1. An Examination of the Factors that Influence the Demand for a Product

2. Definition
Demand is the number of units of a good or service that consumers are willing to purchase at any given market price at any given time.

3. Demand The demand for any good can be measured using market research.
This demand can then be displayed or shown in a number of different ways …

4. Bar chart showing the demand for product X

5. 2. Demand Schedule
A demand schedule is a table showing the number of units of a good or service that consumers are willing to purchase at any given market price at any given time.
Price €1 €2 €3 €4 €5
Quantity 50 43 34 26 22

6. 3. Demand Curve
A demand curve is a graph showing the number of units of a good/service that consumers are willing to purchase at any given market price at any given time.
This is the method most frequently used to display demand. €1 €2 €3 €4
Price
Quantity D
Demand curve D 28 36 43 50

7. Individual and Market Demand
The market demand for a product is the sum of all the individual demand schedules for that product.
Assume that there are only two consumers of product X: Joe and Mary. Their combined demands make up the market demand.
Price
Joe’s demand
Mary’s demand
Market demand €1 20 30 50 €2 18 25 43 €3 17 34 €4 15 13 28

8. Utility
Utility is the amount of benefit or satisfaction derived from the consumption of a good or service.

9. Marginal Utility
Marginal utility is the addition to total utility brought about by the consumption of an extra unit of a good.
Total utility
from 1 unit
800
Total utility
from 2 units
1300
Total utility
from 3 units
1600  
MU of second unit = 500
MU of third unit = 300

10. An Economic Good
An economic good is any good or service that people are willing to pay for.
That is, it is a good or service that can command a price.
Characteristics of an economic good:
It must give utility.
It must be scarce in relation to the demand for it.
It must be transferable.

11. Assumptions Made About Consumers
They act rationally.
They have limited incomes. (Most people do not have enough income to satisfy their wants.)
They aim to get maximum utility from the way they spend their incomes.
They are subject to the law of diminishing marginal utility.

12. Law of Diminishing Marginal Utility
This law states that as a consumer consumes additional units of a particular product, at some stage the marginal utility derived from the consumption of that product will begin to decrease.
Quantity
Total Utility
Marginal Utility 1
500  2
900
400 3
1200
300 4
1400
200 5
1500
100

13. The Law of Diminishing Marginal Utility Assumptions (1)
It applies only after a certain point called the origin.
The origin is the minimum quantity of a good that can be used effectively and MU does not decrease until this quantity is consumed.
Example: MU does not apply after the first spoonful from your morning bowl of cereal; it applies only after the first bowl (depending, of course, on the size of the bowl!).

14. The Law of Diminishing Marginal Utility Assumptions (2)
It assumes that the total utility of a good is not fully used up before the next unit is consumed.
If you eat a bar of chocolate today and do not eat another until this day next week, the MU will not decrease because the total utility from the first bar is fully used up before you consume the next one.

15. The Law of Diminishing Marginal Utility Assumptions (3)
It assumes that income does not change.
As income rises MU may not fall as consumption increases.

16. The Law of Diminishing Marginal Utility Assumptions (4)
It does not apply to addictive goods or to medicines.
With these goods MU may remain constant or it may even increase as consumption increases.
Example:
Each extra tablet from a prescribed course of medication may bring increased MU until the last tablet is taken.

17. Equilibrium
In economics the term equilibrium refers to the ideal situation to be in, under any given set of circumstances.
For a consumer this means that he/she is getting the maximum possible utility from his/her income.

18. The Principle of Equi-Marginal Utility
This principle states that a consumer will be in equilibrium when he or she spends his or her income in such a way that the ratio of marginal utility to price is the same for all goods purchased.
MU(A)
P(A) =
MU(B)
P(B)
MU(C)
P(C)
and so on …

19. Proof of the Principle of Equi-MU (1)
Assume that an individual has an income of €80 per week which he spends on two products, X and Y.
X is priced at €20 and Y is priced at €10 .
The utilities derived from these products are as follows.

20. Proof of the Principle of Equi-MU (2)
Product X (€20)
Possible combinations of purchase:
Quantity TU MU 1
1000 2
1800
800 3
2500
700 4
3100
600
Quantity
Utilities
Combined TU
4X + 0Y
3100
3X + 2Y
5100
2X + 4Y
5300
1X + 6Y
5000
0X + 8Y
4150
5300
Product Y (€10)
Quantity TU MU 1
2000 2
2600
600 3
3100
500 4
3500
400 5
2800
300 6
4000
200 7
4100
100 8
4150 50
The combination that gives the maximum utility is 2X + 4Y.
The MU of 2X is 800 and its price is €20, giving a ratio of 40:1.
The MU of 4Y is 400 and its price is €10, giving a ratio of 40:1.

21. Manipulation of Proof
Make out utility figures for X: make sure that the MU is decreasing.
Pre-decide what combination of the two goods will be purchased, e.g. 2X + 4Y.
The MU of 2X is 800, thus the MU of 4Y will have to be 400  it is half the price of X.
Put in the MU of 4Y.
Fill in the utility figures for 3Y, 2Y and 1Y, ensuring that the MU is increasing as you go backwards.
Start filling in the utilities from 4Y onwards ensuring that MU is decreasing.

22. Manipulation of Proof, cont.
We are using the same utility figures and income as before.
Possible combinations of purchase
Utilities
Combined TU
4X + 0Y
3X + 2Y
2X + 4Y
1X + 6Y
0X + 8Y
Product X
Qty TU MU 1 2 3 4
Product Y 5 6 7 8
1,000 3,
3,100
1,800
800
2, ,600
5,100
2,500
700
1, ,500
5,300
3,100
600
1, ,000
5,000
0 + 4,150
4,150
2,000
You want 2X and 4Y to give the maximum utility.
The MU of 2X is 800, therefore the MU of 4Y must be half of that because Y is half the price of X.
Put in 400 as the MU of 4Y.
Now fill in the other figures for Y:
the MU must increase as you go backward
and decrease as you go forward.
2,600
600
Before you make out any figures, decide which combination you want to give the maximum utility, e.g. 2X and 4Y. Do not take a quantity of zero or 1 of either product
Now fill out any utility figures for the most expensive product.
3,100
500
3,500
400
3,800
300
4,000
200
4,100
100
4,150 50

23. Manipulation of Proof, cont.
Possible combination of purchase
Utilities
Combined TU
4X + 0Y
3X + 2Y
2X + 4Y
1X + 6Y
0X + 8Y
Product X
Qty TU MU 1 2 3 4
Product Y 5 6 7 8
1,000 3,
3,100
1,800
800
2, ,600
5,100
2,500
700
1, ,500
5,300
3,100
600
1, ,000
5,000
0 + 4,150
4,150
2,000
The combination which gives the maximum utility is 2X + 4Y.
The MU of 2X is 800 and its price is €20, giving a ratio of 40:1.
The MU of 4Y is 400 and its price is €10, giving a ratio of 40:1.
2,600
600
3,100
500
3,500
400
3,800
300
4,000
200
Q.E.D.
4,100
100
4,150 50

24. Proving that When P Goes Up D Goes Down
New possible combinations of purchase
Assume the same income and the same utility figures except that the price of Y increases to €20.
1,000
1,800
800
2,500
700
3,100
600
Product €20
Qty TU MU 1 2 3 4
Utilities
Combined Utilities
4X + 0Y 3, ,100
3X + 1Y 2, ,000 4,500
2X + 2Y 1, ,600 4,400
1X + 3Y 1, ,100 4,100
0X + 4Y 0 + 3,500 3,500
2,000
2,600
600
3,100
500
3,500
400
Product €20
Qty TU MU 1 2 3 4
The combination that now gives the highest TU is 3X and 1Y.
Thus, when the price of Y increased, its demand went down from 4 units to 1 unit.
Note that this is the only conclusion to be drawn from the increase in the price of Y.

25. Factors Influencing Demand for a Product
The main factors that govern people’s demand for goods on a day-to-day basis are:
The price of the good itself (P1).
The person’s income (Y).
The price of other goods (Pog).
The person’s taste (T).
Thus:
D = f ( P1, Y, Pog, T )

26. Factors Influencing Demand for a Product
Other factors that influence demand are:
The price and availability of credit (Cr).
Consumers’ expectations (E).
Government regulations (G).
Unforeseeable factors (U).
Thus:
D = f ( P1, Y, Pog, T, Cr, E, G, U )

27. Price An increase in the price of a product …
causes a contraction in demand.
That is, less of the product is purchased as a direct result of an increase in price.
Price
Quantity D €3
100 €5 30

28. Extension in Demand A decrease in the price of a product …
causes an extension in demand.
That is, more of the product is purchased as a direct result of a decrease in price.
Price
Quantity D €5 30 €3
100

29. The Substitution Effect
The effect that a change in the price of a good has on the demand for that good is called the substitution effect.
It assumes no change to any other factor that affects demand.
It is always positive in that it will always react in the same way.
That is, a decrease in the price of a product causes an extension in demand, and an increase causes a contraction in demand.

30. Movements Along a Demand Curve
Extension in demand
Contraction in demand D P1 P2 Q1 Q2 A B D P2 P1 A B Q2 Q1
These are sometimes called movements along a demand curve as demand shifts from point A to point B along the same curve.

31. Income
In economics the term income is used to describe purchasing power.
The full term is
real income.

32. Real Income Real income is the purchasing power of money income.
Real income will change when there is any change in the relationship between money income and prices.

33. Real Income Example: Your money income is €200 a week.
The price of product A is €20 per unit. At this price you can purchase 10 units of A (a ratio of 10:1).
Your money income remains at €200, but the price of A increases to €40. You can now purchase only 5 units of product A each week (a ratio of 5:1).
Your real income has decreased because your purchasing power has decreased.

34. Changes in Real Income Some ways in which real income can increase:
Money income remains unchanged when prices decrease.
Money income increases while prices remain unchanged.
Money income increases by a greater percentage than the percentage increase in prices.
Money income decreases by a smaller percentage than the percentage decrease in price.
Reverse these for decreases in real income.

35. Positive / Negative Income Effect
A positive income effect occurs when demand changes in the same direction as the income change. This always applies to normal goods.
A negative income effect occurs when demand changes in the opposite direction to the income change. This always applies to inferior goods.

36. Decrease in Demand
A decrease in demand means that less of the good is demanded at any given market price.
A decrease in income is one of the causes of this decrease in the demand for normal goods.
Price
Quantity D1 €5
200 D2
100

37. Increase in Demand
An increase in demand means that more of the good is demanded at any given market price.
An increase in income is one of the causes of this increase in the demand for normal goods.
100 D1
Price
Quantity €5 D2
200

38. Inferior Good
An inferior good is one that has a negative income effect.
As income increases, the demand for inferior goods decreases.
The reverse of this happens if income decreases. That is, the demand for inferior goods would increase.
Price €5 Q1
Quantity D1 D2 Q2

39. Movement of a Demand Curve
An increase or a decrease in demand is often referred to as a movement of a demand curve. D2
Price Q1
Quantity D1
Decrease
Increase Q1
Price
Quantity D1 D2 Q2 Q2
In both situations the position of the D curve has moved.

40. The Full Price Effect
The price of a product changing and money income remaining the same has two effects on demand:
the substitution effect
due to the price change.
The effect is always positive.
the income effect
because the price has changed but the money income has not changed.
The effect can be positive or negative.

41. The Full Price Effect
Thus we could have a positive substitution effect combining with either:
a positive income effect, or
a negative income effect.
Positive substitution effect + positive income effect
= a normal good
Positive substitution effect + weaker negative income effect
= an inferior good
Positive substitution effect + stronger negative income effect
= a Giffen good

42. The Full Price Effect Example:
P1 = €1 and Q1 = 100: Money income = €200
P2 = 80¢ and money income remains unchanged
Substitution effect +
Income effect =
Full price effect
+30
+20
+50
(Normal)
D goes up by 50
20
+10
(Inferior)
D goes up by 10
40
10
(Giffen)
D goes down by 10

43. Summary
Demand curve for a Giffen good
A normal good has a positive substitution effect and a positive income effect.
An inferior good has a positive substitution effect and a weaker negative income effect.
A Giffen good has a positive substitution effect and a stronger negative income effect. D
Price
Quantity
This is sometimes called a perverse demand curve.

44. Pog (1) Substitute Goods
Substitute goods are two or more different goods that can be substituted for each other to satisfy any one need or want.

45. Substitute Goods Tea Coffee
When the price of a good decreases it makes its substitute product relatively more expensive. Therefore, many consumers will switch their demand away from the substitute good. Assume tea and coffee are substitutes for each other.
Tea
Coffee Q1
Price D €2
Quantity
Price D €2
Quantity Q1 D2 €1 Q2 Q2
Therefore, a decrease in the price of a product causes a decrease in the demand for its substitute and vice versa.

46. Summary
The D for two goods that are substitutes for each other will always change in opposite directions when there is a change in the price of one of them.

47. Complementary Goods
Complementary goods (goods in joint demand) are two or more different goods that must be purchased together to satisfy any one need or want.
For example:
darts and a dart board
a padlock and a key
knives and forks
cups and saucers.

48. Complementary Goods For example …
The purchase of two complementary goods is normally regarded as one transaction.
Thus if the price of one of the goods changes it changes the cost, or price, of the transaction.
For example …

49. Complementary Goods Keys Locks D D D2 Q1 €1 €3 Q1 €2 Q2 Q2
If the price of a lock is €3 and the price of a key is €1, then the cost (price) of a lock and key is €4.
If the price of the key increases to €2 and the price of the lock remains at €3, the cost (price) of the transaction rises to €5 and fewer locks and keys will be purchased.
Price D
Quantity Q1 €1
Keys €3 Q1
Price D
Quantity D2
Locks
Contraction in demand
Decrease in demand €2 Q2 Q2
When the price of one good increases it causes a decrease in the demand for its complement and vice versa.

50. Goods in Derived Demand
A good is in derived demand when it is not purchased for its own direct utility but for the additional utility that it gives to some other product.
For example:
The demand for blocks is derived from the demand for buildings.
The demand for tickets is derived from the demand for entertainment.
The demand for air transport is derived from the demand for foreign holidays and business visits.

51. Goods in Derived Demand
The demand for blocks is derived from the demand for houses. If the price of houses decreases this will cause an extension in the demand for houses and an increase in the demand for blocks. Q1 D1 P
Block price (€s)
Quantity
Quantity P1
House price (€Ms) D Q1
Houses D2
Blocks
Extension in demand
Increase in demand P2 Q2 Q2

52. The Consumers’ Tastes Tastes reflect marginal utility.
If tastes change in favour of a product it indicates an increase in MU.
When MU increases we demand more of the good without its price changing.
Therefore, a change in taste in favour of a product causes an increase in demand.
If tastes change against a product it indicates a decrease in MU.
When MU decreases we demand less of the good without its price changing.
Therefore, a change in taste against a product causes a decrease in demand.

53. The Price and Availability of Credit
When interest rates are decreased this causes a reduction in the real cost of any good that is purchased on credit. This results in more of these goods being demanded.
Interest rates go down
Demand goes up
Normally it applies only to expensive consumer durables.
Likewise, if credit was not available fewer expensive consumer durables would be purchased – that is, it would cause a decrease in the demand for them.

54. Consumers’ Expectations
If consumers believe that a product may become scarce in supply in the not too distant future, they may increase their demand for that product to ensure that they have an ample supply of it for the immediate future. Thus they buy more of it without its price changing.
This will cause an increase in demand.

55. Government Actions/Regulations
Governments can undertake advertising campaigns or introduce legislation that can result in a change in demand for a product.
For example:
The government’s smoking ban has resulted in a decrease in demand for cigarettes.
Likewise, the government places high taxes on cars, causing a contraction in their demand.

56. Unforeseeable Factors
Sometimes unpredictable events occur, which can affect the D for a product.
When these occur they cause either an increase or a decrease in demand.
For example:
A livestock disease can cause a decrease in demand for meat and an increase in demand for mats and disinfectant.

57. Exceptions to Law of Demand
Giffen goods – when the price goes up the D goes up, e.g. staple foods such as bread.
Goods for which prices are affected by consumers’ expectations, e.g. shares or commodities – if these go up in price people buy more in the hope of selling later at an even higher price.
Goods of conspicuous consumption (“snob goods”). These are products that are purchased by some people to enable them to display their wealth, e.g. top-of-the-range cars, expensive designer clothes. This usually occurs over a certain price range only.

58. Exceptions to Law of Demand
Demand curve for goods of conspicuous / ostentatious consumption D
Normal D curve
Price
Quantity
Perverse D curve
Normal D curve D

59. The Paradox of Value
Some products have a high value in exchange (price), but have a low value in use.
For example: diamonds.
Other products have a low value in exchange but a high value in use.
For example: water.
Thus, water, which is vital for our existence, is cheap, while diamonds, which are a luxury, are expensive.
This is an apparent contradiction in terms – that is, a paradox.

60. Value is based on marginal utility.
Paradox of Value
Water has a high total utility but it has a low marginal utility.
Quantity TU MU 20
5,000  21
5,100
100 22
5,150 50
Diamonds have a lower total utility than water, but they have a higher marginal utility.
Quantity TU MU 1
600  2
900
300 3
1,150
250
Value is based on marginal utility.