Chapter 2

Demand Analysis

Abstract
For the entire business activities, demand analysis is very important. That is why,
before commencing any business demand analysis plays a vital role for rational
entrepreneur, because the main concern is to maximize the profit with fixed
resources. It also helps the entrepreneur in decision making regarding his distribution
of resources. Here, in this chapter meticulous analysis of demand is given.
Determinants of demand of the goods are briefly explained. Law of demand and its
importance in economics, and demand curve are also described. Types of demand i.e.,
income, price and cross are briefly annotated.
Keywords: Demand, resources, goods, price, profit
2.

2.1. Determinants of Demand

The word “demand” replace the meaning ‘to the want’, supported by the essential
ability to pay. The quantity of any good bought per unit of time at the given price is
the demand of that good at given price level. Three aspects of demand are as follows,
Quantity demanded at a certain price level, quantity demanded at a price during a
given time and quantity desired per unit of time
There are multiple factors for determination of scope and quantity of demand.
Function is basically used to describe such "determined" and "determinant"
association (Petersen et al. 2006). To illustrate, we say, quantity demanded of a
product is a function of its price,
Q = f (P)
Here, Q denotes amount demanded, f shows function and P denotes the price of good.
Various significant factors of demand are as,

2.1.1. Price of the Goods

The basic and leading determining factor of demand for a commodity i s price.
Typically, price and quantity demanded shows inverse relationship with each other.
As price goes up, quantity demanded for good will decreases and vice versa.
9
10 M. Ashfaq, S.A.A. Naqvi and S.A. Adil

2.1.2. Income of the Buyer

Quantity demanded will also be influenced with buyer’s income level. Mostly, it is
true that when income rises quantity demanded will also goes up.

2.1.3. Prices of Related Goods

Demand for a product is also effected due to products. Often, demand for item rises
when the price of related good increases. We call these inter-related goods as,”
substitutes”, e.g. T.V. and LCD. But on the other hand, demand for commodity will
decreases as the price of associated product rises. These products which are unified
called complements, e.g. car and petrol, pen and ink, cart and horse, etc.

2.1.4. Tastes of the Buyer

Buyer’s taste has significant influence in case of demand. Consumer can’t purchase
commodity until, it is low priced and valuable, if it is not according to his taste.
Contrarily, a consumer may buy a commodity, if it is preferred by him, even though
it is expensive.

2.1.5. Seasons Prevailing at the Time of Purchase

Season plays a vital on demand for a product. Like, demand for woolen clothes rises
in winter season and demand for cold drinks rises in summer season.

2.1.6. Advertisement and Sales promotion

Advertisement a t Facebook and on other online sources has a substantial effect on
the demand for the good and thereby improves sales. The requisite to have precision
in demand analysis makes us adopt a 'ceteris paribus' assumption, i.e. all factors
other than one remains unchanged. This facilitates us to deliberate the relation
between demand and each of the variable factors considered in isolation.

2.2. Law of Demand

As different factors that affect the demand and price is the most important one. This
law is the association among price and quantity and it is stated as, the greater the
amount to be sold, the smaller must be the price at which it is offered in order that it
may be.
The quantity demanded will rise with the fall of prices and will decrease with the rise
in prices (Marshall 2009). Other things remain same, at lower price quantity
demanded will be higher than at a higher price level. Here, other things include taste,
fashion, hobbies etc., and these do not change in a particular time. Law of demand
depicts the opposite relation among price and quantity demand of a good. However,
this law is only an indicative and not a quantitative statement (Nicholson and
Snyder 1972). Assuming, the consumer is rational in purchasing behavior, according
to the above-mentioned schedule. When price is Rs. 50 per kg apple consumer
2. Demand Analysis 11

demand will be 1 kg; at price Rs. 40 per unit, consumer requires 2 kg of apples, and
so on. The Table 2.1 indicates an inverse relationship between price and demand.

Table 2.1 Demand of a Consumer for apples

Price of Apple in Rs. / Unit Quantity Demanded in kgs

50 1
40 2
30 3
20 4

2.2.1. Importance of the Law of Demand

Law of demand is important for the sake of decision making and sound planning of
business. Production planning in any organization depends on the precise demand
analysis. It also has theoretical and practical benefits. (Gupta et al. 2004).
[Link]. Price Determination
Monopolist fixes the price of the product through law of demand. He also decides
about the most beneficial quantity of output.
[Link]. Useful to Government
This law also helps to make judgment about tax reforms and policies for the
concerned departments like, finance.
[Link]. Useful to Farmers
Through this law, farmer judge how good or bad crops will affect his economic
conditions. If the demand can’t go up of the season with a good crop at the end of the
season, price will go down. Then the other members of the society get benefits.
[Link]. In the Field of Planning
The demand schedule plays a significant role for planning of individual items and
industries. In these cases, the main thing is to judge either variation in price of a
product has a significant effect on product’s demand inside or outside the nation.

2.3. Demand Curve

Demand curve can be plotted by using the data of Table 2.1. For this, we take quantity
demanded on horizontal or x-axis and hypothetical price on vertical or Y-axis. By
joining all the points according to the given schedule, we get a smooth demand curve.
12 M. Ashfaq, S.A.A. Naqvi and S.A. Adil

Fig. 2.1 The demand curve

Demand curve is slopping downward which indicates opposite relationship among

price and quantity demanded for commodity (Figure 2.1).

2.4. Market Demand

Market demand shows the overall quantity bought by all individuals at altered
hypothetical prices. It is an aggregate of individual’s demand. It is obtained by
summing up the quantities demanded by everyone in the market at particular price.
The schedule present the chain of quantity demanded by all individuals of a
commodity in a market at various prices is called Market Demand (Varian 1992).
Curve is obtained by presenting data on a two-dimensional graph. From seller’s point
of view market demand curve shows different quantities that he can sell at various
price levels. Individual’s demand curve is slopping downward and by adding up
individual’s demand curve we get market demand curve that is also downward
slopping.
Market demand shows the overall quantity bought by the individual’s at different
hypothetical prices, it’s the aggregate of individual’s demand. It is calculated by
adding up all the quantities demanded by every person at particular price in the
market.
2. Demand Analysis 13

2.5. Shifts in Demand Curve

The association of price and demand for a commodity is very significant but manager
of any organization must know about the change of demand function (or curve). For
many products, there is a little effect in the quantity demanded due to change in the
price level. Demand is also affected by other factors like income, taste, and fashion
and business activity. Thus, shift in demand have a greater importance to the decision
maker of a firm rather than movement along the demand curve. As we clearly know,
about the difference between the shift and movement of demand curve along the
same curve.

Fig. 2.2(a) Movement along the same demand curve

When price of a commodity varies, ceteris paribus, the quantity demanded of the
commodity varies. When the demand varies with the change in price rather than other
factors, it is called extension or contraction of demand. Which is shown in fig 2.2 (a),
by movement along the same demand line. Price decreases from OP1 to OP2 and
demand rises from OM1 to OM2. At this point, demand of a product has extended
or expanded. Which is shown by change in demand curve from point A to B.
Conversely, if price goes up from OP2 to OP1, demand drops from OM2 to OM1.
Here, the quantity demanded for the product is contracted, which is represented in
the diagram from point B to A along the curve.
When demand curve shifts due to other determinants, such as changes in income,
fashion, tastes, etc. and ceteris paribus assumption is relaxed. This is called increase
or decrease in demand (rise or fall in demand). This change is shown in diagram 2.2
(b). OM1 quantity is demanded at a price of OP1. If, there is an increase in income
more product is demanded, i.e., OM2 at a price of OP1. Note, OM2 is due to the new
demand curve D2D2. But, due to decrease in income level, product’s demand will
also decrease. Thus, rise or fall in demand along shift in demand curve is different
from the extension and contraction of demand.
14 M. Ashfaq, S.A.A. Naqvi and S.A. Adil

Fig. 2.2b Shifts in demand curve

Reasons of changes (shift) in demand are:

1) Income of consumer may change
2) Changes in consumer’s taste
3) Alteration in price of related products (substitutes and complements)
4) Variation in exogenous determinants like fashion, social structure, etc

2.6. Why the Demand Curve Slopes Downward or

Reasons for the Law of Demand
The demand line is negatively sloped but its slope is steeper in few cases, which
depicts that increase in demand due to decrease in price level, and decrease with rise
in price level. Various causes of inverse relationship are discussed in the following
lines.

2.6.1. Law of Diminishing Marginal Utility

This law states that when consumer consumes increasingly units of the product,
utility obtained from every forthcoming unit declines. Which indicates that with the
decline in price of commodity, individuals’ purchase more commodities until
marginal utility obtained from good is equal to the price of product and vice-versa.
2. Demand Analysis 15

2.6.2. Substitution Effect

It is responsible for downward sloping of demand curve. When the price of product
declines, buyers purchase more of that product, while the price of substitute does not
change. For example, tea and coffee are substituted product. If price of tea falls,
consumer may substitute tea with coffee. Consequently, with a reduction in price, the
demand will rise due to favorable substitution effect. Alternatively, with the increase
in price level, the demand goes down due to unfavorable substitution effect. This
is the application of law of demand.

2.6.3. Income Effect

It is another major cause of downward slope of demand curve. With the fall in price
of product, real income of buyer rises. Real income is determined in terms of products
and services. For example, an individual has Rs. 20, he wishes to purchase oranges
whose price is Rs. 20 per dozen. It depicts that consumer may purchase one dozen
of oranges within his income. When price of oranges falls to Rs. 15 per dozen, it
leads to upsurge his real income by Rs 5. In this way, consumer will buy extra
oranges or can purchase any other product.

2.6.4. New Consumers

Usually, when the price of any product falls, the ones who can’t consume that
commodity before, will buy the product. Due to which, aggregate market demand
shifts upward. For example, if price of LCD falls, poor can also buy LCD. Finally,
the total demand of LCD’s goes up.

2.6.5. Several Uses

Some products can be put for several uses, such commodities are used for important
purposes, when their price goes up and that is why, their demand will be limited.
Further, when price falls, product’s demand will be extended. Coal is the best
example for this. When its price goes up, it is used for important purposes and when
its price falls, it is used for many other purposes.

2.6.6. Psychological Effects

It is natural and psychological phenomena that when the of product decreases people
buy more of that product. Therefore, price and demand working opposite to each
other. For instance, with the decrease in price level of silk clothes, its demand
increases.

2.7. Exceptions to the Law of Demand

In some cases, law of demand is not applicable. Like, when the price of product falls,
people buy less, and when the price goes up people buy more. In this case, shape of
16 M. Ashfaq, S.A.A. Naqvi and S.A. Adil

demand curve will be completely different than sloping downward. The exceptions
are as follows,

2.7.1. Conspicuous Goods

Sometimes, consumers measure the worth of commodity on the basis of its price, i.e.,
if the product is costly they think it has high utility. Oftenly, diamond is an example
of precious goods. Diamonds have high price and higher is the prestige value attached
to them, ultimately these have higher demand.

2.7.2. Giffen Goods

Giffen, was surprised to find out that British workers buy more bread, when price is
high. It was totally against the law of demand (Dougan 1982). It can be attributed to
price, when price of bread increases, people who consume meat and other expensive
items shifts towards it because his purchasing power decreases. Even, the price of
bread was high then before people consumes more and not less.
Such goods which show direct relationship between price demands are called
Giffen goods. Generally, consumer consider those products as inferior which occupy
substantial space in his budget. Examples are Bajra, wheat and low quality rice.

2.7.3. Future Expectations about Prices

Sometimes, consumer buys more quantity of product when the price of product rises
because he thinks that its price in future will increase more. For example, when
t h e r e i s scarcity of food, people think that the price of food grains will go up in
the future. They require more quantity of food as their price increases. But, it is not
the law of demand, which is invalidated but there is an alteration in one of the
determinant which was held remains same, while deriving the law of demand,
namely change in the price expectations of the people.

2.7.4. Market-Conditions
The law is applicable when we assume that consumer is rational and have complete
knowledge about market conditions. However, occasionally buyer is irrational and
he does impulsive buying without calculations concerning price and usefulness of
the commodities and in such circumstances law of demand fails. Likewise, in
practice, an individual demands higher amount of product at a high price level.
Because, consumer is unaware about the ruling price of product. In this situation, law
will be invalid. If the demand for a product fails due to other factors, law of demand
will also fail. The inverse relationship between price and demand will not hold if
demand changes due to income, taste, fashion, hobbies, price of related items.

2.8. Types of Demand

There are three types of demand.
2. Demand Analysis 17

2.8.1. Price Demand

With other factors remains constant, consumer buy various quantities of product at a
particular price level. As, we are related with price demand only. So, it is discussed
earlier in the law of demand.

Fig. 2.3 Price demand curve

2.8.2. Income Demand

It denotes to the different quantities that a buyer can buy at a given time at different
income levels. Generally, there is a direct or positive relationship between income
and demand. When income increase demand for product will also increases and vice
versa.

2.8.3. Cross Demand

Price of one commodity related to the demand of other commodity is called cross
demand. Substitutes are those products which are used in place of each other like tea
and coffee. In these cases, relationship between priced and demand is positive. Which
shows that when price of one product increase, the demand for the other product will
also increase and vice versa. Complementary goods are those that are used jointly to
satisfy wants. In simple words, these goods are incomplete without one another.
These products are used simultaneously with each other like petrol and car.
Ball and Bat, USB and laptop, etc. In case of these types of products, price and
demand is negatively related with each other. Which means when price of one
product raises demand for another product will falls.
18 M. Ashfaq, S.A.A. Naqvi and S.A. Adil

Fig. 2.4 Income demand curve

Fig. 2.5 Cross Demand Curves

2.8.4. Extension and Contraction of Demand

When quantity demanded of a product changes only due to price (other factors
remains unchanged) is known as extension or contraction of demand. When demand
increase due to fall in price is called extension of demand and fall in demand because
of raise in price is known as contraction of demand. Extension and contraction of
demand depicts the change in original demand curve. These are shown in the Figure
2.6
2. Demand Analysis 19

Fig. 2.6 Extension and Contraction of Demand

Downward movement of demand curve of DD from point “a” to point “c” shows the
extension of demand with rise of price up to OP1, demand will decrease up to OQ2.
This is upward change along the demand curve from point “a” to “b” is known as
contraction of demand. The demand for a commodity may change without change in
price but due to change in other factors. It is called rise and fall in demand. There
may be change in demand due to change in population, change in taste of people,
change in distribution or change in quantity of money.

2.8.5. Other Types of Demand

[Link]. Joint Demand
When various commodities are required for single purpose or for achieving a definite
desire, this is a case of joint demand. Milk, sugar and tea are jointly demanded to
make tea. Similarly, for writing purpose, we demand paper, pen, and ink. So, demand
for these types of commodities together are known as the joint demand. Land, labor,
capital and organization is also an example of joint demand.
[Link]. Composite Demand
Demand for single product used in several ways is composite demand. For example;
electricity is used for lighting, heating, for running the engine, for the fans etc.
Similarly, coal is used in industries, for cooking etc.
[Link]. Direct and Derived Demand
Demand for a product used for direct consumption, i.e., for ultimate project is called
direct demand. It is also known as autonomous demand. Here, demand is not
concerned to the buying of key product. When a product is wanted due to the demand
of other good or service, it is called derived or induced demand. For example,
20 M. Ashfaq, S.A.A. Naqvi and S.A. Adil

demand for cement is derived from the demand for building construction; demand
for tires is derived from the demand for cars or motorbike, etc.

Box 2.1 Winner-Take-All

"There is a concept by Robert Frank “winner-take-all”. This concept explains
the concentration of wealth in a few hands. It can be explained considering
the superstars of the time. Demand of the talent in film industry is based on
the performance of the actor/musician. If a star has excellent performance
people will demand their performance. Moreover, industries use their talent
for the advertisement of their products because consumer prefers the stars
products. Thus, it can be concluded that top talented people in the economy
can achieve a greater share in the total revenue in the economy”.
Source: Hacker and Pierson (2011)

References
Dougan, W.R. (1982). Giffen goods and the law of demand. J. Polit. Econ. 90:809-
815.
Frank, R. H. and Philip J.C. (1996). The Winner-Take-All Society: Why the Few at
the Top Get SO Much More than the Rest of US. Penguin Books Australia
Limited, Victoria, Australia.
Gupta, G.S., S. Paul and V.L. Mote. (2004). Managerial Economics: Concepts and
Cases. McGraw Hill Education, New York, USA.
Hacker, J.S. and P. Pierson. (2011). Winner-take-all Politics. Tantor Media
Publishing Company, Connecticut, USA.
Marshall, A. (2009). Principles of Economics: Unabridged. Eighth edition. Cosimo
Inc., New York-10011, USA.
Nicholson, W. and C. Snyder. (1972). Microeconomic Theory: Basic Principles and
Extensions, 6th edition. South Western Cengage Learning, OH-45040, USA.
Petersen, C.H., W. C. Lewis and S.K. Jain. (2006). Managerial Economics. Pearson
India Publisher, Uttar Pradesh, India.
Varian, H.R. (1992). Micro Economics Analysis. W. W. Norton & Company, Inc.,
New York-10110, USA.