Theories of Demand – Demand Function, Law of Demand

Demand:

Demand refers to the quantity of a goods or services that consumers are willing and able to purchase at a given price over specific period of time.

According to Benham, “the demand for anything at a given price is the amount of it, which will be bought per unit of time at that price.”

Law of Demand:

The law of demand simply expresses the relation between quantity of a commodity demanded and its price. It states the inverse relationship between the price and quantity demanded of a commodity.

According to Law of Demand, “all other things being equal, the quantity demanded of a good or service decreases as its price increases, and vice versa.”

In simpler terms, people tend to buy less of something when its price goes up and more when its price goes down. 

Law of Demand, as described by some eminent economists:

1. According to Bilas, “the law of demand states that other things being equal, the quantity demanded per unit of time will be grater, lower the price and smaller, higher the price.”
2. According to Marshall, “the amount demanded increases with a fall in price and diminishes with a rise in price.”
3. According to Professor Samuelson, “law of demand states that people will buy more at lower prices and buy less at higher prices, other things being constant.”
4. According to Ferguson, “according to law of demand, the quantity demanded varies inversely with price.”

Assumption of Law of Demand:

Some assumptions related to the Law of Demand are as follows: -

1. No change in tastes and preferences.
2. Consumer’s income, both money and real income must remain the same.
3. Prices of other commodities related to the commodity in demand should not change.
4. No change in the wealth of consumers.
5. Substitutes are not discovered.
6. There should be perfect competition in the market.

Importance of Law of Demand:

1. Price determination in perfect competition.
2. Tax imposition.
3. Planning for individual purchase of commodities.
4. Planning of industries regarding the production of output.

Exceptions / Limitations of Law of Demand:

Some exceptions of Law of Demand are as follows: -

1. Giffin Goods / Special type of inferior goods – Sir Giffin pointed out that Law of Demand does not apply to inferior goods. This is called Giffin Paradox. Inferior Goods refer to those goods whose demand decrease with an increase in income. Eg.: toned milk and full cream milk; bread and meat.

2. Veblen Effect / Articles of Distinction – There are some commodities which are purchased by the upper section of the society. If the price of such commodities is increasing, then there will be more demand for them. Eg.: antique items, artistic goods, diamonds etc.

3. Fear of shortage – When there is fear of shortage due to a war like situation or an emergency, people buy more of a commodity given at a higher price, due to panic situation.

4. Expectation of change in price in future / Speculative Effect – If people expect a rise in price in future, they will rush to purchase more of the commodity at present price. If they expect the price to fall, they will purchase less of the commodity to enjoy benefit from the fall in price later.

5. Ignorance on the part of consumers about quality – A lower price commodity may be considered inferior and people buy lesser amount of it. But when its price is more, they consider it to be superior and purchase more.

6. Necessities of Life – In case of the basic necessity like food items, medicines, water, clothes etc. people purchase the same quantity even at high price.

Demand Schedule:

A demand schedule is a table that shows the quantity of a good or service that consumers are willing and able to buy at different prices during a certain time period. Law of Demand is represented through Demand Schedules. They summarise the information on prices and quantity demanded.

Types of Demand Schedule –

The Demand Schedule can be of two types: -

1. Individual Demand Schedule – It refers to the price and amount demanded of a commodity by an individual.

2. Market Demand Schedule – It shows the total quantity demanded that all the consumers in the market are willing and able to buy at all possible prices and, at a given amount of time.

Sample Demand Schedule –

Demand Curve:

If we show the demand schedule graphically, we get the demand curve. The Demand Curve shows the maximum quantities per unit of time that consumers will take at various prices.

The Demand Curve slopes downward from left to right.

According to RG Lipsey, “this curve, which shows the relation between the price of a commodity and the amount of that commodity the consumers wishes to purchase, is called Demand Curve.”

Reasons for downward sloping of the Demand Curve: -

1. Diminishing Marginal Utility – as the price of the commodity falls, the consumer more of the commodity so that this marginal utility falls to equal to the reduced price. If the price rises, the opposite happens.
2. New Consumers – when the price of the commodity is reduced, then many other consumers who were not consuming the commodity earlier will start purchasing it now because it is within their reach now.
3. Income Effect – as the price of the commodity is reduced, he can get the same commodity for less amount. This may be taken to be a rise in his real income, part of the increase in his real income can be used to purchase more of the cheaper commodity. Thus, when the price falls, amount demanded rises and vice-versa.
4. Substitution Effect – when thrice of the commodity falls, it becomes cheaper as compared to other commodities which the consumer is purchasing. As a result, the consumer would like to substitute the cheaper commodity for other commodities, whose prices remains the same.
5. Different Uses of the Commodity – commodities can be put various uses. If the price of the commodity is reduced, it will be put to many other uses where it had not been used earlier and the demand will increase. If its price rises, it will be used only for more important purposes, and the demand will go down.

Demand Function:

A demand function is a mathematical representation of the relationship between the quantity of a good or service that consumers are willing and able to buy (quantity demanded) and the various factors that influence that quantity. 

These factors, known as determinants of demand, include the price of the good, consumer income, prices of related goods, consumer tastes and preferences, and expectations about future prices.

The effect of all factors of demand on the amount demanded for the commodity is called Demand Function.

Demand Function: D(x) = f (Px, Py, I, T, W)

1. D(x) = demand of the commodity x
2. Px = price of the commodity x
3. Py = price of other commodities
4. I = income
5. T = Tastes and Preferences
6. W = wealth of the consumer

When other things remain constant, demand depends on the price of the commodity.

D(x) = f (Px) [simple form].

This demand function is considered as the law of demand.

Factors affecting Demand / Causes of change in Demand:

1. Price of the Commodity – demand is decisively affected by the change in price of the commodity. There is inverse relationship between price and quantity demanded.
2. Income of the Consumer – the demand for a normal commodity goes up with rise in income, and falls down when income falls. Thus, the demand has direct relationship with the income of the consumer.
3. Price of Related Goods – in case of substitutes, for instance, tea and coffee, when coffee becomes cheaper, the consumer substitutes coffee for teas. As a result, the demand for coffee increases and that of tea decreases. In case of complimentary goods, rise in demand for one leads to rise in demand for the other. For instance, car and petrol, when demand for car increases, the demand for petrol also increases.
4. Taste and Preferences of the Consumer – the quantity demanded also depends on consumer’s taste and preferences. It depends upon the cultural and social standard of the consumer. If the consumer develops a liking for a particular commodity, he/she will buy the product at any price. The particular lifestyle also influences the consumers to buy luxurious goods and quality products. For eg.: in past few years, people purchase more of big size cars (SUVs). It is due to change in preference over the time.
5. Advertisements – in the era of modern civilisation, advertisements in TV, radio, newspaper etc. influences the demand for the product and even can change demand pattern of the consumers.
6. Consumer expectations – consumer expectations regarding the future changes in the price of a commodity also affects the demand. If consumers expect their income to rise in near future, they may increase the demand for a commodity now only. If prices are expected to rise in future, the demand for the goods will increase now in the market.

Changes in Demand:

The demand curve shows the inverse relationship between price and quantity demanded, i.e., how the various quantities of a commodity can be sold at different prices assuming other things constant. The effect of change in demand consequent to changes in other things is called “shift in demand schedule.” If the shift is towards right, it is called increase in demand and when there is leftward shift in demand curve, it is called decrease in demand.

Since here price is not the sole factor in determining demand, but changes in other things are equally important. Therefore, in increase and decrease in demand, we keep price as a constant factor and we take other things (income of consumers, shares and debentures) into consideration.

On the other hand, if the changes arise due to change in price, it is called expansion and contraction in demand.

Different kind of changes in demand:

1. Increase in Demand
2. Decrease in Demand
3. Extension of Demand
4. Contraction of Demand

Difference between Increase in Demand and Decrease in Demand:

Difference between Extension of Demand and Contraction of Demand:

Difference between Extension of Demand and Increase in Demand:

Difference between Contraction of Demand and Decrease in Demand:

Note: - in all the differentiations above, do make diagram of each (increase, decrease, extension, contraction) in each distinction, depicting their movement.

Indifference Curve Approach

Indifference Curve (IC):

It is a diagrammatic representation of different sets/combinations of two commodities yielding the same level of satisfaction to the consumer.

For eg.: apples and oranges.

Each point on the IC indicates one combination of two goods.

Properties of Indifference Curve:

1. Slopes downward from left to right.
2. Convex to the origin; IC tends to decline.
3. Higher IC gives higher satisfaction.
4. IC never touches ‘x’ and ‘y’ axis.
5. 2 IC never intersect each other.