WHAT DETERMINES DEMAND?

WHAT DETERMINES DEMAND? 

Knowledge of the determinants of demand for a product and the nature of relationship between demand and its determinants are essential for a business firm for estimating market demand for its products. There are a number of factors which influence demand for a commodity. All these factors are not equally important. Moreover, some of these factors cannot be easily measured or quantified. The important factors that determine demand are given below.

(i) Price of the commodity: Ceteris paribus i.e. other things being equal, the demand for a commodity is inversely related to its price. It implies that a rise in the price of a commodity brings about a fall in the quantity purchased and vice-versa. This happens because of income and substitution euects.

(ii) Price of related commodities: Related commodities are of two types: (a) complementary goods and competing goods or substitutes. Complementary goods are those goods which are consumed together or simultaneously. For example; tea and sugar, automobile and petrol and pen and ink. When two commodities are complements, a fall in the price of one (other things being equal) will cause the demand for the other to rise. For example, a fall in the price of petrol-driven cars would lead to a rise in the demand for petrol. Similarly, a fall in the price of fountain pens will cause a rise in the demand for ink. The reverse will be the case when the price of a complement rises. Thus, we find that, there is an inverse relation between the demand for a good and the price of its complement.

             Two commodities are called competing goods or substitutes when they satisfy the same want and can be used with ease in place of one another. For example, tea and couee, ink pen and ball pen, are substitutes for each other and can be used in place of one another easily. When goods are substitutes, a fall in the price of one (ceteris paribus) leads to a fall in the quantity demanded of its substitutes. For example, if the price of tea falls, people will try to substitute it for couee and demand more of it and less of couee i.e. the demand for tea will rise and that of couee will fall. Therefore, there is direct or positive relation between the demand for a product and the price of its substitutes.

(iii) Income of the consumer: Other things being equal, the demand for a commodity depends upon the money income of the consumer. The purchasing power of the consumer is determined by the level of his income. In most cases, the larger the average money income of the consumer, the larger is the quantity demanded of a particular good. 

The nature of relationship between income and quantity demanded depends upon the nature of consumer goods. Most of the consumption goods fall under the category of normal goods. These are demanded in increasing quantities as consumers’ income increases. Household furniture, clothing, automobiles, consumer durables and semi durables etc. fall in this category. Essential consumer goods such as food grains, fuel, cooking oil, necessary clothing etc., satisfy the basic necessities of life and are consumed by all individuals in a society. A change in consumers’ income, although will cause an increase in demand for these necessities, but this increase will be less than proportionate to the increase in income. This is because as people become richer, there is a relative decline in the importance of food and other non durable goods in the overall consumption basket and a rise in the importance of durable goods such as a TV, car, house etc.

There are some commodities for which the quantity demanded rises only up to a certain level of income and decreases with an increase in money income beyond this level. These goods are called inferior goods. A same good may be normal for one condition and may be inferior in another. For example Bajra may become an inferior good for a person when his income increases above a certain level and he can now auord better substitutes such as wheat. Demand for luxury goods and prestige goods arise beyond a certain level of consumers’ income and keep rising as income increases.

Business managers should be fully aware of the nature of goods which they produce (or the nature of need which their products satisfy) and the nature of relationship of quantities demanded with changes in consumer incomes. For assessing the current as well as future demand for their products, they should also recognize the movements in the macro economic variables that auect the incomes of the consumers.

(iii) Tastes and preferences of consumers: The demand for a commodity also depends upon the tastes and preferences of consumers and changes in them over a period of time. Goods which are modern or more in fashion command higher demand than goods which are of old design and out of fashion. Consumers may perceive a product as obsolete and discard it before it is fully utilised and prefer another good which is currently in fashion. For example, there is greater demand for LCD/LED televisions and more and more people are discarding their ordinary television sets even though they could have used it for some more years.

‘Demonstration euect’ or ‘bandwagon euect’ plays an important role in determining the demand for a product. An individual’s demand for LCD/LED television may be auected by his seeing one in his neighbour’s or friend’s house, either because he likes what he sees or because he figures out that if his neighbour or friend can auord it, he too can. A person may develop a taste or preference for wine after tasting some, but he may also develop it after discovering that serving it enhances his prestige. On the contrary, when a product becomes common among all, some people decrease or altogether stop its consumption. This is called ‘snob euect’. Highly priced goods are consumed by status seeking rich people to satisfy their need for conspicuous consumption. This is called ‘Veblen euect’ (named after the American economist Thorstein Veblen). In any case, people have tastes and preferences and these change, sometimes, due to external and sometimes, due to internal causes and influence demand.

Knowledge regarding tastes and preferences is valuable for the manufacturers as it would help them plan production appropriately and design new models of products and services to suit the changing tastes and needs of the customers.

(v) Consumers’ Expectations: 

Consumers’ expectations regarding future prices, income, supply conditions etc. influence current demand. If the consumers expect increase in future prices, increase in income and shortages in supply, more quantities will be demanded. If they expect a fall in price, they will postpone their purchases of nonessential commodities and therefore, the current demand for them will fall.

Other factors: Apart from the above factors, the demand for a commodity depends upon the following factors:

(a) Size of population: Generally, larger the size of population of a country or a region, greater is the demand for commodities in general.

(b) Composition of population: If there are more old people in a region, the demand for spectacles, walking sticks, etc. will be high. Similarly, if the population consists of more of children, demand for toys, baby foods, touees, etc. will be more.

(c) The level of National Income and its Distribution: The level of national income is a crucial determinant of market demand. Higher the national income, higher will be the demand for all normal goods and services. The wealth of a country may be unevenly distributed so that there are a few very rich people while the majority are very poor. Under such conditions, the propensity to consume of the country will be relatively less, because the propensity to consume of the rich people is less than that of the poor people. Consequently, the demand for consumer goods will be comparatively less. If the distribution of income is more equal, then the propensity to consume of the country as a whole will be relatively high indicating higher demand for goods.

d) Consumer-credit facility and interest rates: Availability of credit facilities induces people to purchase more than what their current incomes permit them. Credit facilities mostly determine the demand for durable goods which are expensive and require bulk payments at the time of purchase. Low rates of interest encourage people to borrow and therefore demand will be more.

Apart from above, factors such as government policy in respect of taxes and subsidies, business conditions, wealth, socioeconomic class, group, level of education, marital status, weather conditions, salesmanship and advertisements, habits, customs and conventions also play an important role in influencing demand.