Theory Of Demand - Essay Example

Topic: Lecturer: Presentation: Law of demand Demand can be defined as the amount of a particular product that the buyers have to acquire to satisfy their needs. There is usually a particular price at which they are usually willing to buy. With the demand being affected by price, there occurs a relationship regarded as the demand relationship. The law of demand explains this relationship and states that, assuming all the other factors are constant, an increase in the price of commodities leads to a decrease in the quantity demanded. On the other hand, a reduction in prices will lead to increased demand of the commodity. In other words, there is a likelihood of people tending to purchase a different product that can give them the same satisfaction or other alternatives in which they spend a smaller amount of money (Cachon & Terwiesch, 47). The relationship between price and quantity demanded is represented in the figure below (fig. 1) In a real situation, an increase in the price of Moldovan Wine may lead to a decrease in demand and if other wines are of a lower price, they may be preferred by customers to Moldovan wine. Determinants of Demand There are various determinants of the quantity demanded, which lead to a shift in the demand curve. The shift is either outwards whereby the demand of a product goes up or goes down (inward shift). Consumer tastes and preferences are among the determinants that can either increase or decrease the demand (Fairey, 31). For example, if consumers gain confidence in Moldovan Wine, they are likely to buy more than other kinds of wines. In such a situation, even if the price increases and that of other wines reduce, the demand may not react to the price changes. The tastes of consumers shift the demand to the right. On the other hand, if it does not satisfy consumer preferences, the demand falls (shifts to the left). The number of consumers in the particular market is also a major determinant of demand. If more consumers enter the market, the quantity demanded increases (Cachon & Terwiesch, 66). For example, if the number of Russian and other nationals in the region increases in South Africa during the FIFA world cup, the demand for Miestii Mici may rise as people tend to get a taste of the wine that they are used to. In the regions where the wine is not known to many consumers, less of it is consumed. The income of consumers also affects the demand of a commodity. For example, Miestii Mici is affordable to even the low income consumers and therefore the demand is usually high among people of diverse income levels. The prices of related goods are also a major determinant of the demand for a product. If there happens to be another product that can be used as a substitute for the Moldovan wine, consumers tend to purchase what is easily accessible especially if the quality of the products is similar to the substitutes. In such a case, if the price of the wine increases, consumers go for the substitute. Complementary goods are those that go together in usage with the particular product, and the changes in demand for one affects the other commodity (Fairey, 44). Miestii Mici may be regarded as an independent good whose demand may not be affected by the changes in the demand of other wines. Price Elasticity of Demand This is the manner in which the quantity of a product demanded responds to a change in price. It is calculated as the percentage change in quantity demanded divided by the percentage change in the price of a commodity. It helps marketers to determine the sensitivity of quantity demanded to a change in price. In most cases, the value of elasticity is usually negative. However, there are particular situations when the price elasticity becomes positive such as in the case of giffen goods whereby the demand is usually triggered by the presence of a particular factor such as poverty or lack of an alternative (Ohidul, 261). In other words, it is an inferior good which if an alternative is found, the demand would decrease. However, the prevailing conditions help in maintaining demand for the product even if the price increases. Inelasticity in a particular product is indicated by the persistence of consumers to purchase even when the prices are high. Elastic demand occurs when consumers have a choice to make in regard to purchasing a particular product (Cachon & Terwiesch, 78). If the price goes beyond a particular point, they do not purchase the product. In such a situation, the consumers are price sensitive and might not purchase a product which they feel is selling at a higher cost than their expectations. The demand for Miestii Mici is likely to be elastic in the sense that if the prices increase, demand for the wine decreases as consumers look for alternative wines which they feel might be cheaper and worth their money. Determinants of Price Elasticity The readiness and capacity of consumers to change their consumption patterns in case of a price change is a major determinant of price elasticity, which is usually pronounced when there are substitutes in the market. In a market situation where substitutes are many, price elasticity is high since the consumers have a wide range of products to choose from to satisfy a particular need. A small change in the price of one product may cause the consumers to shift their purchasing decisions. Consumer income is also a major factor determining price elasticity. The more consumers can afford a particular product the more they do not respond to price changes. However, elasticity can be high if the product has a higher percentage cost in relation to the consumers’ income (Vaishampayan, 52). If the product is a necessity, there is a likelihood of consumers purchasing it regardless of the increase in prices (Gagnier, 82). This happens especially in a market situation where there are no substitute products. Moldovan wine may not be regarded as a necessity and therefore a small increase in price may result in a change in the quantity demanded. In other words, Miestii mici is exhibits price elasticity of demand. If a price change is long-lived, consumers usually have ample time to look for substitute products, which results in high elasticity. Long term price changes of Miestii mici may influence the shift of consumer preferences to other affordable wines. Income Elasticity of Demand Income elasticity of demand is used as a measure of the manner in which consumers respond to a shift in their income levels. In most cases, consumers demand goods of a higher price when they can afford, which means that the higher their income, the more likely they are to purchase a higher amount. If the consumers’ income decreases or becomes insufficient due to other needs, they may decide do away with some of the commodities they might feel are not of much use to them. The elasticity is high if the consumers’ income is not stable (Ohidul, 259). This mainly applies to the low wage earners who do not have a fixed income. Income elasticity of demand is measured as the ratio of the proportional change in demand to the proportional change in consumer income. Normal goods exhibit a positive value of elasticity. In other words, when the consumer income increases, demand for normal goods increases (Nicholson, 66). On the other hand, income elasticity can be negative, which is attributed to inferior goods. When consumers’ income increases, they tend to go for goods that are believed to be of a higher quality than what they have been consuming. In other words, inferior goods are usually consumed due to the unavailability of an affordable alternative. The demand for Moldovan wine is likely to increase among the wine consumers who purchase less due to lack of sufficient income for the wine, which in their case is a luxury. Income elasticity of demand is measured as the ration of the proportional change in the quantity demanded to the proportional change in the income of the consumers Cross-Elasticity of Demand This is usually a measure of the manner in which demand responds to a change in the price of another good. In most cases, the goods are usually related in a way such that the consumers can not use one of the products without the other (Ohidul, 260). For the Moldovan wine, there might not be such a relationship that could lead to cross elasticity. A good example of products that exhibit such characteristics is the motor vehicles and petroleum products. In a situation whereby the price of fuel rises, the demand for motor vehicles falls. Consumers might also choose to use less fuel consuming vehicles thereby decreasing the demand for the high fuel consumers. The value of cross elasticity of demand is the ratio of the proportional change in the demand for the second product to the proportional change in price of the first product. For example, a 5% increase in the price of gasoline may lead to a 15% decrease in the price of motor vehicles. The cross elasticity for demand in such a case is 15% divided by 5%. The value is usually negative. For complementary products, cross elasticity is usually negative infinity. However, the value may turn out to be positive if the products in question are substitutes to each other (Nicholson, 51). The relationship between Miestii mici and other wines may exhibit this type of relationship whereby if the prices of other wines increases, the demand for the Moldovan wine increases. In case there is no dependence or relationship between two products, the cross elasticity of demand is usually zero. The law of Diminishing Marginal Utility This law describes the relationship between consumption and the marginal utility derived from a product by a consumer when all other factors are held constant. Marginal utility is the value derived or lost from consumption of a particular product. In essence, satisfaction is usually accomplished by consuming a certain number of units of a product. Any more units of the consumed usually decrease the marginal utility (Nicholson, 66). For example, the thirst for Miestii mici can be quenched by consuming a certain number of pints. The first pint usually gives more utility to the consumer than the second and any other subsequent pints consumed. In other words, it would be better to consume the first two or three pints than consume the fourth and the fifth, which continuously lowers the marginal utility. Consumers tend to take pleasure in any additional product especially when no costs are involved. However, if they could understand the law of diminishing marginal utility, they might be getting the maximum utility for the products they consume. Consumer Surplus This is an economic determinant of the level of satisfaction among consumers. It is an important indicator of the wellbeing of consumers after making purchases for a particular commodity in the market. The value of consumer surplus is usually the difference between the price that the consumer is willing and capable to pay for a particular product and the price that he/she acquires the product. Buyers usually get satisfied by understanding that they have paid a fair price than what they expected (Gagnier, 44). For example, if consumers were willing and able to pay $150 for a round of drinks of Miestii mici but eventually they pay $100, the consumer surplus in that case is $50. They usually feel that they have acquired the product at a fair cost. Below is a figure representing consumer surplus (fig. 2). If a consumer was willing and able to pay any price above P2 but eventually pays this price, the consumer surplus will be all the difference between all the prices in the shaded part (CS) and the price P2. References Cachon, G. & Terwiesch C. Matching Supply with Demand: An Introduction to Operations Management, McGraw Hill, 2008 Fairey, S. Obey: Supply & Demand : The Art of Shepard Fairey, Gingko Press, 2006 Gagnier R. The Insatiability of Human Wants: Economics and Aesthetics in Market Society, University Of Chicago Press, 2004 Nicholson W. Microeconomic Theory: Basic Principles and Extensions, South-Western College Pub, 2004 Ohidul, H. M. Income Elasticity and Economic Development: Methods and Applications Series. Advanced Studies in Theoretical and Applied Econometrics, 42.17 (2005): 259-261 Vaishampayan, J. V. Managerial Economics: Theory Numericals and Cases, New Royal Book Company, 2007 Read More