Demand and Its Determinants Lecture 6

8/3/2019 Demand and Its Determinants Lecture 6

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Demand and its

determinants

Demand reflects the size and the pattern of market.Business activity is always market-determined. The manufacturers’ inducementto invest in a given line of production islimited by the size of market The demand foroutput and input; the demand for the firm andthe industry; the demand by the consumerand stockist;For example, suppose the firm is aiming at ‘customer service’ not profit. How can itensure quantity and quality of service, without

analyzing what the customer really wants? Orsuppose, the firm is destined to discharge ‘social responsibility’ of business. Can this bedone without evaluating social preferences?Tastes, preferences and choices are allconcepts directly built into the economicconcepts of ‘demand’.



SIGNIFICANCE OF DEMANDANALYSIS

Demand is one of the crucialrequirements for the functioning of any

business enterprise its survival andgrowth.

Information on the size and type of

demand helps management in planning itsrequirements of men, materials,machines, money and what have you.



example

if the demand for a product is subject to temporarybusiness recession, the firm may plan to pile up the stockof unsold products.

If the demand for a product shows a trend towards a

substantial and sustained increase in the long run, the firmmay plan to install additional plant and equipment to meetthe demand on a permanent basis.

If the demand for a firm’s product is falling, while its rival’ssale is increasing, the firm needs to plan its sales tactics;the firm may need to undertake some sales promotionactivity like advertisement.

If the firm’s supply of the product is unable to meet itsexisting demand, the firm may be required to revise itsproduction plan and schedule; or the firm may have toreview its purchase plan for inputs and the suppliers’ response to input requirements by the firm.



The common theme underlying these

examples is that the whole range of planning by the firm–production planning,

inventory planning, cost budgeting,purchase plan, market research, pricingdecision, advertisement budget, profitplanning etc. – call for an analysis of demand. The decision which managementmakes with respect to any functional area,always hinges on an analysis of demand.



Demand analysis seeks to identifyand measure the forces thatdetermine sales; it reflects themarket conditions for the firm’sproduct. Once the demand analysis

is done, the alternative ways of creating, controlling or managingdemand can be inferred.



Activity 1

Briefly answer the following questions :

a) Why is a person interested in knowing thedemand for the shares he has purchased?

……………………………………………………………………………………………………………………………………………………………………………………………………………………………………

b) Why should the Food Corporation of India be

concerned about the demand for foodgrains to bereleased for public distribution system?



CONCEPT OF DEMAND

Demand for product implies:

• a) desires to acquire it,

• b) willingness to pay for it, and

• c) Ability to pay for it.

All three must be checked to identify andestablish demand.



example

A poor man’s desires to stay in a five-star hotelroom and his willingness to pay rent for thatroom is not ‘demand’, because he lacks thenecessary purchasing power; so it is merely his

wishful thinking. Similarly, a miser’s desire forand his ability to pay for a car is not ‘demand’,because he does not have the necessarywillingness to pay for a car.



It should also be noted that thedemand for a product–-a commodityor a service–has no meaning unless

it is stated with specific referenceto the time, its price, price of itsrelated goods, consumers’

income and tastes etc. This isbecause demand, as is used inEconomics, varies with fluctuations in

these factors.



To say that demand for an Atlascycle in India is 60,000 is notmeaningful unless it is stated in

terms of the year, say 1994 when anAtlas cycle’s price was around Rs.800, competing cycle’s prices were

different or same.



To Sum up

demand for a product is thedesire for that product backed bywillingness as well as ability to

pay for it. It is always definedwith reference to a particulartime, place, price and given

values of other variables onwhich it depends.



Activity 2

a) Construct some specific examplesshowing that despite having a ‘desire’, aperson may not have

i) ‘willingness to pay’ : ii) ‘ability to pay’ :

b) What do you mean by :

i) A household’s demand for a T.V. set:

ii) A firm’s demand for labour :

iii) Our Government’s demand for defenceequipment:



Demand Function and DemandCurve

Demand function is a comprehensiveformulation which specifies thefactors that influence the demand for

the product. What can be thosefactors which affect the demand?



For example

Dx = D (Px, Py, Pz, B, W, A, E, T, U)Here Dx, stands for demand for item x (say, acar)

Px, its own price (of the car)Py, the price of its substitutes (otherbrands/models)Pz, the price of its complements (like petrol)B, the income (budget) of the purchaser

(user/consumer)W, the wealth of the purchaserA, the advertisement for the product (car)E, the price expectation of the user

T, taste or preferences of userU, all other factors.



Impact of these determinants

Briefly we can state the impact of thesedeterminants, as we observe in normalcircumstances:

i) Demand for X is inversely related to its own

price. As price rises, the demand tends to fall andvice versa.

ii) The demand for X is also influenced by itsrelated price—of goods related to X. For example,if Y is a substitute of X, then as the price of Y

goes up, the demand for X also tends to increase,and vice versa. In the same way, if Z goes upand, therefore, the demand for X tends to go up.



Psychology of consumer

iii) The demand for X is also sensitive toprice expectation of the consumer; buthere, much would depend on thepsychology of the consumer;

This is speculative demand. When theprice of a share is expected to go up,some people may buy more of it in theirattempt to make future gains; others maybuy less of it, rather may dispose it off, tomake some immediate gain. Thus theprice expectation effect on demand is notcertain.



iv) The income (budget position) of

the consumer It is another important influence on demand. As

income (real purchasing capacity) goes up,people buy more of ‘normal goods’ and less of ‘inferior goods’. Thus income effect on demand

may be positive as well as negative. The demandof a person (or a household) may be influencednot only by the level of his own absolute income,but also by relative income—his income relativeto his neighbour’s income and his purchase

pattern. Thus a household may demand a newset of furniture, because his neighbour hasrecently renovated his old set of furniture. This iscalled ‘demonstration effect’.



v) Past income or accumulated

savings

It determine the nominal stock of wealthof a person. To this, you may also addone’s current stock of assets and other

forms of physical capital; it will have aninfluence on his demand.



vi) Advertisement

It also affects demand. It is observedthat the sales revenue of a firmincreases in response to

advertisement up to a point. This ispromotional effect on demand(sales).



vii) Tastes, preferences, and habits

of individuals

Sometimes, even social pressure—customs, traditions and conventionsexercise a strong influence on demand.These socio-psychological determinants of demand often defy any theoreticalconstruction; these are non-economic andnon-market factors—highly indeterminate.



Demand Function

You may now note that there are variousdeterminants of demand, which may be explicitlytaken care of in the form of a demand function.

In other words, a generalized demand function is

a multivariate function whereas the demandcurve is a single variable demand function.

Dx = D(Px)



TYPES OF DEMAND



i) Direct and Derived Demands

Direct demand refers to demand for goods meant for finalconsumption; it is the demand for consumers’ goods likefood items, readymade garments and houses.

By contrast, derived demand refers to demand for goodswhich are needed for further production; it is the demandfor producers’ goods like industrial raw materials, machine

tools and equipments. Thus the demand for an input orwhat is called a factor of production is a derived demand;its demand depends on the demand for output where theinput enters.

For example, the demand for gas in a fertilizer plantdepends on the amount of fertilizer to be produced and

substitutability between gas and coal as the basis forfertilizer production.



ii) Domestic and IndustrialDemands

The example of the refrigerator can berestated to distinguish between thedemand for domestic consumption and thedemand for industrial use.

Coal has both domestic and industrialdemand, and the distinction is important

from the standpoint of pricing anddistribution of coal.



iii) Autonomous and InducedDemand

When the demand for a product is tied to the purchase of some parent product, its demand is called induced orderived. For example, the demand for cement is inducedby (derived from) the demand for housing. As statedabove, the demand for all producers’ goods is derived orinduced. In addition, even in the realm of consumers’ goods, we may think of induced demand. Consider thecomplementary items like tea and sugar, bread and butteretc. The demand for butter (sugar) may be induced by thepurchase of bread (tea).

Autonomous demand, on the other hand, is not derived orinduced. All direct demand may be loosely calledautonomous.



iv) Perishable and Durable Goods’ Demands

we can classify goods into several categories:single-use consumer goods, single-use producergoods, durable-use consumer goods and durable-use producer’s goods.

Non-durable items are meant for meetingimmediate (current) demand, but durable itemsare designed to meet current as well as futuredemand as they are used over a period of time.Because of continuous use, such assets like

furniture or washing machine, suffer depreciationand thus call for replacement. Thus durablegoods demand has two varieties – replacement of old products and expansion of total stock. Suchdemands fluctuate with business conditions,speculation and price expectations.



v) New and Replacement Demands

If the purchase or acquisition of an item ismeant as an addition to stock, it is a newdemand. If the purchase of an item is meant for

maintaining the old stock of capital/asset, it isreplacement demand. Such replacementexpenditure is to overcome depreciation in theexisting stock.

The demand for spare parts of a machine is

replacement demand, but the demand for thelatest model of a particular machine (say, thelatest generation computer) is a new demand.



vi) Final and IntermediateDemands

This distinction is again based on the typeof goods- final or intermediate. The

demand for semi-finished products,industrial raw materials and similarintermediate goods are all deriveddemands, i.e., induced by the demand for

final goods. In the context of input-outputmodels, such distinction is oftenemployed.



vii) Individual and Market Demands

A market is visited by different consumers, consumerdifferences depending on factors like income, age, etc.They all react differently to the prevailing market price of acommodity. For example, when the price is very high, alow-income buyer may not buy anything, though a highincome buyer may buy something. In such a case, we may

distinguish between the demand of an individual buyer andthat of the market ,which is the aggregate of individuals. You may note that both individual and market demand

schedules (and hence curves, when plotted) obey the law of demand. But the purchasing capacity varies betweenindividuals. For example, A is a high income consumer, B isa middle-income consumer and C is in the low-income

group. This information is useful for personalized service ortarget-group-planning as a part of sales strategyformulation.



viii) Total Market and Segmented Market Demands

Different individual buyers together mayrepresent a given market segment; and severalmarket segments together may represent thetotal market. For example, the Hindustan

Machine Tools may compute the demand for itswatches in the home and foreign marketsseparately; and then aggregate them together toestimate the total market demand for its HMTwatches. This distinction takes care of different

patterns of buying behavior and consumers’ preferences in different segments of the market.Such market segments may be defined in termsof criteria like location, age, income, nationality,and so on



x) Company and IndustryDemands

An industry is the aggregate of firms (companies). Thus theCompany’s demand is similar to an individual demand,whereas the industry’s demand is similar to aggregatedtotal demand.

For example, you may think of the demand for cement

produced by the Cement Corporation of India (i.e., acompany’s demand), or the demand for cement producedby all cement manufacturing units including the CCI (i.e.,an industry’s demand). The determinants of a company’sdemand may not always be the same as those of anindustry’s. The inter-firm differences with regard to

technology, product quality, financial position, market(demand) share, market leadership and competitiveness---- all these are possible explanatory factors. In fact, a clearunderstanding of the relation between company andindustry demands necessitates an understanding of different market structures.

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Demand and Its Determinants Lecture 6