Leon Walras (1834-1910) a French economist, gave demand theory as a fundamental principle of microeconomics which gives the analysis of the relationship between the demand for goods or services and prices or incomes. A Bit of History… The theory was subsequently developed by English economist Alfred Marshall (1842-1924), Italian Vilfredo Pareto (1848-1923), Soviet EugenSlutsky (1880-1948), American Kenneth Arrow (1921- ) and the French-born Gerard Debreu (1921- ). -economyprofessor.com 3
Demand is the basis of all productive activities. Demand theory is an economic theory that concerns the relationship between the demand for goods and their prices; it forms the core of microeconomics. The generation of demand can be pictorially shown as below, DEMAND NEED WANT 4
Demand Law of Demand Hedonic theory The law of demand is normally depicted as an inverse relation of quantity demanded and price: the higher the price of the product, the less the consumer will demand, ceteris paribus ("all other things being equal"). It is an economic theory that the price an individual will pay for a good reflects the sum of the characteristics of that good. 6
A Demand Table Price per cassette Rs. DVD rentals demanded per week E G D A B C D E 0.501.00 2.00 3.00 4.00 9 8 6 4 2 Demand for DVDs C B A Demand Schedule: A demand schedule is a tabular presentation of the amount of goods consumers are willing and able to buy at different level of prices over a given period of time. Demand Curve: The graphical representation of demand schedule is the demand curve. The demand curve is a downward sloping curve from left to right. This characteristic of the demand curve is due to the inverse relationship between price and quantity demanded. 6.00 A Demand Curve 5.00 4.00 3.50 3.00 Price per DVDs (in rupees) 2.00 1.00 F .50 1 2 3 5 6 7 8 9 10 4 Quantity of DVDs demanded (per week) 7
8 Reasons behind Demand The Income Effect: There is an income effect when the price of a good falls because the consumer can maintain current consumption for less expenditure. The Substitution Effect: There is also a substitution effect when the price of a good falls because the product is now relatively cheaper than an alternative item and so some consumers switch their spending from the good in competitive demand to this product.
9 Conditions of Demand The conditions of demand for a product in a market can be summarized as follows: D = f (Pn, Pn…Pn-1, Y, T, P, E) Where: Pn = Price of the good itself Pn…Pn-1 = Prices of other goods – e.g. prices of Substitutes and Complements Y = Consumer incomes – including both the level and distribution of income T = Tastes and preferences of consumers P = The level and age-structure of the population E = Price expectations of consumers for future time periods
10 Exceptions to the Law of Demand ostentatious consumption effects of speculative demand The demand for the product is a direct function of its price. It comprises of luxury items. They are called Veblen goods. Eg. Expensive perfumes, designer clothes etc. The potential buyers are interested not just in the satisfaction they may get from consuming the product, but also the potential rise in market price leading to a capital gain or profit. Eg. Housing & shares etc.
11 Integrability & Aggregation in Theory of Demand Harold Hotelling believed that integrability was a necessary characteristic of both individual and market demand equations, and he demonstrated that it would hold if consumers did not have a budget constraint. If there was a budget constraint, he contended, the usual integrability condition would be replaced by a condition which assures that an integrating factor can be introduced. Aggregation by summation of individual demands is considered, and it is shown that this form of aggregation is valid if there is a budget constraint only when income effects are the same for all individuals.
13 Demand Shocks A model of business cycles driven by shocks to consumer expectations regarding aggregate productivity. Agents are hit by heterogeneous productivity shocks, they observe their own productivity and a noisy public signal regarding aggregate productivity. A calibrated version of the model is able to generate realistic amounts of short-run volatility due to demand shocks, in line with existing time-series evidence. Guido Lorenzoni MIT Department of Economics E52-251C 50 Memorial Drive Cambridge, MA 02142 and NBER.
14 MASSIVE DROP IN U.S. DEMAND IN APRIL U.S. oil demand in April was 863,000 barrels per day less than previously estimated and down 811,000 bpd from a year earlier, putting petroleum consumption at the lowest level for any April month in six years, the Energy Information Administration said on Monday.The lower oil demand was due to rising fuel prices and a faltering U.S. economy that has cut into petroleum use. The size of this drop (down 811,000bpd, year-on-year) is massive. Indeed it's almost enough to wipe out total worldwide growth in oil consumption from 2006 to 2007 (990,000bpd, according to the BP Statistical Review 2008). Monday, June 30, 2008-Reuters Washington
15 It is enough to wipe out two years worth of consumption growth from China.
16 The benefits a person gets from a product depend on his goals. These goals are referred to in many ways in discussions of demand. The words "tastes," "wants," "needs," "preferences" and "usefulness" all refer to goals. When people's goals change, the amount of benefit they get from the good changes, and this will cause them to change the amount of the good they want to buy.