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THEORY OF DEMAND

  • Demand refers to quantity of the goods and services consumers are able and willing to purchase at the prevailing price in a given period of time.
  • According to Bober “By demand we mean the various quantities of a given commodity or service which consumers would buy in one market in a given period of time at various prices or at various incomes, or at various prices related goods.
  • From the point of view of the seller, the demand price is the average revenue (revenue per unit) or income he expects to earn from the sale of unit of a commodity. Thus, demand price is identical with average revenue (AR). That is why; the demand curve is also drawn as AR curve.
The law of demand states that “The higher the price the lower the demand, the lower the price the higher the demand, other factors remaining constant.
Assumptions of the law of demand
The law of demand operates when all factors affecting demand apart from the price of the commodity are kept constant, therefore the following are the assumptions of the law of demand;-
  1. No change in the level of distribution of income
  2. The consumer’s level of income remains the same
  3. Population size remains unchanged
  4. The prices of other related goods remains the same
  5. There is no change in taste and preferences
  6. The level of advertisement remains the same
  7. The level of income tax remains unchanged.
The Demand Schedule
This is the table that shows different price levels and the corresponding quantities demanded of the commodity
Price of milk per ltr in Tshs.
100
200
300
400
Quantity demanded of milk in ltrs
8
6
4
1
Types of Demand Schedule
  1. Individual demand schedule -This is the type of table which shows different quantities demanded of the commodity by an individual
  2. Market demand schedule– This is the table which shows different total quantities demanded of the commodity at different prices in the whole market.
NOTE. In order to get a market demand schedule we add up individual demand schedules.
Price of milk per ltr
Qty demanded milk by John in ltr
Qty demanded of milk by Jane ltrs
Market demand
100
8
6
14
200
6

4
10
300
4
2
6
400
1
1
2
Assuming there are two buyers in the market for milk, John and Jane, the market demand schedule will be derived as above
The Demand Curve
This is a graphical presentation of the demand schedule showing the relationship between price of the commodity and its demand.
A demand curve has a negative slope and its slopes downwards from left to right showing that as the price decrease the quantity demanded increases, other factors remaining constant.
The demand curve


The demand curve of Jane

The market demand curve
FACTORS AFFECTING DEMAND
Demand of a good or service will be high or low depending on the following factors;-
  1. The price of the commodity.
When the price of the commodity is high the demand will be low, and when the price of low demand will be high, other things being constant.
  1. Population size
The demand on an area with high population will be high while the demand of the area with low population will be low.
  1. Consumer’s level of income
When the consumer’s level of income is high, the demand will be high as the consumer’s ability will be high. However the consumer’s level of income is low, the demand will also be low as the consumer’s ability will be low.
  1. Level of advertisement
The commodity which is extensively advertised will be highly demanded, while the commodity which is not advertised the demand will be low.
  1. Tastes and Preference.
If the commodity is favored, people’s taste and preference, the demand will be high while the commodity which is not favored by people’s tastes and preference the demand will be low.
E.g. the demand of Hi-jab in Saudi Arabia is higher compared to the demand in USA.
  1. The level of Taxation.
When the income tax charged is high, demand will be low and when the income tax is low, demand will be high, in which the disposable personal income will be high.
  1. The price of the substitute goods
If the price of the substitute increases demand of the good will decrease and when the price of the substitute decreases the demand of good in qn will increase.
Substitutes are goods for which one can be used instead of the other e.g. pepsicola and Coca-Cola
  1. Price of the complement
Complement goods which are jointly demanded. These are goods which the demand of one result into demand of the other e.g. Car & petrol.
If the price of the complement is high the demand of the good in question will be low and when the price of the complement is low the demand f the good in question will be high. (e.g. When the price of a car is high, demand for petrol will be low and when the price of the car is low, demand for petrol will be high)
  1. Season
The demand of some goods is seasonal in nature. When the prevailing seasons favors certain goods, its demand will be high and when the prevailing season does not favor a certain good, its demand will be low.
E.g. The demand of woolen jacket in winter will be high compared to the demand of woolen jacket in summer which will be low.
The downward sloping demand curve
The demand curve slopes downwards from left to right (negative slope). The indicates that more is demanded as the price falls and less is demanded when the price increases such negative slope is due to the following factors;-
  1. Income effect
As the price falls real income, increases and therefore consumers can now buy more units of a commodity with the same income. On the other hand when the price increases, real income decrease and therefore consumers can now buy less units with the same income.

2. The law of diminishing marginal utility.

The law of diminishing marginal utility states that,” as more and more units of the commodity is consumed the additional satisfaction goes on declining” therefore more and more units of the commodity will be purchased only if the price is falling.
3. Substitution effect.
When the price of the commodity is low it becomes cheaper in comparison to other competing commodities and the consumers start to substitute this commodity in place of other commodity therefore demand for the commodity increases with the fall in price

4. New customers

When the price of the commodity for new customers join buying that commodity those who could not afford before and hence increase in demand, on the other hand when the price rises, some old customers may stop to purchase the commodity and hence fall in demand.

Uses of the commodity.
  1. A commodity tends to be to more uses or less urgent uses when it becomes cheaper. For example, if water is dear, we shall use it for drinking only, but when it becomes cheaper, we shall use it for washing and other less urgent uses.
Change in quantity demanded and change in demand
Change in quantity demanded.
  • This means increase or decrease in quantity demanded due to change in the price of the commodity, other factors remaining constant
  • It is illustrated through the movement along the same demand curve. Through extension it is increase in Qd and contraction is the decrease in Qd
Let us assume the economy in equilibrium at point “E2” that is at price “OP2” and quantity demand is “OQ2”
Case I (contraction of demand)
Let us assume that the price increase from “OP2” to “OP1” and the quantity demand reduce from “OQ2” to OQ1”. This behavior is referred to as “Contraction of demand”
  • Case II (Extension of demand)
In this case the price decrease from “OP2” to “OP3” due to this the quantity demand increase from “OQ2” to “OQ3” → this is nothing but the extension of demand.
Change in demand
Is the increase or decrease in demand due to change in all the factors affecting demand apart from the price.
It is illustrated through the shift demand curve either to the right (increase in demand) or to the left (decrease in demand).
In the diagram, “dd” is original demand curve. “d
d” is decrease in demand curve. “” is increase in demand curve, “OP” original price OQ – original quantity.
“OP” Original Price “OQ1” Increase in demand.
“OP” Original Price “OQ2” Increase in demand.
REASONS FOR CHANGE IN DEMAND
  1. Change in the consumer’s level of income
When the consumer’s level of income increase, demand will also increase because of the increase in purchasing ability and when the level of income decrease, demand will decrease due to decrease in purchasing ability.
  1. Change in population size
When the population size increases, demand will also increase because of more consumers and the population decrease demand will also decrease due to less consumers.
  1. Change in the level of direct taxes
When the level of direct tax increase, demand will decrease due to the decrease of disposable personal income and when the level of direct taxes decrease, demand will increase due to the increase of disposable personal income.
  1. Expectation or Anticipations
Expectations also bring about a change in demand. If prices are expected to rise in future, the demand for goods will increase now in the present. Similarly, expectation of rising incomes will restrain current purchases and post pone purchases to a future favorable situation.
  1. Change in tastes, preferences and fashion.
When the tastes, preferences & fashion change in favor of certain goods, demand will increase and when the taste, preferences & fashion change against a certain good its demand will decrease.

  1. Change in price of the substitute.
If the price of the substitute increases, the demand of a good in question will increase and if price of the substitute decrease the demand of a good in question will decrease.
  1. Change in the price of the complement.
If the price of the complement increases, the demand of the good in question will decrease. However if the price of the complement decreases, the demand of the good in question will increase.
8. Exceptions of the law of Demand.
There are some situations where the law of demand does not operate. This gives rise to abnormal demand curve (regressive).
Aggressive demand curve has a positive slope indicating that as the price increases quantity demand also increases and vice verse. A situation which is against the law of demand.
The exceptions of the law of demand are the following;-
9. Veblen goods or Article of ostentation
These are the luxurious goods which are demand to emphasize economic status for example expensive cars, expensive mobile phones etc for such goods as the price increase, quantity demand also increases.
  1. Giffen goods (inferior goods)
This can also be called inferior goods, example of such includes;- maize flour. For such goods when the price increases more is bought of them, but as the price fall less is demand of them for a low income earner when the price of beans increase, he will buy more of them by reducing his expenditure on meat.
  1. Fear of the future rise in price.
When the consumers expect the price of the commodity to increase now and then because of factors such as expected shortage they will tend to buy more of the commodity as the price increases
  1. Necessities
These are goods that are necessities of life, eg medicines, food, salt etc.
For such goods a minimum quantity has been purchased by the consumer irrespective of their price because of such a situation, the law of demand is operative to a certain extent.
  1. Ignorance of the consumer.
These are situations where consumers buy goods at a higher price because they are ignorant of lower price for the same goods in other market.
Interrelated Demand
Under inter – related we examine the relationship between goods that are related in one way or another by looking at how change of one will affect demand of the other.
Types of Inter – related Demand
  1. Joint Demand (complementary demand)
This is the demand for two or more commodities which are jointly needed to satisfy a particular need
When P.E.D is elastic a businessman should reduce the price in order to earn more revenue because decrease in price spark off a big increase in demand.


2. To a Monopoly
When carrying out price discrimination the monopolist considers the price elasticity of demand in the market in order to decide in which market to charge a high price and in which to charge low price. In that market where price is elastic, he should charge a low price and in that market where price is inelastic, he should charge a high price.

3. Wage Determination

Elasticity of demand for labor is important in wage determination in such a way that when demand for labor in a firm is inelastic, trade unions and laborers can easily succeed in bargaining for high wages than when the elasticity of demand of labor is elastic.

4. Government in Taxation

The government uses the concept of price elasticity of demand in determining which commodity to levy high tax and which to levy low taxes in order to collect more revenue. Those goods whose demand is price inelastic e.g. Cigarettes, alcohol etc.The government will levy high taxes however for the goods whose demand is price elastic the government will levy law taxes.

5. Determination of incident of a tax

Determination of the incident of a tax between producer and the buyer is on the basis of the price elasticity of demand of the commodity as below.

Px
Dx
Sx
1
500
100
2
400
200
3
300
300
4
200
400
5
100
500


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2 Comments

  • Adolph, June 19, 2023 @ 5:23 pm Reply

    Wow wat a very nice app for studying

  • Mwanahamis, June 5, 2023 @ 5:18 am Reply

    Yah i apreciate ur notes they are well understood but in this topic of theory of demand no graphs which made our study become difficult

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