Main Aspects of Theory of Demand - Essay Example

Theory of Demand Demand is the economic theory that explains a consumer’s desire and readiness to pay a price for a precise good or service. Normally, the price of commodities and services increase as their demand dwindles while the price decreases when there is a high demand for them. According to Taylor and Weerapana (53), the term demand is a relationship between two economic variables namely: the price of a particular good; and the quantity of that good that consumers are willing to buy at the price during a specific time period. It describes how much of a good consumers will purchase at each price and it can be represented by a numerical table or by a graph. As the price of goods and services rise, the quantity demand by consumers goes down. Siddiqui (35) further describes demand as that effective desire which can be satisfied meaning that desires are simply imaginations. It is required that the demand commodity should be available at a certain place, time, and price. Demand must satisfy the following requirements; desire for the specific commodity; sufficient resources to purchase the desired commodity; willingness to spend the resources; and the availability of the commodity. In addition, demand can also be used to measure or predict the quantity of commodities and services which the buyers would be motivated to buy in a market at a given time and at a given place. The changes in the price of the commodities that are related to that which a consumer uses affects the market demand for it and an example of this would be the price of margarine (which the consumer does not normally use) is much lower than the price of butter. Inevitably, the consumer will decide to go for the cheaper product although their preference lies with the more expensive one. The demand for certain commodities may also be affected by the changes of the income of potential buyers, for example, if the income of a buyer is reduced, then he will opt to purchase cheaper commodities in line with his diminished income; but if the income is increased, then the buyer’s demand for the same product at higher prices will increase significantly. The future expectations of buyers almost always have a tendency of influencing the market demand of a product and this is usually displayed by considering the income security of potential buyers. If a potential buyer is confident in his belief that his future income will be stable, the he is more likely to spend more in buying both the commodities that he needs and wants. If however his future income is very insecure, then he is most likely to keep most of his money in savings in anticipation of a bleak financial future than spending it on commodities. The demand schedule is a table that shows the quantity of demand of a good at the various price levels and it is a very important feature within the market because it helps to predict the future trends in the demand of commodities. In this way, given the price level, it is easy to determine the expected quantity demanded. A demand schedule is normally used alongside a supply schedule and these show the amount of certain goods that can be supplied to a market or markets at given price levels at various times and it is used to indicate that there is an inverse relationship between the price and the quantity demanded. Lipsey and Chrystal (40) state that a demand schedule is one way of showing the relationship between quantity demand and price. It is a numerical table that is used to show the quantity of goods that will be demanded at some selected prices. Hoag and Hoag (59) state that the law of demand shows an inverse relationship between the price of a good and the quantity demanded of that good. When the value of a commodity goes in a certain direction, the amount of the equal commodity that is in demand goes in the opposite direction. As the price rises, less is purchased and this is indicated by the quantity demanded decreasing. There is a clear evidence of the law of demand at work in our daily lives. For example, when postage rates increase, then fewer Christmas cards are sent because the quantity demanded has fallen as the price has risen. When retail stores advertise sales, then these sales serve to increase the quantity demanded by lowering the price. The buyer response to higher fuel and energy prices will lead to smaller and more energy efficient cars, and in the homes, cooler temperatures and sweaters because there is a lower quantity demanded of energy at the higher price. One reason why a consumer buys more of a good as the price falls is that the good becomes an attractive substitute for other goods and this encourages the consumer buys more of the good and consequently less of the other goods related to it. As the price of a good goes down, the consumer is able to purchase more of this good than he could before the price fell. Therefore, the consumer appears to have more income but this is not the case because it should be noted that the amount of money that the consumer actually has remains unchanged yet the purchasing power of the money increases as the price falls. The law of demand tells us that people have a tendency to respond to the price changes of given commodities and learning this would be helpful for a trader in fixing the prices of his commodities because he knows how much the demand for that particular commodity will fall if the price is raised beyond a certain level. The law of demand also helps the government in the setting of taxes on various commodities by analyzing the effects of taxes on the demand of these commodities in the market and adjusting the tax rates so that they may be more to the government’s advantage. It is also a very important factor in the planning of when and where to sell commodities due to their demand. There are however some exceptions to the law of demand and an example of this is the inability of this law to explain why when the price of some goods increases, their demand also increase, and when their prices fall, then their demand decreases with this fall. A good example of such goods are precious stones and metals whose demand will continue to be high when their prices are high and the demand for them falls when their prices fall. A lot of people out of ignorance consider goods of cheaper prices to be of low quality and they buy it less, but when the prices of such commodities become high, then there is a tendency among these buyers to buy more of this commodity. The law of demand further does not work when in anticipation for the rise of the price of goods; consumers begin to buy more of these goods even after there is an increase in the price of these goods in the present time. Similarly, if the prices are expected to fall in the foreseeable future, the consumers will buy less of these goods even if the costs of these commodities have become even lower in the present. Moreover, the law of demand does not work during the times of war or emergencies because if there are fears of a food shortage, then consumers will buy more food commodities for the purpose of hoarding and building stock. On the other hand, under certain situations, during an economic depression when prices are continuously falling, people tend to postpone their demand and thus buy less at lower prices. In order to define marginal utility, we shall first define what utility is. Utility is the way defined by market participants of measuring gratification or contentment and how these relate to the decisions that people make while purchasing goods and it measures the advantages or disadvantages of consuming certain goods or services. Lipsey and Harbury (39) state that marginal utility is defined as the difference in utility arising from a change in the rate of consumption per period of time. Marginal utility is the added fulfillment that consumers gain from consuming additional units of commodities or services. It is an essential economic concept because the economists make use of it to determine how much of an item potential consumers will buy. The marginal utility is positive when the consumption of a bonus item increases the total utility while marginal utility is considered to be negative when the consumption of the bonus item decreases the total utility. Mishra (20) defines the demand curve as the graphic illustration of a demand schedule depicting the relationship between the price of certain commodities and the amount of these commodities that buyers are able and willing to but at a given price. Demand curves are used to approximate the conducts in the market and these are often combined with supply curves to approximate the price at which sellers are willing to put up for sale the equivalent quantity of goods as buyers are willing to buy. The demand curve represents the highest quantities for every unit of time that consumers will take at various prices. The demand curve is used to show the relationships between the diverse quantities demanded at diverse prices. There are various factors which affect the demand of commodities in the market and this is elaborated by Siddiqui (43) who states that an increase in the number of buyers will increase the demand for the good, for example, the demand for land increases as the population increases. An increase in the price of a commodity expected in future increases the demand in the present while a decrease in the same decreases the current demand. For example, when a good is temporarily put on sale, the people stock up on the good with the expectation that the good will no longer be in the market in the near future. Demand can shift due to the changes in taste over time, for example, the demand for breakfast cereal may possibly be very high in the morning but its demand may turn out to be very low at night. Furthermore, changes in quality also affect demand, for example, CDs cost more than cassettes because the music in CDs is of a higher quality than that in cassettes. Siddiqui (52) states that elasticity of demand is a measure of the relative change in the amount purchased in response to any change in price or a given demand curve. Price elasticity deals with how sensitive the demand for a certain commodity is to a change in the products own price and in relation to this, there are several factors which determine the elasticity of a product or service and some of these include the following: the more the number of close substitutes for a good in the market, the more elastic is the demand for a product because consumers can more easily switch their demand if the price of one product changes relative to others in the market. Furthermore, there may be significant transaction costs involved in switching between different goods and services and in this case, demand tends to be inelastic, for example, cell phone service providers may decide to include fine sections in contracts or may insist on twelve month contracts being taken out. Goods and services that are considered by consumers to be necessities tend to have a more elastic demand because the said consumers can still survive without luxuries when their financial plans are stretched to their limits. Demand has a tendency to be more price elastic the longer consumers are allowed to respond to a price change by varying their purchasing decisions because it takes time for consumers to notice and to respond to price fluctuations. Works Cited Hoag, Arleen J & Hoag, John H. Introductory Economic. Singapore: World Scientific, 2006. Lipsey, Richard G. Economics. Oxford: Oxford University Press, 2007. Mishra, Sasmita. Engineering Economics and Costing. New Delhi, India: PHI Learning, 2009. Siddiqui, S.A. Managerial Economics and Financial Analysis. New Delhi, India: New Age International, 2006. Taylor, John B. & Weerapana, Akila. Economics. Andover, United Kingdom: Cengage Learning, 2007. Read More