Contents
What’s it: Market demand is the sum of individual demand in the market at a given price. Economists define demand as our willingness and ability as consumers to buy goods or services for any given price combination.
The more consumers available in the market, the greater the demand. For aggregate figures, it is usually associated with the total population. Therefore, a large population indicates a high demand potential.
By definition, demand has two keywords: willingness and ability to pay. Willingness shows consumers want goods. Ability means being supported by resources (having enough money). So, when we want an item and have the money to buy it, it will lead to demand. But, if we only have wants but no money, or we have money but don’t want the item, that doesn’t lead to demand.
What is the difference between market demand and individual demand?
Individual demand comes from a single consumer. It can come from one individual, company, or other organization, depending on who is the consumer of an item. It represents the quantity it will buy at a certain price point at a certain point in time.
Meanwhile, market demand comes from all consumers, where they are willing to buy goods and have the ability to pay. In other words, it represents the aggregate number of all individual demands in the market.
Several factors affect individual demand. First, of course, price is the main determinant – and because of that, economists use it to explain demand theory. But, in addition to price, other influencing factors are income, tastes, preferences, prices of related goods (substitutes and complements), and future price expectations.
Meanwhile, what determines market demand is also the same as the above factors. However, it is on a wider scale. So, it’s not only about a person’s income, tastes, habits, but also all individuals in the market. So, the next determining factor is the number of consumers in the market. The larger the number of consumers, the higher the market demand.
How to calculate market demand function from individual demand function?
Calculating market demand is basically simple. We just add up all the individual demands. Likewise, with the market demand function, we can apply the same thing.
Let’s take a simple example. There are 3,000 consumers with identical demand functions. Say, it is:
- Qd = 75 – 10 P
So, to determine the market demand function, we can multiply the individual functions by 3,000. It will be:
- Qd x 3,000 = (75 – 10 P) x 3,000
- Qd = 75 – 10 P
However, if the demand function varies between individuals, we cannot apply the above calculation. Instead, we have to add each demand function.
For example, there are three consumers in the market: A, B, and C. The three demand functions for a product are as follows:
- Qda = 70 – 10 P
- Qdb = 80 – 4 P
- Qdc = 30 – P
From this information, we can derive the market demand function by adding up all the individual functions. Thus, the market demand function is:
- Qdm = (70 – 10 P) + (80 – 4 P) + (30 – P) = 180 – 15P
Is the formula above correct? Assume the price (P) is $1. That will yield a total quantity of:
- Qda = 70 – (10 x 1) = 60
- Qdb = 80 – (4 x 1) = 76
- Qdc = 30 – 1 = 29
So, Qdm = 60 + 76 + 29 = 165. Using the market demand formula above, we get 180 – (15 x 1) = 165. Even so, the Qdm equation above is not completely accurate because each individual demand function has different slopes.
Now, say, the price is at $10, then:
- Qda = 70 – (10 x 10) = -30
- Qdb = 80 – (4 x 10) = 40
- Qdc = 30 – 10 = 20
Qda is negative, so Qdm in the above equation does not hold for customer A when $10. Because at that price, he will not buy. Thus, the minimum value of Qda should be equal to zero, as well as Qdb and Qdc.
To reflect such conditions, we must consider the case where each customer’s demand becomes zero. For customer A, it’s at P = $7, for customer B, it’s at P = $20, and for customer C, it’s at P = $30. So that,
Suppose the price is less than $7 (P < 7). In that case, we calculate the market demand function by adding up the demand function of the three individuals because, in that price range, all three will buy the product.
- Qdm = Qda + Qdb + Qdc = 180 – 15P
Meanwhile, if the price is more than or equal to $7 but less than $20 ($7 ≤ P < $20), customer A will not buy, and only customers B and C will. So, we only consider customer demand functions B and C.
- Qdm = Qdb + Qdc = (80 – 4 P) + (30 – P) = 110 – 5 P
Finally, customers A and B will not buy if the price is more than or equal to $20 (P $20). Only customer C buys. So:
- Qdm = Qdc = 30 – P
What are the determinants of market demand?
What affects market demand is the same as what affects individual demand, except for the number of consumers. Price is the main influencing factor of market demand for an item.
In most cases, quantity demanded has a negative relationship with price. When the good’s price rises, its quantity demanded falls. In contrast, the quantity demanded will increase when the price falls. We call them normal goods.
Then, if we draw this relationship onto a graph, the demand curve will have a downward slope (negative slope). And, a price change will change the quantity demanded to move along the curve line.
Meanwhile, in specific cases, such a relationship does not hold. Two examples are:
- Veblen goods: when prices go up, their demand goes up. They are a specific case of luxury goods, where a price increase gives more satisfaction because it reflects a higher image or prestige.
- Giffen goods: when prices fall, their demand falls. They are inferior goods, where lower prices reflect poorer quality.
Then, other determinants of market demand are:
- Income
- Price of substitute goods
- Price of complementary goods
- Future price expectations
- Tastes and preferences
- Number of consumers in the market
Changes in these factors cause changes in demand. And, in the graph, the change shifts the demand curve to the right or left.
Why is market demand important in marketing?
Many businesses conduct market research to calculate potential market demand and its characteristics. It helps them to estimate potential sales as well as profits. When market demand is large, they expect to sell more.
Through research, the company explores information related to product demand in the market. For example, it is not only the number of consumers but also related to the consumer profile in the market. With that data and information, they can design products and develop an appropriate marketing mix.
Then, companies might offer a product by developing a cost leadership strategy. Alternatively, they adopt a differentiation strategy by highlighting uniqueness to drive consumer demand and willingness to pay higher.
Companies usually focus on three variables in conducting market research. They are:
- Market size
- Profitability
- Growth rate
Market size reflects the number of potential customers. The bigger the number, the more attractive a market is. Often, marketers will divide the market into market segments and identify their profitability and growth prospects. Also, they identify the competition level in each segment before selecting the targeted ones.
Profitability is related to how profitable the market is to exploit, considering the company’s resources and capabilities. For example, some markets may offer relatively small profit margins, and consumers tend to be price-conscious. Meanwhile, other markets offer thick profit margins as consumers are willing to pay premium prices.
Growth is usually related to the product life cycle. At the beginning of the cycle, the market promises high growth opportunities. Markets like this are attractive to companies because they can make a lot of money in the future.
On the other hand, mature markets offer lower growth prospects. It will then enter a declining phase. In mature markets, competition is more intense than in the growth phase. Each existing company will try to maintain its dominance. They will try to seize competitors’ customers to grow the business.
