Demand in Economics: Meaning and Determinants

What’s it: Demand refers to our willingness and ability – as consumers – to buy a product or service. Two keywords we need to remember: willingness and ability to buy.

Both keywords must be present for the demand to occur. For example, we want an item. But, we do not have the ability to buy (not having enough money, for example). So, it doesn’t generate demand because we can’t possibly afford it.

In other cases, we have enough money. But, we don’t have the will to buy. It also doesn’t generate demand. Even though we have money, we don’t need or want them.

What is the difference between individual demand and market demand?

Individual demand represents the quantity demanded by a person for any given price. Meanwhile, market demand is the sum of individual demand in the market.

Hence, both have similar determinants. Price is the most important – so economists use it to explain demand theory. Other factors are income, tastes and preferences, and prices of related goods. The exception is the population or number of consumers in the market. Thus, it only affects market demand, but not individual demand.

In other words, market demand has the same determinants as individual demand. But that’s on a broader scale. So, for example, a change in taste is influenced not only by one person but by all people in the market or society.

What is the law of demand?

The law of demand is an important principle in microeconomics. It states that the quantity demanded for a good is inversely proportional to its price. Thus, if the price falls, the quantity demanded increases. On the other hand, if the price increases, the quantity demanded decreases.

The law applies to most goods. They are normal goods. When the price of an item drops, we want it more and more.

The exceptions are for Veblen goods and Giffen goods. Veblen goods are luxury goods whose rising prices make them more attractive to consumers. It increases their satisfaction because, for example, it increases their prestige or image.

Meanwhile, Veblen goods are inferior goods, where a decrease in price makes consumers avoid them even more. Second-hand clothes are a good example of Giffen goods. When the price falls, its demand will fall because consumers perceive a lower price indicating poorer quality.

What is a demand curve?

The demand curve is a graphic representing the law of demand. It has two dimensions. The x-axis represents the quantity demanded. Meanwhile, the y-axis represents the product’s price.

The curve has a downward slope, indicating a negative relationship between price and quantity demanded. When the price falls, more quantity is demanded. On the other hand, increased price causes less quantity demanded.

Movement along the curve Vs a shift in the curve

Meanwhile, if we translate the law into a mathematical equation, it will produce a demand function. The most common model is a linear model, where the formula can be written as follows:

Qd = α – βp

Qd is the quantity demanded, α is a constant or intercept, and p is the price. Then, β explains how much impact a price change has on the quantity demanded. For example, if the price increases by $1, the quantity demanded will decrease by β.

Please remember, economists use price as a determining factor. That means, its change will cause the quantity demanded to change and move along the curve line.

Other factors not explained in the curve – such as income and tastes – can also affect demand. Their changes do make the quantity also change. But, it doesn’t happen along the curve. Instead, it shifts the curve to the right or to the left.

Changes in demand and changes in quantity demanded

Economists distinguish the terms “change in demand” from “change in quantity demanded.” They use changes in quantity demanded to explain the effect of changes in the own price of a good. Meanwhile, other factors such as income and the price of related goods cause changes in demand.

Take the demand for tea as an example and assume coffee is the substitute. When the price of tea changes, it causes a change in the quantity demanded of tea. Specifically, we say, “the quantity demanded will fall as the price rises.”

On the other hand, a change in the price of coffee causes a change in the demand for tea. So, for example, if the price rises, it causes consumers to increase the demand for tea as a substitute.

Likewise, when a consumer’s income changes, it causes a “change in demand,” not a “change in the quantity demanded.”

The next implication is the quantity on the demand curve. Changes in quantity demanded to occur along the curve. The curve does not move (e.g., from the graph above, it remains at DC1).

Conversely, a change in demand causes quantity to change, and the curve moves to the right or left (in the graph, from DC1 to DC2). So, for example, an increase in the price of coffee above will cause the tea demand curve to move to the right (more quantity).

What are the demand determinants?

As economists explain demand theory, its own price is the most important factor in the demand for a good. For example, the demand for tea is determined primarily by its price. Likewise, the demand for cars is highly dependent on the price.

However, there are other determining factors. They include:

Income
Tastes and preferences
Price of substitute goods
Price of complementary goods
Future price expectations
Number of consumers in the market

Usually, economists consider these factors unchanged or ceteris paribus. Such an assumption makes it easy to explain the relationship between price and quantity demanded.

Note: We use the term own-price to distinguish it from the price of related goods (substitution and complement). The first affects the quantity demanded and occurs along the curve line. The second affects demand and shifts the curve to the right or to the left.

Income

For most of our everyday goods, their demand increases as consumer incomes rise. Conversely, when income decreases, the demand for them decreases. We call them normal goods.

Economists then classify normal goods into two categories: luxury goods and necessities. The two differ in their responsiveness to changes in income. Luxury goods are elastic, where, for example, a 5% increase in income will increase their demand by more than 5%. Meanwhile, it increased demand by less than 5% for necessities but remained positive.

In a specific case, an increase in income causes the demand for an item to fall. We call it inferior goods.

Tastes and preferences

Positive changes in tastes or preferences increase demand. Otherwise, it lowers demand. For example, consumers are becoming increasingly health-conscious, encouraging them to consume more low-sugar foods. Or they ask for more organic food.

Price of substitute goods

Substitutes satisfy the same need. Thus, when the price of a good rises, consumers will switch to a substitute good, reducing demand for it. For example, Coca-Cola is a substitute for Pepsi. Thus, when the price of Coca-cola rises, consumers turn to Pepsi. The opposite effect applies when prices fall.

Price of complementary goods

Complementary goods are other categories of related goods besides substitute goods. For example, two items complement each other if we use them together. Or, we need the complement when using an item.

Thus, when the price of the complement falls, the demand for the good will increase. Take cars and gasoline as examples. When car prices fall, demand for gasoline increases as more people buys new cars.

Future price expectations

Future price expectations also affect current demand. For example, consumers expect the price of a product to increase in the next month. Hence, they are likely asking for more now, before prices go higher.

Conversely, if prices in the month are expected to fall, consumers will delay buying now. So, they can save dollars.

Number of consumers in the market

The total population reflects how much potential demand is. The bigger the population, the more consumers. More consumers mean more demand in the market.

Demand in Economics: Meaning and Determinants

What is the difference between individual demand and market demand?

What is the law of demand?

What is a demand curve?