1
2. THEORY OF DEMAND AND SUPPLY:
THEORY OF DEMAND:
Demand refers to the quantity of a product that consumers are willing and able to buy at a
particular price and over a given period of time. The law of demand states that more is bought at a lower
price than at a higher price. In other words, the law of demand postulates an inverse relationship
between the price and quantity demanded of a commodity, all other factors affecting demand remain
constant (ceteris paribus).
A market demand curve for a certain product is derived from the horizontal summation of all
individuals demand curves at each and every price of the quantity demanded.
Price ($) Consumer A + Consumer B + Consumer C = market demand
1 20 30 40 90
2 18 26 35 79
3 15 18 22 55
4 11 12 19 42
5 7 10 12 29
Thus, by plotting price against quantity demanded from the market schedule, a downward
sloping demand curve from left to right for the entire market is drawn.
Price D
P
P1
D
0 Quantity demanded
Q Q1
A fall in the price from OP to OP1 expands the quantity demanded from OQ to OQ1, whilst a
rise will do the contrary.
, 2
FACTORS INFLUENCING DEMAND (DETERMINANTS):
There are indeed several factors which affect the quantity demanded for a certain product.
1. Change in the price of the commodity itself:
Changes in the price of the commodity will lead to changes in quantity demanded. For instance,
a rise in the price of good X will lead to a fall in quantity demanded for good X. This is because good X
is now more expensive and consumers buy less.
2. Change in real income:
A change in real income means that there is a change in the quantity of goods and services
money income can buy. For most goods, an increased in real income will lead to an increase in demand.
Goods for which demand increases when income increases are called normal goods. In fact, there exists
a direct relationship between income and quantity demanded for normal goods. However, there are some
goods for which demand decreases as income increases. These are called inferior good, for example,
cheap clothing, cheap foodstuff, black and white TV. Hence, there exists an inverse relationship between
income and quantity demanded for inferior goods.
3. Tastes and fashion:
Demand depends on the individual’s taste which is controlled and influenced by advertising and
sales promotion. A change in consumer tastes in favour of a good can increase the demand for that
commodity. This may be attributed to a successful advertising campaign. Similarly, if a commodity is in
fashion, demand will rise.
4. Changes in the prices of complements and substitutes:
Demand for a commodity depends much on the price of its complementary goods. If the price of
a complementary good falls, demand for the product will rise. For example, if the price of car falls,
demand for petrol will increase. This is because more people will buy cars, and hence, more petrol.
Thus, there exists an inverse relationship between demand for a commodity and the price of its
complements.
Demand for a commodity is also influenced by changes in the price of its substitutes. If the price
of substitutes increases, demand for a commodity will also increase. For example, if the price of tea
increases, demand for coffee will also increase. This is because people will buy less tea, and therefore,
they will shift to coffee. Thus, there exists a direct relationship between demand for a commodity and
the price of its substitutes.
, 3
5. Changes in population:
When the size of the total population changes, demand for goods and services would generally
change. An increase in total population would generally lead to an increase in demand. However, the
pattern of demand depends on the composition of the population in terms of age and sex. An increase in
old age people would mean a greater demand for walking sticks, spectacles. An increase in young
people would mean greater demand for CD players. On the other hand, more females in the population
indicate that demand for goods and services consumed by women will rise.
6. Expectation of future changes in price:
Expectations by consumers of future changes in prices would affect demand. For example, if
consumers expect future increases in the price of a commodity, then they will buy more of it now in
order to avoid paying a higher price for it later.
7. Changes in distribution of income:
Demand is also affected by changes in the distribution of income within a society. Incomes could
be redistributed to achieve greater equality of income by taxing the rich and subsidizing the poor. This
would leave the poor with more money, thus, increasing their demand for goods and services.
8. Government policy – income tax:
If government imposes high income tax rate or lowers transfer payments, this would lead to a
fall in disposable incomes, thus reducing demand for the commodities.
9. Saving and Rate of interest:
An individual’s desire to save would influence his demand for commodities. An increase in
savings would lead to a fall in demand since the individual forgoes present consumption in order to save.
But what encourages people to save is the rate of interest. Hence, an increase in rate of interest will
cause demand to fall.
2. THEORY OF DEMAND AND SUPPLY:
THEORY OF DEMAND:
Demand refers to the quantity of a product that consumers are willing and able to buy at a
particular price and over a given period of time. The law of demand states that more is bought at a lower
price than at a higher price. In other words, the law of demand postulates an inverse relationship
between the price and quantity demanded of a commodity, all other factors affecting demand remain
constant (ceteris paribus).
A market demand curve for a certain product is derived from the horizontal summation of all
individuals demand curves at each and every price of the quantity demanded.
Price ($) Consumer A + Consumer B + Consumer C = market demand
1 20 30 40 90
2 18 26 35 79
3 15 18 22 55
4 11 12 19 42
5 7 10 12 29
Thus, by plotting price against quantity demanded from the market schedule, a downward
sloping demand curve from left to right for the entire market is drawn.
Price D
P
P1
D
0 Quantity demanded
Q Q1
A fall in the price from OP to OP1 expands the quantity demanded from OQ to OQ1, whilst a
rise will do the contrary.
, 2
FACTORS INFLUENCING DEMAND (DETERMINANTS):
There are indeed several factors which affect the quantity demanded for a certain product.
1. Change in the price of the commodity itself:
Changes in the price of the commodity will lead to changes in quantity demanded. For instance,
a rise in the price of good X will lead to a fall in quantity demanded for good X. This is because good X
is now more expensive and consumers buy less.
2. Change in real income:
A change in real income means that there is a change in the quantity of goods and services
money income can buy. For most goods, an increased in real income will lead to an increase in demand.
Goods for which demand increases when income increases are called normal goods. In fact, there exists
a direct relationship between income and quantity demanded for normal goods. However, there are some
goods for which demand decreases as income increases. These are called inferior good, for example,
cheap clothing, cheap foodstuff, black and white TV. Hence, there exists an inverse relationship between
income and quantity demanded for inferior goods.
3. Tastes and fashion:
Demand depends on the individual’s taste which is controlled and influenced by advertising and
sales promotion. A change in consumer tastes in favour of a good can increase the demand for that
commodity. This may be attributed to a successful advertising campaign. Similarly, if a commodity is in
fashion, demand will rise.
4. Changes in the prices of complements and substitutes:
Demand for a commodity depends much on the price of its complementary goods. If the price of
a complementary good falls, demand for the product will rise. For example, if the price of car falls,
demand for petrol will increase. This is because more people will buy cars, and hence, more petrol.
Thus, there exists an inverse relationship between demand for a commodity and the price of its
complements.
Demand for a commodity is also influenced by changes in the price of its substitutes. If the price
of substitutes increases, demand for a commodity will also increase. For example, if the price of tea
increases, demand for coffee will also increase. This is because people will buy less tea, and therefore,
they will shift to coffee. Thus, there exists a direct relationship between demand for a commodity and
the price of its substitutes.
, 3
5. Changes in population:
When the size of the total population changes, demand for goods and services would generally
change. An increase in total population would generally lead to an increase in demand. However, the
pattern of demand depends on the composition of the population in terms of age and sex. An increase in
old age people would mean a greater demand for walking sticks, spectacles. An increase in young
people would mean greater demand for CD players. On the other hand, more females in the population
indicate that demand for goods and services consumed by women will rise.
6. Expectation of future changes in price:
Expectations by consumers of future changes in prices would affect demand. For example, if
consumers expect future increases in the price of a commodity, then they will buy more of it now in
order to avoid paying a higher price for it later.
7. Changes in distribution of income:
Demand is also affected by changes in the distribution of income within a society. Incomes could
be redistributed to achieve greater equality of income by taxing the rich and subsidizing the poor. This
would leave the poor with more money, thus, increasing their demand for goods and services.
8. Government policy – income tax:
If government imposes high income tax rate or lowers transfer payments, this would lead to a
fall in disposable incomes, thus reducing demand for the commodities.
9. Saving and Rate of interest:
An individual’s desire to save would influence his demand for commodities. An increase in
savings would lead to a fall in demand since the individual forgoes present consumption in order to save.
But what encourages people to save is the rate of interest. Hence, an increase in rate of interest will
cause demand to fall.
