Contents of the Assignment

Demand, law of demand, demand schedule, demand function, demand curve

Page 1 Introduction to demand

Page 2 Demand, Demand Schedule

Page 3 Demand function, Demand curve

Page 4 From individual to market demand curve

Page 5 Price elasticity of demand

Page 6 Elasticity of demand

Page 7 Law of supply

Page 8 Supply and demand relationship

Page 9 Factors effects the demand

Page 10

Demand:
In economics, demand is the desire to own anything and the ability to pay for it and willingness
to pay (see also supply and demand). The term demand signifies the ability or the willingness to
buy a particular commodity at a given point of time. Demand is also defined elsewhere as a
measure of preferences that is weighted by income.

Economists record demand on a demand schedule and plot it on a graph as an inverse (downward
sloping) demand curve. The inverse curve reflects the relationship between price and quantity
demanded: as price decreases, quantity demanded increases. The demand curve is equal to the
marginal utility (benefit) curve. If there are no externalities, the demand curve is also equal to the
social utility (benefit) curve

Demand schedule:

The demand schedule shows the quantity of goods that a consumer would be willing and able to
buy at specific prices under the existing circumstances. Some of the more important factors
affecting demand are the price of the good, the price of related goods, tastes and preferences,
income, and consumer expectations.

Factors affecting demand

• Innumerable factors and circumstances could affect a buyer's willingness or ability to buy a
good. Some of the more common factors are:

Good's own price: The basic demand relationship is between the price of a good and the
quantity supplied. Generally the relationship is negative or inverse 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. The
assumption of an inverse relationship is reasonable and intuitive. If the price of a new
novel is high, a person might decide to borrow the book from the public library rather
than buy it. Or if the price of a new equipment is high a firm may decide to repair
existing equipment rather than replacing it.
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. Close complements behave as a
single good. If the price of the complement goes up the quantity demanded of the other
good goes down. Mathematically, the variable representing the complementary good
would have a negative coefficient. For example, Qd = P - Pg where Q is quantity of
automobiles demanded, P is the price of automobiles and Pg is the price of gasoline. The
other main category of related goods are substitutes. Substitutes are goods that can be
used in place of the primary good. The mathematical relationship between the substitute
and the good in question is negative. If the price of the substitute goes down the demand
for the good in question goes up,
Income: The more money you have the more likely you are to buy a good.
Taste or preferences: The greater the desire to own a good the more likely you are to buy
the good. There is a basic distinction between desire and demand. Desire is a measure of
 the willingness to buy a good. Demand is the willingness and ability to affect one's
desires. It is assumed that tastes and preferences are relatively constant.
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 (Demand increases).

 This list is not exhaustive. All facts and circumstances that a buyer finds relevant to his
willingness or ability to buy goods can affect demand. For example, a person caught in an
unexpected storm is more likely to buy an umbrella than if the weather were bright and
sunny.

Demand function/equation:

The demand function is the mathematical expression of the relationship between demand and
those factors that affect the willingness and ability of a consumer to buy goods. For example, Qd
= f( P,⎮ Prg Y ) is a demand function where P equals price of the good Prg equals the price of
related goods and Y equals income. The vertical bar means that the variables to the right are
being held constant. The demand equation is the explicit mathematical expression of the
functional relationship. For example, Qd = 325 + P - 30 Prg + 1.5Y. 325 is x-intercept; it is the
repository of all non-specified factors that affect demand for the product. P is the price of the
own good. The coefficient is negative in accordance with the law of demand. Prg may be either a
complement or substitute. If a complement, the term would be negative. If a substitute the term
would be positive. Income, Y, has a positive coefficient indicating that the good is a normal
good. If the coefficient was negative the good in question would be an inferior good meaning
that the demand for the good would fall as the consumer's income increased.

Demand curve:

The relationship of price and quantity demanded can be exhibited graphically as the demand
curve. The curve is generally negatively sloped. The curve is two dimensional and depicts the
relationship between two variables only; price and quantity demanded. All other factors affecting
demand are held constant. However, these factors are part of the demand curve and are present in
the intercept. Economics puts the independent variable on the y-axis and the dependent variable
on the x=axis. Consequently, the graphical presentation is of the inverse demand function = P =
f(Q).

Movements versus shifts:

The demand curve is a two dimensional depiction of the relationship between price and quantity
demanded. Movements along the curve occur only if there is a change in quantity demanded
caused by a change in the goods own price. A shift in the demand curve, referred to as a change
in demand, occurs only if a non-price determinant of demand changes. For example, if the price
of a complement were to increase, the demand curve would shift in reflecting a decrease in
demand. The shifted demand curve is a new demand equation. [11]For example assume the
demand for livermush in Western North Carolina is Q = 225 - P + 20Ps - 30Pc + 0.90 Pop +
1.5Y and assume that the price of cornbread increases 40% inducing the demand for livermush to
shift 30% to the left. The new demand equation will be Q = .70(225 - P + 20Ps - 30Pc + 0.90 Pop
+ 1.5Y) = 157.5 = .7P + 14Ps - 21Pc + 0.63 Pop + 1.05Y. Contrast this situation with a change in
the goods own price. If the price of livermush increased by 0.25 per kg. quantity demanded
would decrease by 0.25 units. The change in price of the good would not affect demand.

From individual to market demand curve:

The market demand curve is the horizontal summation of individual consumer demand curves.
Aggregation introduces three additional non price determinants of demand - (1) the number of
consumers (2) "the distribution of tastes among the consumers" and (3) "the distribution of
incomes among consumers of different taste." Thus if the population of consumers increases
ceteris paribus the demand curve will shift out. If the proportion of consumers with a strong
preference for a good increases certeris paribus the demand for the good will change. Finally if
the distribution of income changes is favor of those consumer with a strong preference for the
good in question the demand will shift out. factors that affect individual demand can also affect
aggregate demand. However, net effects must be considered. For example, a good that is a
complement for one person is not necessarily a complement for another. Further the strength of
the relationship would vary among persons.

Price elasticity of demand (PED):

PED is a measure of the sensitivity of the quantity variable, Q, to changes in the price variable,
P. Elasticity answers the question of how much the quantity will change in percentage terms for
a 1% change in the price. The formula for calculating PED is :(∂Q/∂P) (P/Q).

Determinants of PED:

The overriding factor in determining PED is the willingness and ability of consumers after a
price changes to postpone immediate consumption decisions concerning the good and to search
for substitutes (wait and look). The greater the incentive the consumer has to delay consumption
and search for substitutes and the more readily available substitutes are the more elastic the
demand will be. Specific factors are:

Availability of Substitutes: The more choices that are available, the more elastic is the
demand for a good. If the price of Pepsi goes up by 20%, one can always purchase Coke,
7-Up, Dr. Pepper and so forth. One's willingness and ability to postpone the consumption
of Pepsi and get by with a "lesser brand" makes the PED of Pepsi relatively elastic.
Necessity: With a true necessity a consumer has neither the willingness nor the ability to
postpone consumption. There are few or no satisfactory substitutes. Insulin is the ultimate
necessity.
Importance is terms of proportion of Income Spent on a Good: Most consumers have
both the willingness and ability to postpone the purchase of big ticket items. If an item
constitutes a significant portion of one's income, it is worth one's time to search for
 substitutes. A consumer will give more time and thought to the purchase of a $3000
television than a $1 candy bar.
Duration: The more time a consumer has to search for substitute goods, the more elastic
the demand.[20]
Breadth of definition: How specifically the good is defined. For example, the demand for
automobiles is more elastic than the demand for Toyotas which is in turn greater than the
demand for Red Toyota Priuses.
Availability of Information Concerning Substitute Goods: The easier it is for a consumer
to locate the substitute goods, the more willing he will be to undertake the search.

Elasticity along linear demand curve:

The slope of a linear demand curve is constant. The elasticity of demand changes continuously as
one moves down the demand curve. At the point the demand curve intersects the y axis PED is
infinitely elastic.[21] At the point the demand curve intersects the x axis PED is zero. [22]At one
point on the demand curve PED is unitary elastic - PED equals one. Above the point of unitary
elasticity is the elastic range of the demand curve. Below, is the inelastic range. The decline in
elasticity as one moves down the curve is due to the falling P/Q ratio.

Market structure and the demand curve:

In perfectly competitive markets demand, average revenue, marginal revenue and price are
equal. (D = AR = MR = P). The demand curve is perfectly elastic and coincides with the average
and marginal revenue curves.[23] Economic actors are price takers. Perfectly competitive firms
have zero market power; that is, they have no ability to affect the terms and conditions of
exchange. A PC firm's decisions are limited to whether to produce and if so, how much. In non-
competitive markets the demand curve is negatively sloped and there is a separate marginal
revenue curve. A firm in a non-competitive market is a price maker. The firm can decide how
much to produce or what price to charge. [24]

Inverse demand function:

In it standard form the demand equation is q = f(p). That is, quantity demanded is a function of
price. The inverse demand equation, or price equation, treats price as a function of quantity
demanded - p = f(q). To compute the inverse demand function, simply solve for P in the demand
function. For example, if the demand function is Q = 240 - 2P then the inverse demand function
would be P = 120 - .5Q.[25]

The inverse demand function is useful in deriving the total and marginal revenue functions. Total
revenue equals price, P, times quantity, Q, or TR = P×Q. Multiply the inverse demand function
by Q to derive the total revenue function: TR = (120 - .5Q) × Q = 120Q - 0.5Q². The marginal
revenue function is the first derivative of the total revenue function or MR = 120 - Q. Note that
the MR function has the same y-intercept as the inverse demand function, the x-intercept of the
MR function is one-half the value of the demand function and the slope of the MR function is
twice that of the inverse demand function. This relationship holds true for all linear demand
equations. The importance of being able to quickly calculate MR is that the profit-maximizing
conditions for firms regardless of market structure is to produce where marginal revenue equals
marginal cost. To derive MC the first derivative of the total cost function is taken. For example
assume cost, C, equals 420 + 60Q + Q2. then MC = 60 + 2Q[3] Equating MR to MC and solving
for Q gives Q = 20. So 20 is the profit maximizing quantity - to find the profit-maximizing price
simply plug the value of Q into the inverse demand equation and solve for P.

Demand and supply:

Supply and demand is perhaps one of the most fundamental concepts of economics and it is the
backbone of a market economy. Demand refers to how much (quantity) of a product or service is
desired by buyers. The quantity demanded is the amount of a product people are willing to buy at
a certain price; the relationship between price and quantity demanded is known as the demand
relationship. Supply represents how much the market can offer. The quantity supplied refers to
the amount of a certain good producers are willing to supply when receiving a certain price. The
correlation between price and how much of a good or service is supplied to the market is known
as the supply relationship. Price, therefore, is a reflection of supply and demand.

The relationship between demand and supply underlie the forces behind the allocation of
resources. In market economy theories, demand and supply theory will allocate resources in the
most efficient way possible. How? Let us take a closer look at the law of demand and the law of
supply.

The Law of Demand:

The law of demand states that, if all other factors remain equal, the higher the price of a good,
the less people will demand that good. In other words, the higher the price, the lower the quantity
demanded. The amount of a good that buyers purchase at a higher price is less because as the
price of a good goes up, so does the opportunity cost of buying that good. As a result, people will
naturally avoid buying a product that will force them to forgo the consumption of something else
they value more. The chart below shows that the curve is a downward slope.
  

A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation
between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1
and the price will be P1, and so on. The demand relationship curve illustrates the negative
relationship between price and quantity demanded. The higher the price of a good the lower the
quantity demanded (A), and the lower the price, the more the good will be in demand (C).

The Law of Supply:

Like the law of demand, the law of supply demonstrates the quantities that will be sold at a
certain price. But unlike the law of demand, the supply relationship shows an upward slope. This
means that the higher the price, the higher the quantity supplied. Producers supply more at a
higher price because selling a higher quantity at a higher price increases revenue.
A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation
between quantity supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and the
price will be P2, and so on. (To learn how economic factors are used in currency trading, read
Forex Walkthrough: Economics.)

Time and Supply:

Unlike the demand relationship, however, the supply relationship is a factor of time. Time is
important to supply because suppliers must, but cannot always, react quickly to a change in
demand or price. So it is important to try and determine whether a price change that is caused by
demand will be temporary or permanent.

Let's say there's a sudden increase in the demand and price for umbrellas in an unexpected rainy
season; suppliers may simply accommodate demand by using their production equipment more
intensively. If, however, there is a climate change, and the population will need umbrellas year-
round, the change in demand and price will be expected to be  long term; suppliers will have to
change their equipment and production facilities in order to meet the long-term levels of demand.

Supply and Demand Relationship:

Now that we know the laws of supply and demand, let's turn to an example to show how supply
and demand affect price.

Imagine that a special edition CD of your favorite band is released for $20. Because the record
company's previous analysis showed that consumers will not demand CDs at a price higher than
$20, only ten CDs were released because the opportunity cost is too high for suppliers to produce
more. If, however, the ten CDs are demanded by 20 people, the price will subsequently rise
because, according to the demand relationship, as demand increases, so does the price.
Consequently, the rise in price should prompt more CDs to be supplied as the supply relationship
shows that the higher the price, the higher the quantity supplied.

If, however, there are 30 CDs produced and demand is still at 20, the price will not be pushed up
because the supply more than accommodates demand. In fact after the 20 consumers have been
satisfied with their CD purchases, the price of the leftover CDs may drop as CD producers
attempt to sell the remaining ten CDs. The lower price will then make the CD more available to
people who had previously decided that the opportunity cost of buying the CD at $20 was too
high.

Equilibrium:
When supply and demand are equal (i.e. when the supply function and demand function
intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its
most efficient because the amount of goods being supplied is exactly the same as the amount of
goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the
current economic condition. At the given price, suppliers are selling all the goods that they have
produced and consumers are getting all the goods that they are demanding.

As you can see on the chart, equilibrium occurs at the intersection of the demand and supply
curve, which indicates no allocative inefficiency. At this point, the price of the goods will be P*
and the quantity will be Q*. These figures are referred to as equilibrium price and quantity.

In the real market place equilibrium can only ever be reached in theory, so the prices of goods
and services are constantly changing in relation to fluctuations in demand and supply.
Factors which effects demand:
Economists are concerned only with what they describe as effective demand. Demand is only
effective when the desire to buy is combined with the ability. Income is a flow of money over a
period of time. For real income to rise, money income must increase faster than prices.
Disposable income refers to income after compulsory deductions such as tax. A large part of this
is committed to regular payments (rent, mortgage, energy, travel to work, basic necessities). The
residual amount is known as discretionary income and is crucial to firms selling non-necessities.
We also have to consider other factors that will affect demand for a product, such as: the price of
substitutes - rival goods; the price of complements - goods which are jointly demanded, such as
cars and petrol; the availability of credit; the liquidity of the potential buyer; expectations about
the future. Effective demand mans demand backed by the ability to pay. Consequently,
economists are centrally concerned with how the ability to pay is affected by economic forces.
The economic determinants of demand are: (1) Price. As price goes up generally demand goes
down. (2) Income. As real income increases consumer spending habits change. A large part of
one's income is committed to regular payments, the remainder is called discretionary income.
Obviously, as real income increases discretionary income increases. In this case, the general
pattern is for consumers to switch from inferior (basic) to superior (luxury/differentiated) goods.
"Inferior" here does not necessarily mean "bad", but indicates a product which is perceived to
have less quality and to be less distinctive, and therefore to command a lower price. (3) The state
of the economy as a whole - for example, whether the economy is booming, or in recession. This
affects average incomes so the impact on a business is not really distinct from the second point.
In a recession real incomes fall and consumers tend to switch from superior to inferior goods;
this is called "trading down". The opposite process - "trading up" - occurs during (1) booms, (2)
the general increase in living-standards; (3) improvements in income during the lifetime of a
consumer or household; (4) existence of substitutes- that is, the more near alternatives there are
to a product, the more likely consumers are to change from your product. (4) Substitutes. A
substitute is an alternative to a product. For example, a substitute for tinned cat food is fresh raw
meat. The one is not a perfect substitute for the other; however, one brand of tinned cat food can
be almost identical in quality to another, and so constitute a perfect substitute. The more
substitutes there are and the less difference there is between the substitutes, the more sensitive
the demand for a product will be to changes in price. In other words, it is the presence of
substitutes that determines whether the demand for a good will be elastic or inelastic.