DEMAND ANALYSIS
Concept of Demand
Demand refers to the quantity of a product or service that consumers are willing and able to
purchase at various prices, during a specific period of time, ceteris paribus (assuming all other
factors remain constant). It represents the relationship between the price of a good and the
quantity demanded, typically inversely related.
Thus demand shows how much of a product consumers want to buy depending on its price. As
prices decrease, demand generally increases, and vice versa.
Factors Affecting Demand of a Product
Several factors can influence the demand for a product, including:
Price of the product: The primary determinant. Generally, as the price of a product
increases, the quantity demanded decreases (law of demand).
Income of consumers: As consumers' income increases, demand for normal goods typically
increases, and demand for inferior goods may decrease.
Prices of related goods:
o Substitutes: If the price of a substitute (e.g., tea for coffee) increases, the demand for
the original product may increase.
o Complements: If the price of a complement (e.g., printers for computers) increases,
the demand for the original product (computers) may decrease.
Tastes and preferences: Consumer preferences and trends can shift demand. If a product
becomes fashionable or gains popularity, demand will rise.
Expectations of future prices: If consumers expect the price of a product to rise in the
future, they may purchase more of it now, increasing current demand.
Population size: A larger population generally leads to higher demand for most goods.
Government policies: Taxes, subsidies, or regulations can either encourage or reduce
demand for certain products.
Demand Curve Derivation
The demand curve is derived from the demand schedule, which lists the quantity of a good that
consumers are willing to buy at different prices.
Demand Schedule
A demand schedule is a table that shows the relationship between the price of a good and the
quantity demanded for that good at each price level.
Price (P) Quantity Demanded (Q)
10 100
8 120
6 150
4 180
2 200
Demand Curve
A demand curve is a graphical representation of the demand schedule. It typically slopes
downwards from left to right, showing the inverse relationship between price and quantity
demanded. As the price falls, the quantity demanded increases.
Movement Along the Demand Curve
A movement along the demand curve occurs when the price of the product changes, causing a
change in the quantity demanded.
Increase in price: Results in a movement upward along the demand curve (decrease in
quantity demanded).
Decrease in price: Results in a movement downward along the demand curve (increase in
quantity demanded).
This movement reflects the law of demand—price and quantity demanded are inversely related,
all other factors remaining constant.
Shift in the Demand Curve
A shift in the demand curve occurs when factors other than the price of the good change,
causing a change in demand.
Rightward shift: An increase in demand, where consumers are willing to purchase more at
any given price. This can happen due to factors like increased income, changes in consumer
tastes, or a rise in the price of a substitute.
Leftward shift: A decrease in demand, where consumers are willing to purchase less at any
given price. This can happen due to factors like a decrease in income, a decrease in the price
of a substitute, or changes in consumer preferences.
For example:
If the price of gasoline rises, people may demand less gasoline (movement along the
curve).
If consumer incomes rise, people may demand more cars (shift of the demand curve to
the right).
Definition of Elasticity of Demand
Elasticity of demand measures how sensitive the quantity demanded of a good is to a change in
its price. In other words, it shows the responsiveness of demand to changes in factors like price,
income, or the price of related goods.
Mathematically, it is defined as the percentage change in quantity demanded divided by the
percentage change in price:
Elasticity of Demand=% change in Quantity Demanded% change in Price
Price elasticity of demand refers to the responsiveness of quantity demanded to a change in price.
The five types are:
1. Perfectly Elastic Demand: Quantity demanded changes infinitely with any price change.
Example: Identical products in a perfectly competitive market.
2. Elastic Demand: A small price change causes a large change in demand. Elasticity > 1.
Example: Branded clothing or electronics.
3. Unitary Elastic Demand: Percentage change in price equals percentage change in quantity
demanded. Elasticity = 1. Example: Mid-range restaurant meals.
4. Inelastic Demand: Quantity demanded changes slightly with a price change. Elasticity < 1.
Example: Petrol, salt.
5. Perfectly Inelastic Demand: Demand remains constant regardless of price. Elasticity = 0.
Example: Life-saving insulin.
There are different types of elasticity of demand based on how quantity demanded responds to
changes in price or other factors:
1. Price Elasticity of Demand (PED): This measures the responsiveness of quantity demanded
to a change in the price of the good.
2. Income Elasticity of Demand (YED): This measures how quantity demanded changes in
response to a change in consumer income.
3. Cross Elasticity of Demand (XED): This measures how the demand for one good responds
to changes in the price of another related good.
Price Elasticity of Demand (PED)
Price Elasticity of Demand (PED) is the most commonly used measure of elasticity and reflects
how the quantity demanded of a good changes when its price changes. It can be categorized as:
Elastic demand (PED > 1): A small change in price leads to a larger change in quantity
demanded. Example: Luxury goods like expensive electronics.
Inelastic demand (PED < 1): A large change in price leads to a small change in quantity
demanded. Example: Necessities like salt or basic medicine.
Unitary elastic demand (PED = 1): A percentage change in price leads to an equal
percentage change in quantity demanded.
Perfectly elastic demand (PED = ∞): Any price change leads to an infinite change in
quantity demanded (e.g., perfectly competitive markets).
Perfectly inelastic demand (PED = 0): Quantity demanded does not change at all with
changes in price (e.g., life-saving drugs).
Formula for Price Elasticity of Demand:
PED=% Change in Quantity Demanded/% Change in Price
Definition Recap:
Price Elasticity of Demand measures how much the quantity demanded of a good or service
changes in response to a change in price.
PED=% change in quantity demanded% change in price
Factors Influencing Price Elasticity of Demand:
Price Elasticity of Demand (PED) measures how sensitive the quantity demanded of a product is
to a change in its price. Several factors influence whether demand is elastic or inelastic.
Availability of Substitutes greatly affects elasticity. If close substitutes exist, consumers
can easily switch when prices rise, making demand more elastic. For example, if the price
of maize flour increases, consumers may opt for rice or wheat flour.
Necessities vs. Luxuries also play a key role. Necessities such as basic food items and
medicine have inelastic demand since they are essential regardless of price changes.
Luxuries like designer clothes or smartphones are more elastic, as they are not essential.
The proportion of income spent on a product determines how much price changes affect
consumers. Expensive items that consume a large portion of income tend to have elastic
demand, while cheaper goods like salt have inelastic demand.
The time period influences how consumers react. In the short run, demand is often
inelastic as people need time to adjust. In the long run, demand becomes more elastic as
alternatives become available or habits change.
Addictiveness or habitual consumption reduces elasticity. Products like alcohol,
tobacco, or miraa have inelastic demand, as users continue purchasing despite price
increases.
The definition of the market matters. Broadly defined goods (e.g., food) have inelastic
demand, while narrowly defined goods (e.g., soda) are more elastic due to available
substitutes.
Brand loyalty can make demand inelastic, as consumers stick to preferred brands
regardless of price.
Durability and storability influence elasticity. Durable goods like appliances have
elastic demand as purchases can be delayed. Perishable or non-durable goods tend to
have more inelastic demand.
purchases when prices rise = elastic.
Non-durable goods (like fresh milk) → less elastic
Income Elasticity of Demand (YED) measures the responsiveness of the quantity demanded of
a good to a change in consumer income.
Positive YED: If YED > 0, the good is a normal good. Demand increases as income rises
(e.g., luxury items).
Negative YED: If YED < 0, the good is an inferior good. Demand decreases as income rises
(e.g., lower-quality foods).
Luxury goods: If YED > 1, the good is a luxury good and demand increases more than
proportionately as income rises.
Factors Influencing Income Elasticity of Demand
Income Elasticity of Demand (YED) measures the responsiveness of the quantity demanded of a
good or service to changes in consumer income. It helps classify goods as normal or inferior and
indicates how demand patterns shift as income levels change. Several factors influence YED:
1. Nature of the Good: Whether a product is a necessity or luxury greatly affects its
income elasticity. Necessities such as basic food, clothing, and housing typically have
low income elasticity because demand changes little with income variations. In contrast,
luxury goods like private cars, vacations, and designer clothing have high income
elasticity—demand increases significantly as incomes rise.
2. Level of Income: The income level of consumers influences how sensitive they are to
changes. At lower income levels, even small increases can lead to higher demand for
basic goods. However, at higher income levels, the increase in demand is more
pronounced for luxury or non-essential items.
3. Availability of Alternatives: If a product has more attractive or higher-quality
alternatives, demand may shift quickly with income changes. For example, with
increased income, consumers might switch from using public transport to owning
personal cars.
4. Time Period: Over time, the effect of income on demand can change. In the short run,
consumers may not immediately adjust their consumption habits. In the long run, they
are more likely to shift towards higher-quality or luxury goods as income increases.
5. Consumer Preferences and Tastes: Shifting preferences, influenced by culture, trends,
or advertising, also affect how income changes impact demand.
6. Type of Economy: In developing countries, demand for basic goods may be more
income-elastic compared to developed economies, where most basic needs are already
met.
Formula for Income Elasticity of Demand:
YED=% Change in Quantity Demanded /% Change in Income
Cross Elasticity of Demand (XED) measures the responsiveness of the demand for one good to
a change in the price of another related good.
Substitute goods (XED > 0): If the price of one good increases, the demand for a substitute
good also increases. For example, if the price of tea increases, the demand for coffee may
rise.
Complementary goods (XED < 0): If the price of one good increases, the demand for a
complementary good decreases. For example, if the price of printers increases, the demand
for computers might fall.
Formula for Cross Elasticity of Demand:
XED=% Change in Quantity Demanded of Good A% Change in Price of Good
Cross Elasticity of Demand (XED) measures the responsiveness of the quantity demanded for
one good when the price of another good changes. It is especially useful in analyzing the
relationship between substitute goods and complementary goods. Several key factors influence
the magnitude and direction of cross elasticity.
1. Type of Goods (Substitutes or Complements): The most important factor is the
relationship between the goods. Substitute goods (e.g., tea and coffee) have a positive
XED—if the price of coffee increases, demand for tea rises. Complementary goods
(e.g., printers and ink) have a negative XED—if the price of printers increases, the
demand for ink decreases.
2. Closeness of the Relationship: The closer the relationship between two goods, the
greater the cross elasticity. For example, Pepsi and Coca-Cola are close substitutes and
have a high positive XED, while cars and fuel are strong complements with a high
negative XED.
3. Availability of Alternatives: When there are many alternatives in the market, consumers
can easily switch, increasing the XED between similar products.
4. Time Period: In the short run, consumers may not immediately change their
consumption habits, so XED might be low. Over time, however, they may switch
between products, increasing the elasticity.
5. Brand Loyalty: Strong brand loyalty reduces cross elasticity, even between close
substitutes. A consumer loyal to a particular brand may not switch even if a competing
product becomes cheaper.
6. Consumer Preferences: Changing tastes and preferences can influence how sensitive
demand is to changes in the price of related goods.