Demand

Concept in economics

In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item is a function of an item's perceived necessity, price, perceived quality, convenience, available alternatives, purchasers' disposable income and tastes, and many other options.

Innumerable factors and circumstances affect a consumer's willingness or to buy a good. Some of the common factors are:

The price of the commodity: 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. The assumption of a negative relationship is reasonable and intuitive. For example, if the price of a gallon of milk were to rise from $5 to a price of $15, that would be a big price increase. Such a significant price increase causes the consumer to demand less of that product at the price of $15 because not only is it more expensive, but the new price is very unreasonable for a gallon of milk. 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. (Perfect 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 price of the complementary good would have a negative coefficient in the demand function. For example, Qd = a P Pg where Q is the 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 price of the substitute and the demand for the good in question is positive. 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) a person has, the more likely that person is to buy. Tastes or preferences: The greater the desire to own a good the more likely one 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. Consumer expectations about future prices, income and availability: If a consumer believes that the price of the good will be higher in the future, he/she is more likely to purchase the good now. If the consumer expects that his/her income will be higher in the future, the consumer may buy the good now. Availability (supply side) as well as predicted or expected availability also affects both price and demand. Population: If the population grows this means that demand will also increase. 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. The number of consumers in a market: The market demand for a good is obtained by adding individual demands of the present, as well as prospective consumers of a good at various possible prices. The larger the consumer base is for a good, the greater the market demand for it.

The demand equation is the mathematical expression of the relationship between the quantity of a good demanded and those factors that affect the willingness and ability of a consumer to buy the good. For example, Qd = f(P; Prg, Y) is a demand equation where Qd is the quantity of a good demanded, P is the price of the good, Prg is the price of a related good, and Y is income; the function on the right side of the equation is called the demand function. The semi colon in the list of arguments in the demand function means that the variables to the right are being held constant as one plots the demand curve in (quantity, price) space. A simple example of a demand equation is Qd = 325 P 30Prg + 1.4Y. Here 325 is the repository of all relevant non specified factors that affect demand for the product. P is the price of the good. The coefficient is negative in accordance with the law of demand. The related good may be either a complement or a substitute. If it is a complement, the coefficient of its price would be negative as in this example. If it is a substitute, the coefficient of its price would be positive. Income (Y), has a positive coefficient, indicating that the good is a normal good. If the coefficient were negative, the good would be an inferior good meaning that the demand for the good would fall as the consumer's income has increased. Specifying values for the non price determinants, Prg = 4.00 and Y = 50, results in demand equation Q = 325 P 30(4) +1.4(50) or Q = 275 P. If income were to increase to 55, the new demand equation would be Q = 282 P. Graphically, this change in a non price determinant of demand would be reflected in an outward shift of the demand function caused by a change in the x intercept.

The price elasticity of demand is a measure of the sensitivity of the quantity variable, Q, to changes in the price variable, P. It shows the percent by which the quantity demanded will change as a result of a given percentage change in the price. Thus, a demand elasticity of 2 says that the quantity demanded will fall 2% if the price rises 1%. For infinitesimal changes, the elasticity is (∂Q/∂P)×(P/Q).

The slope of a linear demand curve is constant. The elasticity of demand changes continuously as one moves down the demand curve because the ratio of price to quantity continuously falls. At the point the demand curve intersects the y axis, demand becomes infinitely elastic, because the variable Q appearing in the denominator of the elasticity formula is zero. At the point the demand curve intersects the x axis, the elasticity is zero, because the variable P appearing in the numerator of the elasticity formula is zero. At one point on a linear demand curve, demand is unitary elastic: an elasticity of one. For higher prices, the elasticity is greater than 1 in magnitude: demand is said to be elastic because percentage quantity changes are bigger than price changes. For prices below the point of unit elasticity, the elasticity is less than 1 and demand is said to be inelastic.

Perfectly inelastic demand is represented by a vertical demand curve. Under perfect price inelasticity of demand, the price has no effect on the quantity demanded. The demand for the good remains the same regardless of how low or high the price. Goods with (nearly) perfectly inelastic demand are typically goods with no substitutes. For instance, insulin is nearly perfectly inelastic. Diabetics need insulin to survive so a change in price would not effect the quantity demanded. Insulin is not perfectly inelastic, however, as a prohibitively high price would cause some individuals to be incapable of purchasing insulin entirely. On the other hand, if insulin was sold at a very low price, it is possible that some individuals would purchase more insulin if they were not able to afford it before. Because of the effects of extreme pricing, no good can be considered truly perfectly inelastic.

In perfectly competitive markets the demand curve, the average revenue curve, and the marginal revenue curve all coincide and are horizontal at the market given price. The demand curve is perfectly elastic and coincides with the average and marginal revenue curves. 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 perfectly competitive firm's decisions are limited to whether to produce and if so, how much. In less than perfectly competitive markets the demand curve is negatively sloped and there is a separate marginal revenue curve. A firm in a less than perfectly competitive market is a price setter. The firm can decide how much to produce or what price to charge. In deciding one variable the firm is necessarily determining the other variable

In its standard form a linear demand equation is Q = a bP. That is, quantity demanded is a function of price. The inverse demand equation, or price equation, treats price as a function f of quantity demanded: P = f(Q). To compute the inverse demand equation, simply solve for P from the demand equation. For example, if the demand equation is Q = 240 2P then the inverse demand equation would be P = 120 .5Q, the right side of which is the inverse demand function. 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; here MR = 120 Q. Note that the MR function has the same y intercept as the inverse demand function in this linear example; the x intercept of the MR function is one half the value of that 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 condition for firms regardless of market structure is to produce where marginal revenue equals marginal cost (MC). 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. 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.

If the demand curve is linear, then it has the form: Qd = a b*P, where p is the price of the good and q is the quantity demanded. The intercept of the curve and the vertical axis is represented by a, meaning the price when no quantity demanded. and b is the slope of the demand function. If the demand function has the form like that, then the Total Revenue should equal quantity demanded times the price of the good, which can be represented by: TR= q*p = q(a bq).

Demand reduction refers to efforts aimed at reducing the public desire for illegal and illicit drugs. The drug policy is in contrast to the reduction of drug supply, but the two policies are often implemented together.

Energy demand management, also known as demand side management (DSM) or demand side response (DSR), is the modification of consumer demand for energy through various methods such as financial incentives and behavioral change through education.