Demand is the quantity of goods or services consumers will buy at a particular price, at a particular time period. Market demand refers to the sum of individual demand for a good or service. It is assumed that the demand being represented is effective demand- the ability of consumers not just to want, but be able to buy the product. Quantity demanded is the inverse function of price, however there are other factors which influence the level of demand.
Factors influencing individual demand differ from the factors influencing market demand. The price of other goods and services affects the demand for a product. If a product has close substitutes, then the responsiveness of demand to change in price is high. The level of income of an individual also influences demand (especially effective demand). The higher ones income the number of wants to be satisfied. People on higher incomes spend more money on goods and services in absolute terms, but less in proportional terms due to their lower average propensity to consume. Personal preference and trends in fashion also dictate the level of individual demand.
The size of the population, age composition, distribution of people by sex, and socio-economic status influence the market demand. Big businesses study the composition of the population to best establish their most viable market place. Both consumer expectations and the level of technological progress influence market demand.
These factors may affect demand either positively or negatively, resulting in an expansion or contraction of demand. The following model works on the assumption that aside from price all other factors will be kept constant.
When the demand curve shifts to the right or left this results in consumers willing to buy more/less of the product at every possible price. A shift in the demand curve could be resulting from changes in tastes, real income, population size and composition, consumer expectations or technological progress. These factors often work simultaneously to increase or decrease demand. However these factors do not apply similarly to all goods. The demand for generic brand products decreases as income rises.
The price elasticity of demand refers to the responsiveness of quantity demanded to a change in price. Elasticity is represented by the mathematical formula where the change in quantity demanded is divided by the change in price. If the resulting coefficient is less than one, the product is said to be inelastic. Thus, if prices change by a greater proportion than quantity demanded, the product is inelastic. This applies to basic goods and services, necessities such as bread, and habit-forming goods such as cigarettes.
A good is unit elastic if the coefficient of the equation is equal to one. Thus the proportional change in price is equal to the proportional change in quantity demanded. If the proportional change in quantity is greater than the change in price, then the product is said to be elastic. These goods and services are usually quite durable, and high priced such as furniture. There are usually lots of close substitutes, and the industry of the good or service is very competitive. These concepts of elasticity can be visually represented by the gradient or slant of the demand curve. The steeper a curve, the greater the inelasticity, as changes in quantity demanded is quite small.
The elasticity of a product is important to governments and producers in making economic decisions. For producers, the elasticity of a product determines any possible price changes. If a product is elastic for example, a price rise may lead to lower total revenue as demand sharply drops. Over the long term businesses try to overcome elasticity by building consumer goodwill and brand loyalty through advertising. Governments, likewise exploit elasticity to maximise total revenue. Governments usually impose high taxes on relatively inelastic goods such as alcohol and tobacco. Despite the higher cost of the product, the demand remains relatively similar, and thus governments earn more from their taxation policy.
Both demand and elasticity work in conjunction to influence the decision making process of business and government. They are subject to change due to a number of external factors, yet help in maintaining equilibrium in the market.
*expansion and contraction in demand
*shifts in the demand curve