Demand and supply

1. Introduction to demand

DEMAND 
APPLY CONCEPT OF DEMAND IN MARKET ANALYSIS
INTRODUCTION 
Price theory is concerned with the determination of price of any commodity. 
Price is determined at that level where demand for and supply of any commodity are equal to each other. 
In economics, by demand we mean the quantity which the consumer stands ready to buy at varying prices, where all other conditions are constant. 
These conditions are: — 
Income of the consumers 
Taste and preferences of the consumer, and 
Prices of substitute commodities. 
We may distinguish between demand, desire and need. 
A person desires to have a radio set but it is not his demand unless he has purchasing power. Similarly, a sick person needs a tonic. But it is not his demand unless he purchases. 
Demand is the function of the price of any commodity. 
It varies with the variation in price. 
The relation between price and demand can be explained by the help of the LAW OF DEMAND. 
The law of demand says that demand changes inversely with the price.
 It means if the price falls, then demand will increase and vice-versa. 
The Law of Demand may be defined in the words of Alfred Marshall as: — 
"OTHER THINGS BEING EQUAL, WITH A FALL IN PRICE, THE DEMAND FOR THE COMMODITY IS EXTENDED AND WITH A RISE IN THE PRICE, THE DEMAND IS CONTRACTED". 

1.1. More information on demand

2. Assumption of law of demand

ASSUMPTIONS OF LAW OF DEMAND 
We have stated above that the Law of Demand will apply when other things remain the same. 
These other things are called the assumptions of the Law of Demand. 
These assumptions are the following: — 
1. INCOME OF THE CONSUMER 
There should be no change in the incomes of the consumers when price of any commodity changes, because only in this case, law of demand will apply. If due to rise in price level, income also increases at the same time, consumer will not decrease the demand for this commodity, so law will not apply and vice-versa. 
2. TASTE AND PREFERENCES OF THE INDIVIDUAL 
There should be no change in the taste and preferences of the individuals, because if taste of any consumer changes, demand will not increase in spite of fall in price level. 
3. PRICE OF SUBSTITUTE COMMODITIES 
There should be no change in the prices of substitute commodities. If price of any substitute commodity changes the law of demand will not apply. For example, when price of tea rises and at the same time, price of coffee also rises, in that case, demand for tea may remain the same. 
4. FURTHER EXPECTED CHANGES 
If any further change is expected in the price of any commodity, law of demand will not apply. For example, if price of any commodity falls and it is expected that this price will further fall, in this case, the consumers will not purchase greater quantity of this commodity because they will wait for a further fall in price level. 
5. NEW INVENTION 
New goods must not be invented. If new goods are invented, in that case, in spite of a fall in the price of that commodity, demand will not increase. 
EXCEPTIONS OF THE LAW OF DEMAND 
In certain cases, Law of Demand does not apply. There are some demand curves that slope upwards from left to right showing that as prices of a product rise more is demanded and vice versa. These are known as exceptions of Law of Demand. These types of demand curves are known as regressive, exceptional or abnormal demand curves.
These may be also called the limitations of Law of Demand. 
The exceptions of the law of demand are the following: — 
Giffen Goods
In the case of Giffen Goods, Law does not apply be-cause in such cases due to fall in price level, demand decreases and vice-versa. In this case, Demand Curve moves from left to right upward. 
Giffen Goods refer to basic foodstuffs that constitute a high proportion of the budget of low-income families. When the price of a giffen good rises, the proportion of the total income of individuals who consume these giffen goods rises and since such consumers are worse off in real terms, they can no longer afford to consume other more expensive commodities like meat and fruits. To make up for the foods they can no longer afford to buy, they are likely to purchase more of basic foodstuffs. Conversely, when the price of basic foodstuffs falls, they become better off in real terms and are likely to buy more of relatively more expensive foodstuffs and less of basic foodstuffs.
Fear of a more drastic price change in the future
When there is fear of a more drastic price change in the future. This will cause consumers to increase their quantity demanded to avoid paying an even higher price in the future. This situation is often found in the stock exchange where there is often an increase in the demand for the shares of a company if its share price is expected to increase. 

Goods of ostentation (Veblen goods). 
These are commodities whose prices fall in the upper price ranges and that have a snob appeal. The wealthy are usually especially concerned about status, believing that only goods at high prices are worth buying and have the effect of distinguishing them from other consumers. In the case of such commodities, a firm increasing its prices may find that sales of its product increase and at lower prices less of the commodity may be bought as the commodity is rejected as being sub-standard. Consumers often in making comparisons between two similar products with different prices opt for the relatively more expensive one believing it to be better. Examples of goods of ostentation could be expensive perfumes and jewelry

2.1. More information on assumption of law of demand

Shifts in the demand curve versus movements along the demand curve 
When any of the determinants of demand apart from the price change the entire demand curve shifts. 
This is known as a "change in demand" as opposed to a change in the "quantity demanded" which is movement along the same demand curve. 
An increase in demand or a rightward shift of the demand curve is shown in Figure 

Figure 2.6: A rightward shift in the demand curve Figure 2.6 shows a rightward shift in the demand curve from DD to D1D1. An increase in 'demand' is therefore caused by a factor other than the commodity's own price. The commodity's price remains constant at P while the amount purchased has been increased from Q1 to Q2. 
This could be due to one or more of the following factors: 
An increase in the price of a substitute commodity 
A decrease in the price of a complementary commodity
An increase in a household's real disposable income.
A change of tastes or fashion in favour of a commodity
A successful advertising campaign
The increased availability of credit to consumers
Government legislation making the use of certain commodities such as fire extinguishers in cars mandatory. 

3. Determinants of demand

The determinants of demand 
The demand for a product can be considered from the standpoint of either individual demand or market demand. 
The determinants of individual demand are as follows: 
The price of the product. 
When deciding whether or not to buy a particular product, an individual will compare the price of the product with the amount of utility or satisfaction that he or she expects to receive from the product. If the price is considered worth the anticipated utility, the individual will buy the product and if not, he will not buy it. A decrease in the price of a product will probably increase an individual's demand for it since the amount of utility obtained is more likely to be worth the lower price.
 Conversely, a rise in the price of a product will probably result in a fall in demand, as the amount of utility received is less likely to be worth the higher price to be paid. An example of this phenomenon is the hotel industry in Kenya. There is usually an increase in domestic tourism during the low season when many Kenyans consider the lower hotel prices to be worth the level of satisfaction they are receiving. During the high season when the hotel prices are high, many Kenyans do not consider the satisfaction they receive to be worth the higher prices and hence they do not travel. 
If the amount that a consumer is willing and able to purchase changes due to a change in the price, a change in the "quantity demanded" is said to take place. 
If on the other hand the amount that a consumer is willing and able to purchase changes because of a change in any of the determinants of demand other than price then a change in "demand" is said to take place. 

The prices of related goods which may be either substitutes or complements. 
Two goods X and Y are said to be substitutes if a rise in the price of one commodity, say Y, leads to a rise in the demand of the other commodity X. This can be shown in Figure 3.1 
Substitutes are commodities that can be used in place of each other. 
Examples of substitute goods include: 
Butter and margarine
Beef and mutton 
A bus ride and a matatu ride 
A mango and an orange 
CDs and cassettes 

Demand for some commodities can also be affected by changes in the prices of complementary goods. 
Two goods A and B are said to be complementary if a rise in the price of one of the goods, say, A leads to a fall in the demand of another good, say, B. 
Complementary goods are usually jointly demanded in the sense that the use of one requires or is enhanced by the use of the other. 
Examples of complementary goods are: 
Cars and petrol
Hamburgers and chips 
Computers and software 
Tapes and tape recorders 
Bread and margarine

Demand is influenced by changes in disposable real income. 
An individual's level of income can be said to have an important effect on his or her level of demand for most products. 
If income increases the demand for most goods and services will increase especially the demand for better quality goods and services. 
A rise in income may, however, cause the demand for some goods to fall. 

Such commodities are referred to as inferior goods and comprise items like basic foodstuffs and cheaper clothing. 

Demand is influenced by changes in tastes and fashion. Personal tastes play an important role in governing a consumer's demand with certain consumers. for example, preferring to consume imported commodities despite their being much more expensive than local commodities. Tastes may also change according to the season of the year. Prevailing fashions are an important determinant of tastes. The demand for clothing is, for example, particularly susceptible to changes in fashion. 

The level of advertising is also an important determinant of demand. In highly competitive markets, a successful advertising campaign will increase the demand of a particular product while at the same time decreasing the demand for competing products. 

 The availability of credit to consumers. This factor especially affects the demand for durable consumer goods which are often purchased on credit. Changes in the terms on which credit can be obtained will have a marked effect on the demand for certain products like furniture and electrical appliances. For example, a decrease in the availability of credit or the introduction of more stringent credit terms is likely to lead to a reduction in the demand for some durable consumer goods.

Government policy. The government may influence the demand of a given commodity through legislation. 

For example, making it mandatory to wear seat belts, the consumer will then buy more seat belts as a result.

3.1. More information on determinants of demand

Shifts in the demand curve versus movements along the demand curve 
When any of the determinants of demand apart from the price change the entire demand curve shifts. 
This is known as a "change in demand" as opposed to a change in the "quantity demanded" which is movement along the same demand curve. 
An increase in demand or a rightward shift of the demand curve is shown in Figure 

Figure 2.6: A rightward shift in the demand curve Figure 2.6 shows a rightward shift in the demand curve from DD to D1D1. An increase in 'demand' is therefore caused by a factor other than the commodity's own price. The commodity's price remains constant at P while the amount purchased has been increased from Q1 to Q2. 
This could be due to one or more of the following factors: 
An increase in the price of a substitute commodity 
A decrease in the price of a complementary commodity
An increase in a household's real disposable income.
A change of tastes or fashion in favour of a commodity
A successful advertising campaign
The increased availability of credit to consumers
Government legislation making the use of certain commodities such as fire extinguishers in cars mandatory. 
A decrease in demand or a leftward shift of the demand curve can be shown in the diagram below 

Figure 2.7 illustrates a leftward shift in the demand curve from D1D1 to D2D2. This implies that a factor other than the commodity's own price causes a decrease in demand. 
The commodity's price remains constant at P, while the amount purchased has been reduced from Q4 to Q3. 
This could result from one or more of the following factors:
A decrease in the price of a substitute commodity
An increase in the price of a complementary commodity
A decrease in a household's real disposable income
A change in tastes or fashion against a commodity. This could happen if, for example, a commodity goes out of fashion
A decreased availability of credit to consumers
Government legislation limiting the purchase of certain commodities such as firearms or prohibiting the purchase of commodities such as ivory or animal furs. 
A change in any of the determining factors of demand apart from price causes the demand curve to shift either to the left or to the right with more or less being demanded at each of the original prices. 
A movement along the demand curve occurs when a change in the amount purchased results from a change in the commodity's own price.
In the case of normal goods, an increase in the commodity's price leads to a 'contraction' along the demand curve or a decrease in the quantity demanded. 
In the case of normal goods, a decrease in the commodity's price leads to an increase in the quantity demanded or an 'extension' along the demand curve. 

In Figure 2.8 an increase the price from P1 to P2 leads to a reduction in the quantity demanded from Q2 after Q1 which effectively represents a movement from A to B along the demand curve.
The market demand for a commodity 
The market or aggregate demand for a commodity provides the alternative amounts of the commodity demanded per time period, at various alternative prices, by all the individuals in the market. 
Geometrically, the market demand curve for a commodity is obtained by the horizontal summation of all the individuals' demand curves for the commodity. 
The market demand for a commodity depends on all the factors that affect the individual's demand and, in addition, on the number of buyers of the commodity in the market. 
The greater the number of buyers of the commodity in the market, the larger will be the market or aggregate demand. 
Assume that a market for a particular commodity has two consumers, consumer 1 and consumer 2. 
The market demand for the commodity would be attained by summing up the individual demands of consumer 1 and consumer 2.
This can be illustrated in the diagram below:

In Figure 2.9 the market demand curve MD is obtained by summing up the individual quantities demanded by consumer 1 and consumer 2 at different prices. At price P1 consumer 1 demands a quantity Q1 whereas consumer 2 demands a quantity Q2. 
The relevant market demand quantity at price P1 is obtained by summing Q1 and Q2. At price P2 the relevant market demand is (Q3 + Q4).