change in Demand
A shift or change in demand in economics is quite different from change in the quantity demanded. There is a change in demand if the demand curve shifts to an entirely new position. In this case, there is a completely new demand schedule and demand curve, showing that at the old price more or less of the commodity would be purchased. A shift or change in demand is determined by other factors affecting demand except the price of the commodity.
A shift or change in demand is also grouped into two divisions;
i. Increase in demand: When there is an increase in demand, the demand curve shifts to the right indicating that the old price, more of the commodity will be purchased. An increase in demand is brought about by a favourable change in the factors affecting demand other than the price of the commodity. For example, if the income of consumers increase, more of the commodity is likely to be purchased at the old price
In fig 5 below, the demand curve shifted from D0D0 to D1D1. At the old price of #80, the quantity of the commodity purchased increased from 35 units to 75 units.
Fig 5: Rightward shift (increase) in demand
Fig 6: Leftward shift (decrease) in demand
(b) Decrease in demand: When there is a decrease in demand, the demand curve will shift to the left, including that at the old price, less of the commodity is being purchased. A decrease in demand is brought about by an unfavourable change in any factors affecting demand except the price of the commodity. For example, if there is a change in taste against a commodity, the demand for it will fall, at the former price.
In fig 6 above, the demand curve shifted from D2D2 to D1D1. At the same price of #60, quantity of the commodity purchased decreased from 65 units to 40 units.
Exceptional (Abnormal) Demand
Exceptional or abnormal demand is a demand pattern which does not abide by the laws of demand and therefore gives rise to the reversal of the basic laws of demand. Thus, at a higher price, increased quantities are demanded.
A normal demand curve slopes downwards from left to right indicating that the quantity of a commodity demanded increases as the price decreases and vice versa. But normal or exceptional demand curve slopes upwards from left to right, indicating that as the price of a commodity increases, the quantity demanded also increases and vice versa.
It is as a result of the existence of abnormal demand that it is often said that “a demand curve slopes downwards from left to right, but this may not always be so”.
Fig 7: Abnormal demand curve
Causes of abnormal Demand
i. Articles of ostentation: These are goods which command or have prestige value, e.g golden wrist watches, jewellery, luxury cars, etc. Some consumers take pride in buying goods whose prices are high because the higher the price, the higher it is valued and so the greater the quantity demanded.
ii. Articles of necessity: These are also referred to as “inferior or griffin goods”. These are articles or commodities which are considered essential to the extent that people cannot do without them. Examples are garri, salt etc. The low income earners prefer sacrificing other items at the expense of these ones. Thus, the higher the price of these commodities, the higher will be the demand for them.
iii. Future expectation: If people expect price of certain commodities to rise in future, they will buy more of them but if they expect price to fall, they will buy less of such commodities.
iv. Rare commodities: Some consumers have the tendency to buy certain rare and unique commodities at higher prices. These commodities are special, rare and not easily affordable as a result of the high value attached to them, e.g antique furniture. The higher the value of these items, the higher their demand.
Relationship between Law of diminishing Marginal Utility and Normal Demand Curve
The concept of the law of diminishing marginal utility can be used to explain the slope of the normal demand curve. The higher the marginal utility derived from the good, the higher consumers are willing to pay for it. The rational consumer aims at maximising utility from the use of his resources. To achieve this, the consumer ensures that marginal utility (MU) of a good is equal to the price (P) of the good.
Note: Figure 8 and 9 below represent marginal utility and demand curves.
Fig 8: Marginal Utility
Figure 9. Demand curve
However, MU diminishes as increasing quantities of a commodity are consumed. Therefore, as the MU of a commodity diminishes, a consumer’s willingness to pay diminishes. This inverse relationship between the quantity demanded of a commodity and its price referred to as the law of demand.
Both MU and demand curve slopes downwards from left to right. From the diagram in fig 8 above, the higher the MU derived from a commodity, the higher the price the consumer will be willing to pay for it, hence when MU is high (e.g MU3 at q3), a consumer will be ready to pay P3 for q3. However, when MU diminishes as increasing quantities of goods are consumed (e.g from q3 to q2), willingness to pay diminishes (e.g from P2 to P1). This inverse relationship between the quantities demanded of a good and its prices is referred to as the law of demand while the inverse relationship between MU and quantities consumed is referred to as the law of diminishing marginal utility.
A reduction in price will encourage a consumer to consume a commodity whose marginal utility has fallen, hence marginal utility of a commodity must be equal to the price of the commodity (MUx = Px).
Done studying? See all previous lessons on Economics
Take a quick test for this lesson!
- What do you understand by the demand?
- List and explain the types of demand.
- What are the factors affecting demand?
- What is the relationship between law of diminishing marginal utility and normal demand curve?
- State the causes of abnormal demand.
- Explain the term a shift in demand.
- State and explain the law of demand.
- What is demand schedule?
- State and explain the types of demand schedule.
- What is demand curve?
Questions answered correctly? Bravo!!
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