Concept of Demand in Managerial Economics

In Economics, use of the word ‘demand’ is made to show the relationship between the prices of a commodity and the amounts of the commodity which consumers want to purchase at those price.

Definition of Demand:

Hibdon defines, “Demand means the various quantities of goods that would be purchased per time period at different prices in a given market.”

Bober defines, “By demand we mean the various quantities of 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 of related goods.”

Demand for product implies:

a) desires to acquire it,

b) willingness to pay for it, and

c) Ability to pay for it.

All three must be checked to identify and establish demand. For example : A poor man’s desires to stay in a five-star hotel room and his willingness to pay rent for that room is not ‘demand’, because he lacks the necessary purchasing power; so it is merely his wishful thinking. Similarly, a miser’s desire for and his ability to pay for a car is not ‘demand’, because he does not have the necessary willingness to pay for a car. One may also come across a well-established person who processes both the willingness and the ability to pay for higher education. But he has really no desire to have it, he pays the fees for a regular cause, and eventually does not attend his classes. Thus, in an economics sense, he does not have a ‘demand’ for higher education degree/diploma.

It should also be noted that the demand for a product–-a commodity or a service–has no meaning unless it is stated with specific reference to the time, its price, price of is related goods, consumers’ income and tastes etc. This is because demand, as is used in Economics, varies with fluctuations in these factors.

To say that demand for an Atlas cycle in India is 60,000 is not meaningful unless it is stated in terms of the year, say 1983 when an Atlas cycle’s price was around Rs. 800, competing cycle’s prices were around the same, a scooter’s prices was around Rs. 5,000. In 1984, the demand for an Atlas cycle could be different if any of the above factors happened to be different. For example, instead of domestic (Indian), market, one may be interested in foreign (abroad) market as well. Naturally the demand estimate will be different. Furthermore, it should be noted that a commodity is defined with reference to its particular quality/brand; if its quality/brand changes, it can be deemed as another commodity.

To sum up, we can say that the demand for a product is the desire for that product backed by willingness as well as ability to pay for it. It is always defined with reference to a particular time, place, price and given values of other variables on which it depends.

Demand Function and Demand Curve

Demand function is a comprehensive formulation which specifies the factors that influence the demand for the product. What can be those factors which affect the demand?

For example,

D_x = D (P_x, P_y, P_z, B, W, A, E, T, U)

Here D_x, stands for demand for item x (say, a car)

P_x, its own price (of the car)

P_y, the price of its substitutes (other brands/models)

P_z, the price of its complements (like petrol)

B, the income (budget) of the purchaser (user/consumer)

W, the wealth of the purchaser

A, the advertisement for the product (car)

E, the price expectation of the user

T, taste or preferences of user

U, all other factors.

Briefly we can state the impact of these determinants, as we observe in normal circumstances:

i) Demand for X is inversely related to its own price. As price rises, the demand tends to fall and vice versa.

ii) The demand for X is also influenced by its related price—of goods related to X. For example, if Y is a substitute of X, then as the price of Y goes up, the demand for X also tends to increase, and vice versa. In the same way, if Z goes up and, therefore, the demand for X tends to go up.

iii) The demand for X is also sensitive to price expectation of the consumer; but here, much would depend on the psychology of the consumer; there may not be any definite relation.

This is speculative demand. When the price of a share is expected to go up, some people may buy more of it in their attempt to make future gains; others may buy less of it, rather may dispose it off, to make some immediate gain. Thus the price expectation effect on demand is not certain.

iv) The income (budget position) of the consumer is another important influence on demand. As income (real purchasing capacity) goes up, people buy more of ‘normal goods’ and less of ‘inferior goods’. Thus income effect on demand may be positive as well as negative. The demand of a person (or a household) may be influenced not only by the level of his own absolute income, but also by relative income—his income relative to his neighbour’s income and his purchase pattern. Thus a household may demand a new set of furniture, because his neighbour has recently renovated his old set of furniture. This is called ‘demonstration effect’.

v) Past income or accumulated savings out of that income and expected future income, its discounted value along with the present income—permanent and transitory—all together determine the nominal stock of wealth of a person. To this, you may also add his current stock of assets and other forms of physical capital; finally adjust this to price level. The real wealth of the consumer, thus computed, will have an influence on his demand. A person may pool all his resources to construct the ground floor of his house. If he has access to some additional resources, he may then construct the first floor rather than buying a flat. Similarly one who has a color TV (rather than a black-and-white one) may demand a V.C.R./V.C.P. This is regarded as the real wealth effect on demand.

vi) Advertisement also affects demand. It is observed that the sales revenue of a firm increases in response to advertisement up to a point. This is promotional effect on demand (sales). Thus

vii) Tastes, preferences, and habits of individuals have a decisive influence on their pattern of demand. Sometimes, even social pressure—customs, traditions and conventions exercise a strong influence on demand. These socio-psychological determinants of demand often defy any theoretical construction; these are non-economic and non-market factors—highly indeterminate. In some cases, the individual reveal his choice (demand) preferences; in some cases, his choice may be strongly ordered. We will revisit these concepts in the next unit.

You may now note that there are various determinants of demand, which may be explicitly taken care of in the form of a demand function. By contrast, a demand curve only considers the price-demand relation, other things (factors) remaining the same. This relationship can be illustrated in the form of a table called demand schedule and the data from the table may be given a diagrammatic representation in the form of a curve. In other words, a generalized demand function is a multivariate function whereas the demand curve is a single variable demand function.

D_x = D(P_x)

In the slope—intercept from, the demand curve which may be stated as

D_x = α + β P_x, where α is the intercept term and β the slope which is negative because of inverse relationship between D_x and P_x.

Suppose, β = (-) 0.5, and α = 10

Then the demand function is : D=10-0.5P