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    Session 2: Analysis of Demand

    In a free market individuals are free to make their own economic decisions. Consumers are free to

    decide what to buy with their incomes: free to make demanddecisions. Firms are free to choose whatto sell and what production methods to use: free to make supply decisions. The price mechanism is a

    process where the market forces of demand and supply interact to fix theprice of a good or service.

    Definition of DemandDemand is the quantity of a good or service that consumers are willing and are able to buy at a given

    price within a specified period of time when all other demand factors (such as consumer income,tastes and preferences, prices of related goods, consumer population, expectations, etc.) are held

    unchanged. Hence demand could simply be defined as a set of prices for a good or service with acorresponding set of quantities. In economics, demand goes beyond the expression of mere desire,

    wish or want. That is, economists mean effective demandwhen they mention demand which is thedesire, wish or want, backed by the ability to pay for what you desire, wish or want.

    The Law of Demand

    The way consumers react to a change in the price of a good or service is so typical that economistsstate it as a law. The law of demand states that if the price of a good or service rises quantity

    demanded will decline, and if the price falls quantity demanded will increase when all other factors ofdemand remain unchanged. Stating the law in another way, we say that the quantity demanded of a

    good is inversely (or oppositely) related to its price, when we hold constant other factors thatinfluence consumers consumption of a commodity.

    Representation of Demand

    The demand for a commodity may be represented in three ways: as a schedule, a curve or a function(equation).

    The DemandSchedule

    The demand schedule is a table or a listof various prices of a good or service and the correspondingquantities that would be purchased at a particular time period, when all other demand factors are held

    fixed. Table 1.1 is an example of a demand schedule for a good.

    Table 1.1: The Demand Schedule for a Good

    Price of Jeans(GH)

    Quantity of Jeans Sold(units)

    0

    510

    1520

    2530

    3540

    80,000

    70,00060,000

    50,00040,000

    30,00020,000

    10,0000

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    It shows the quantity of a good that will be demanded at a given price, holding all other demand

    factors fixed. When the price is GH0, quantity demanded is 80,000 units. When the price increasesto GH5, quantity demanded decreases to 70,000 units. As the price of the good increases from

    GH0 through to GH40, quantity demanded decreases from 80,000 units through to 0 unitsdepicting the law of demand.

    The Demand Function/EquationWe have defined demand as the quantity of a good or service that consumers are willing and are ableto buy at a given price within a specified period of time when all other demand factors remain fixed.

    The other factors that influence demand but are expected to remain unchanged include consumerincome (Y), prices of related goods and services (PR), and other variables affecting demand. The

    demand function or equation is a mathematical expression that relates the quantity demanded of agood or service to the own price of the good or service and the other demand factors.

    Mathematically, a general demand function (for say Good X) may be stated as follows:

    Qxd

    = f(Px ,PY , M, H,)

    Qxd

    = quantity demand of good X.

    Px = price of good X.

    PY = price of a related good Y. Substitute good. Complement good.

    M = income. Normal good. Inferior good.

    H = any other variable affecting demand (advertising, consumer population, etc).

    Illustrations

    Problem 1An economic consultant for X Corp. recently provided the firms marketing manager with this

    estimate of the demand function for the firms product:

    xyx

    d

    x AMPPQ 2143000,12 !

    Where dxQ represents the amount consumed of good X, Px is the price of good X, Py is the price of

    good Y, M is income , and Ax represents the amount of advertising spent on good X. Suppose good X

    sells for GH200 per unit, good Y sells for GH15 per unit, the company utilizes 2,000 units ofadvertising, and consumer income is GH10,000.

    a) How much of good X do consumers purchase?

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    b) Are goods X and Y substitutes or complements?c) Is good X a normal or an inferior good?

    Solution

    (a) unitsQd

    x 460,5)000,2(2)000,10(1)15(4)200(3000,12 !!

    (b) Since the coefficient ofPy in the demand equation is 4>0 (positive), we know that GH1

    increase in the price of good Y will increase the consumption of good X by 4 units. ThusGoods X and Y are substitutes.

    (c) Since the coefficient of M in the demand equation is -1

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    The DemandCurve/Graph

    When the set of quantities demanded in the demand schedule is plotted against the set of prices, we

    obtain a demand curve or graph. Hence, the demand curve is a graph (or a locus of points) showingthe various quantities that will be bought at given prices of a commodity for a given time period,

    when all other demand factors remain fixed or constant. Usually price is plotted on the verticalaxis with quantity demanded is on the horizontal axis. A typical demand curve has a negative

    slope. That is, it slopes downward from left to right depicting the law of demand.

    Figure 1.1: The Demand Curve

    Price (GH)

    D

    0 Q1 Q2 Quantity demanded (in units)

    In Figure 1.1, D is a typical demand curve. At price OP1 quantity demanded is OQ1. A fall in price

    from OP1 to OP2 brings about an increase in quantity demanded from OQ1 to OQ2.

    Determinants (Shifters) of DemandEconomists mean shifters of the demand curve when they refer to the determinants of demand.Whereas the quantity demanded of a commodity is determined by the own price of the commodity,

    the demand for a commodity on the other hand is determined by factors other than the own price ofthe commodity. For most commodities, when the price falls, more of it is purchased whiles when the

    price rises, lesser quantity than before is purchased when all other demand factors remain unchanged.

    Under the determinants of demand, we usually focus on those factors that collectively determine theposition of the demand curve in price-quantity demanded space.

    The demand for a commodity is determined by several factors including prices of related

    (substitutable or complementary) commodities, consumer income, consumer taste and preference,consumer expectation in both income and price, and population of consumers, etc.

    ConsumerIncome

    A change in consumer income, given that all other demand factors remain unchanged, may bringabout a change in the demand for a commodity. However, the direction of change in demand will

    depend on the type of commodity in question. For a normal good, demand might increase when

    P1

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    consumer income increases and demand might fall when consumer income falls, given that all otherdemand factors remain unchanged. In the case of an inferior good, demand might decline when

    consumer income increases whiles demand might increase as consumer income increases, also giventhat all other demand factors remain unchanged. Hence, for inferior goods we consume more when

    we are worse off financially but consume less when we are better off. For instance who would wantto buy second hand or home used goods (such as clothing, shoes, vehicles, etc.) when he or she is

    rich? For a necessity, a change in consumer income may not affect demand.

    PricesofRelatedCommodities

    Commodities when related may either be complements orsubstitutes. Commodities are described as

    complementary when they havejoint demand. That is, they are jointly needed before a want can besatisfied. Examples of complementary commodities are camera and film. One can satisfy a want to

    take a photograph only when he or she has both commodities. With complementary commodities, asteep rise in the price of one will lead not only to a fall in its consumption but a fall in the

    consumption (decrease in demand) of the other commodity too. A fall in the price of one commoditywould lead to an increase in the demand for the other.

    Substitutable commodities are those that only one is needed to satisfy a want/need (not both). For

    substitutable commodities, a fall in the price of one leads to a decrease in demand for the other and anincrease in the price of one leads to an increase in the demand for the other, all other factors

    remaining unchanged. Tea and coffee, or butter and margarine could be considered as examples ofsubstitutable commodities. Only one of each pair is needed. Only butter or margarine (but not both) is

    needed to add to say bread. A sharp increase in the price of margarine will let people consume morebutter (increase in demand for butter) if the price of butter does not increase too.

    ConsumerTaste, HabitandCustom

    A change in taste, habit or custom will change demand for certain commodities. Increased taste for aparticular commodity will increase demand whilst a declining taste will decrease the demand, other

    factors remaining unchanged. Taste or preference for goods and services is in turn influenced by

    marketing strategies such as advertisement, publicity, sales promotions (e. g. raffles) and fashion. Ifone forms a habit of consuming a particular commodity, the demand for such a commodity willincrease. On the other hand, if custom forbids the consumption of a particular commodity, its demand

    will decline.

    ConsumerExpectations

    The decision to buy a commodity today is influenced by the expected future price of the commodity

    and expected change in consumer income. If a consumer anticipates the price of a commodity toincrease in future, todays demand for the commodity will increase but if the consumer anticipates a

    fall in future price, then todays demand for the commodity will fall. Similarly, an expected increasein consumer income in the near future may cause current demand for a normal commodity to increase

    and that of an inferior commodity to decline.

    PopulationofConsumersIncrease in population or changes in the structure of population may affect the demand for a certain

    commodities. If the population of a country increases, the demand for certain commodities will alsoincrease. For example, if the population of Ghana increases the demand for certain goods and

    services will increase, and if there is a decline in the population of Ghana the demand for certain

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    commodities will decline. A change in the structure or composition of population may change thedemand of certain goods and services. If the structure of the population of Ghana changes such that

    the population of aged (people above 60 years) increases the demand for commodities demanded bythe aged, such as hats, walking sticks, etc., may increase.

    NaturalFactors

    Variations in seasons may affect the demand for a commodity at certain times of the year. Forexample, during the raining season, demand for commodities such as jackets, raincoats and umbrellaswill increase while during the dry season, demand for the commodities mentioned above will

    decrease but the demand for commodities such as fans and air conditioners will rise.

    Availability ofcredit

    The availability of credit facilities in the form of credit purchases, hire purchases and the use of credit

    cards and cheques, may increase the demand for certain commodities such as consumer durables (TVsets, fridges, sound systems, cars, etc.). Granting credit facilities, therefore, increases demand for

    goods covered by these facilities, all things being equal.

    Costofborrowing (Interestrate)In a country lower interest rates mean cost of borrowing is low. This encourages people to borrow

    much from financial institutions to consume more of normal goods and services. If credit facilitiesare available (i. e. financial institutions are will to lend to the consuming public) but cost of

    borrowing is high people will be unwilling to go in for the credits and so cannot consume more goodsand services.

    TypesofDemand

    Under this section, we look at the different types of demand that we have. Demand may be

    complementary, derived, or composite.

    Joint/Complementary Demand

    Goods are in joint/complementary demand when they produce more consumer satisfaction when they

    are consumed together than when they are consumed separately. Examples include bread andmargarine, camera and film, automobile and gasoline, and cassette player and cassette. One gets

    some satisfaction from the consumption of bread but will be satisfied better when it is consumedtogether with margarine.

    Competitive Demand

    Goods are said to be in competitive demand when they all compete for the same consumers income.Competitive goods are mostly substitutes - i.e. goods that are alternatives to one another in

    consumption. Examples are peak milk and ideal milk; pork, beef and chicken. When one is takingsay, tea, it is unusual for the person to use peak milk and ideal milk at the same time.

    DerivedDemand

    The demand for final products leads to the demand for other products which are used to produce thefinal products - i.e. if the demand for a product is not for its own sake, but for the making of another

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    product which is in demand. For example, the demand for furniture derives the demand for woodwhile the demand for petrol derives the demand for crude oil.

    Composite Demand

    A commodity is said to have a composite demand when it is demanded for alternative uses. Forexample, wood has composite demand because it is demanded for several alternative uses such as the

    making of tables, chairs, windows, doors, body of vehicles, etc.

    Change in Quantity Demanded

    A change in quantity demanded occurs when the consumption of a commodity changes (increases ordecreases) as a result a change (an increase or a decrease) in the price of the commodity, when all

    other demand factors remain unchanged. This will result in a movement along a demand curve.There are two types of changes in quantity demanded: an increase in quantity demanded and a

    decrease in quantity demanded. The only cause of a change in quantity demanded is a change in priceof the commodity.

    Increasein Quantity Demanded

    When consumption of a commodity increases as a result of a fall in the own price of a commodity itis referred to as increase in quantity demanded. It produces a downward movement along the same

    demand curve. In our milk example, buying more milk as a result of a fall in its price with GH20 isan example of an increase in quantity demanded.

    Figure 1.2: An Increase in Quantity Demanded

    Price (GH)

    A

    B

    D

    0 Q1 Q2 Quantity demanded (in units)

    From Figure 1.2 when the price of the commodity was OP1, quantity demanded was OQ1 and when

    price decreased to OP2, consumption increased to OQ2. This produces a movement AB along thensame demand curve, D.

    P1

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    Decreasein Quantity Demanded

    When consumption of a commodity declines as a result of a rise in the price of the commodity, it is

    referred as a decrease in quantity demanded. This is shown as an upward movement along a demandcurve. In Figure 1.3 when the price of the commodity was OP1, quantity demanded was OQ1 and when

    price increased to OP3, consumption decreased to OQ3. This produces a movement from point A topoint C along the demand curve, D.

    Figure 1.3: A Decrease in Quantity Demanded

    Price (GH)

    C

    A

    D0 Q3 Q1 Quantity demanded (in units)

    Changein Demand

    The consumption of a commodity may change (either increase or decrease) when the price has notchanged. Economists refer to such a situation as change in demand for the commodity in question. A

    change in demand is normally brought about by a change in any of the other demand factors (referredto as demand shifters). It causes a complete shift in the demand curve either to the right or to the left.

    a) Increasein Demand

    A situation where the price of a commodity remains unchanged but consumption of the commodity

    increases is referred to as an increase in demand. In the milk example, the second instance showed that

    milk was still being sold at GH4, but demand increased when my monthly income increased. Thissituation could be described as increase in the demand for milk. An increase in demand causes acomplete shift in the demand curve of the commodity to the right.

    Figure 1.4: An Increase in Demand

    Price (GH)

    A B

    D2

    D10 Q1 Q2 Quantity demanded (in units)

    P3

    P1

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    The initial demand curve is D1 in Figure 1.4 and as a result of the increase in demand D1 has shiftedcompletely to D2. At the same price of the commodity of OP1, consumption has increased from OQ1 to

    OQ2 units.

    b) Decreasein Demand

    A decrease in demand for a commodity occurs when the consumption of a commodity decreases when

    the commoditys price has not changed. A decrease in demand causes a complete shift in the demand

    curve of the commodity to the left as shown in Figure 1.5. The initial demand curve is given asD

    1and as a result of a decrease in demand D1 has shifted completely to D3. At the same price of thecommodity of OP1, consumption has increased from OQ1 to OQ3 units.

    Figure 1.5: A Decrease in Demand

    Price (GH)

    B A

    D1

    D3

    0 Q3 Q1 Quantity demanded (in units)

    c) Factors that cause a Change in DemandA change in demand is caused by a change in any of the demand shifters namely:

    y prices of related goods (substitutes and complements),y consumers income (inferior and normal goods),y consumer tastes, habit and custom,y consumer expectations (in prices and income),y population of consumers,y natural factorsy availability of creditsy cost of borrowing (interest rate)

    The explanations of how a change in any of the above factors causes a change in demand are given inthe same ways as we did under determinants of demand for a commodity. But note that a change in

    the own price of a commodity does not cause a change in demand. It causes only a change in quantitydemanded.

    P1

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    Individual Demand and Market Demand

    The demand for a commodity normally refers to the market demand for that commodity butindividuals consume the commodity therefore we may talk of individual demand too.

    The individualdemand for a commodity is the quantities that would be purchased by an individual

    consumer of that commodity at a given set of prices of the commodity, when all other factors remain

    unchanged. For a given set of prices for the commodity individuals make their purchases therefore theset of prices and the corresponding quantities purchased by each individual consumer representshis/her individual demand.

    The marketdemand for a commodity on the other hand is the total quantities that would be purchased

    by all individual consumers of a commodity at the same given set of prices, when all other factorsremain unchanged. Market demand reflects the total demand of all individuals consuming the

    commodity. Hence, market demand is a horizontal summation of all individual demands for acommodity.

    Illustration:

    Let us assume that there are only three consumers, John, Ama and Bob for a good with demandschedules as follows:

    Table 1.2: Individual and Market Demands

    Price

    (GH)

    JohnsQuantity

    Demanded(QJ)

    AmasQuantity

    Demanded(QA)

    BobsQuantity

    Demanded(QB)

    Market

    Quantity

    Demanded

    Q = (QJ + QA + QB)

    1 200 180 150 530

    2 190 170 140 500

    3 150 150 120 420

    4 130 120 110 3605 110 100 90 300

    6 100 80 70 250

    7 80 60 40 180

    From Table 1.2, the set of prices (Gh1 to Gh7) the quantities John will consume ranging from 200 to80 units, holding all other things constant constitute Johns individual demand for the commodity.

    Similarly, the same set of prices and the corresponding set of purchases (ranging from 180 to 60 units)by Ama constitute her individual demand for the commodity. Again, the same set of prices and the

    corresponding set of purchases (ranging from 150 to 40 units) by Bob constitute his individual demandfor the commodity. The market demand for the commodity is obtained by summing horizontally, all

    the individuals purchases at each given price (as depicted by the last column of Table 1.2). Themarket demand schedule will be the set of prices and market quantities demanded.

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    Self Assessment Questions

    1. (a) What do economists mean by the demand for a commodity?

    (b) Explain each of the three (3) ways of representing demand.

    2. The demand equation for a product is given as:

    PQD 8.04000!

    Where QD = the quantity demanded of the product in units,

    P = the price of the product.(a) Compute the quantity demanded when the price of the product is:

    (i) GH100 (ii) GH105 (iii) GH120(b) What price should be charged when quantity demanded is:

    (i) 1000 units (ii) 2000 (iii) 1600 units

    3. List and explain five (5) shifters of the demand curve.