Demand theory

Definitions

Demand: The ability and willingness to pay a price to purchase a good/service

Quantity demanded: The total amount of goods or services that are demanded at any given point in time.

Ceteris Paribus: The relationship between both the price and the quantity demanded of an

ordinary good.

Effective demand: the demand for a product or service which occurs when purchasers are

constrained in a different market

Notional demand: The demand that occurs when purchasers are not constrained in any other

market

Individual demand: The ability and willingness of a consumer to purchase a good/service

Derived demand: Demand for one good or service occurs as a result of the demand for another

intermediate/final good or service

Types of income

Real. Income of an individual or group after taking into consideration the effects of inflation on purchasing power.

Disposable. Amount of money that households have available for spending and saving after income taxes have been accounted for. Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy.

Discretionary. Amount of an individual’s income that is left for spending, investing or saving after taxes and personal necessities (such as food, shelter, and clothing) have been paid. Discretionary income includes money spent on luxury items, vacations and non-essential goods and services.

Good’s own price. The basic demand relationship is between potential prices of a good and the quantities that would be purchased at those prices. Generally the relationship is negative meaning that an increase in price will induce a decrease in the quantity demanded. This negative relationship is embodied in the downward slope of the consumer demand curve. In other words, the lower the price, the higher demand, ceteris paribus

Price of related goods. The principal related goods are complements and substitutes. A complement is a good that is used with the primary good. Examples include hotdogs and mustard, beer and pretzels, automobiles and gasoline. If the price of the complement goes up, the quantity demanded of the other good goes down. The other main category of related goods is substitutes. Substitutes are goods that can be used in place of the primary good. If the price of the substitute goes down, the demand for the good in question goes down.

Personal Disposable Income. In most cases, the more disposable income (income after tax and receipt of benefits) you have the more likely you buy. Any changes in the level of income tax rates and allowances are therefore likely to result in a change in the quantity of goods/services demanded. In a normal good, demand for a product tends to rise as incomes rise. If the demand tends to fall as incomes rise the product is said to be an inferior good.

Tastes, preference or habits. The greater the desire to own a good the more likely you is to buy the good. There is a basic distinction between desire and demand. Desire is a measure of the willingness to buy a good based on its intrinsic qualities. Demand is the willingness and ability to put one’s desires into effect. It is assumed that tastes and preferences are relatively constant. For example, if consumers around the world are demanding good/services that are environmentally-friendly, the derived demand for those goods/services will increase. Advertising also plays a part. Persuasive and informative advertising tends to increase brand awareness and as a result, increase the demand for the good/service.

Consumer expectations about future prices and income. If a consumer believes that the price of the good will be higher in the future he is more likely to purchase the good now. If the consumer expects that her income will be higher in the future the consumer may buy the good now. In other words positive expectations about future income may encourage present consumption.

Seasonal demand. A hot summer can boost sales of cold drinks and ices while a cold winter can boost the demand for fuel for heating.

Higher interest rates can increase the demand for savings schemes but reduce the amount of money people want to borrow, including mortgages for house purchases.

Population change. An increase in population tends to increase the demand for many goods and services in a country. For example, in a country where there is an aging population, demand for walking sticks and retirement homes may increase.

Location of consumers. There is unequal distribution of income and wealth in different areas of the country. In a richer area of the country, the demand for superior goods will be higher in an area of low income.