Demand

Is there a particular item in your mind that you would like to purchase, but are unable to afford at the moment? Would it be correct to call this ‘demand’? Contrary to what you might think, it turns out it isn’t correct. Economists use the term ‘demand’ only if it is backed by the capacity to pay for a good or service. Interested? Read on to find out more.

What is the definition of demand?

The most common use of the term ‘demand’ in theory refers to the households’ demand for the goods and services produced by firms. However, to call it ‘demand’, there is one more condition that needs to be satisfied: the demand needs to be ‘effective’. In other words, the consumer must not only be willing to buy a product or a service but also they must be able to pay for it.

Market and individual demand

There is an important difference between the market and the individual demand. Whenever economists use the word ‘demand’, it means, in a majority of cases, ‘market demand’.

The market demand curve represents an aggregation of individuals’ preferences and therefore comprises a sum of all individual demand curves.

The law of demand

The law of demand states that as the price of a good falls, the quantity demanded increases as consumers are willing to buy more units of a good at a lower price. The reverse is also true. As the price of a good rises, the quantity demanded decreases as consumers are willing to buy fewer units of a good at a higher price.

There is an inverse relationship between the price and the demanded quantity of a good. Figure 1 below shows a movement along the demand curve for a price rise and a price fall.

Fig. 1 - Movements along the demand curve

An increase in price from P1 to P2, leads to a decrease in the quantity demanded. Demand falls from Q1 to Q2. A decrease in price from P1 to P3, leads to an increase in the quantity demanded from Q1 to Q3.

The proportion in which the quantity demanded changes based on price changes depends on a number of different factors.

Demand curves

The demand curve is usually drawn as a downward-sloping straight line. It slopes downwards due to the law of demand. In some cases, the curve won’t be straight or linear, hence the name: the demand curve. In this explanation, we will stick to linear demand curves.

Demand curve diagram

The demand curve for a good or service can be drawn on a diagram. Figure 2 below depicts a demand curve for a good. On the vertical axis there is price, and on the horizontal axis, there is quantity demanded.

At price P1, the quantity that consumers are willing to purchase is Q1. As the quantity demanded is inversely proportionate to the price of a good, an increase in the price from P1 to P2 will reduce the quantity that the consumers are willing to buy from Q1 to Q2.

Fig. 2 - The demand curve

Demand vs quantity demanded

In economics, demand is not the same as the quantity demanded. Demand refers to demand over different price levels (the demand curve), while quantity demanded is a single quantity that can be ‘read off’ the demand curve at a particular price level.

Movement along vs parallel shifts in the demand curve

There are various factors that affect the demand curve. Changes in the price will lead to a movement along the demand curve, whilst changes in all other factors will lead to parallel shifts of the demand curve.

Movement along the demand curve

Demand is affected by many factors, but we assume ceteris paribus, and keep these factors constant. Subsequently, any changes in the price of a good will lead to a movement along the demand curve.

When the price increases, the quantity demanded decreases, leading to a movement along the demand curve known as a contraction of demand. Figure 4 below illustrates the contraction of demand.

Fig. 4 - Contraction of demand

When the price decreases, the quantity demanded increases, leading to a movement along the demand curve known as an extension of demand. Figure 5 below illustrates the extension of demand.

Fig. 5 - Extension of demand

Parallel shifts in the demand curve

When non-price factors are held constant while drawing the demand, the demand curve shifts.

A shift to the right is known as an outward shift. It occurs when a change in any factor affecting demand results in an increase in demand such that more quantities are demanded at each price level.

As Figure 6 shows, the initial demand curve D1 shifts in parallel to the right to D2. At a fixed price level P the quantity demanded increases from Q1 to Q2.

Fig. 6 - Outward shift of the demand curve

A shift to the left is known as an inward shift. It occurs when a change in any factor affecting demand results in a decrease in demand such that fewer quantities are demanded at each price level.

As Figure 7 shows, the initial demand curve D1 shifts in parallel to the left to D2. At a fixed price level P the quantity demanded decreases from Q1 to Q2.

Fig. 7 - Inwards shift of the demand curve

Multiple factors affecting the demand curve simultaneously

If there are multiple factors affecting the demand curve at once, the final demand curve will be a sum of all these factors together, taking their magnitude into account.

In Figure 8 below, there is an outward shift in the demand curve. It shifts from D1 to D2, causing an increase in the quantity demanded from Q1 to Q2. But at the same time, there could also be a factor that surpasses demand and causes the demand curve to shift inward. The demand curve shifts from D2 to D3 and the quantity demanded falls from Q2 to Q3. Overall, the resulting shift in the demand curve is an outward shift as D3 is to the right of D1. The magnitude of the increase in demand is greater than the decrease in demand.

Fig. 8 - Multiple factor shift of the demand curve

What are the main demand determinants?

Demand determinants are all the factors, apart from the price, that affect demand. These are held constant when the demand curve is drawn as a function of price.

The main demand determinants

The main demand determinants are:

1. The price of substitutes. If the price of a competing product decreases, the demand curve for its substitute will shift outwards.
2. The price of complements. If the price of a good in joint demand increases, the demand curve for its complement will shift inwards.
3. Consumers’ disposable income. If consumers’ disposable income increases, the demand curve for a good will shift outwards.
4. Consumer preferences and tastes. Tastes and preferences may be influenced by advertising. If a company pursued a successful advertising strategy, the demand curve for their product will shift outwards.
5. Population. An increase in population will mean that there is more demand for a good, which would shift its demand curve outwards.
6. Seasonality. There are some goods such as Christmas decorations, which are in high demand at the end of the year. This leads to an outward shift in their demand. They are in low demand throughout the rest of the year, which leads to an inward shift in their demand.