The
knowledge of the determinants of market demand for a product and the nature of
relationship between the demand and its determinants proves very helpful in
analysing and estimating demand for the product. It may be noted at the very
outset that a host of factors determines the demand for a product. In general,
following factors determine market demand for a good:
·
Price of the good- .
·
Price of the related goods-substitutes, complements and
supplements
·
Level of consumers' income
·
Consumers' taste and preference
Advertisement of the product
·
Consumers' expectations about future price and supply
position
·
Demonstration effect and 'bend-wagon effect’
·
Consumer-credit facility
·
Population of the country
·
Distribution pattern of national income.
These factors also include factors such as off-season
discounts and gifts on purchase of a good, level of taxation and general social
and political environment of the country. However, all these factors are not
equally important. Besides, some of them are not quantifiable. For example,
consumer's preferences, utility, demonstration effect and expectations, are
difficult to measure. However, both quantifiable and non-quantifiable
determinants of demand for a product will be discussed.
1. Price
of the Product
The price
of a product is one of the most important determinants of demand in the long
run and the only determinant in the short run. The price and quantity demanded
are inversely related to each other. The law of demand states that the quantity
demanded of a good or a product, which its consumers would like to buy per unit
of time, increases when its price falls, and decreases when its price
increases, provided the other factors remain' same. The assumption 'other factors
remaining same' implies that income of the consumers, prices of the substitutes
and complementary goods, consumer's taste and preference and number of
consumers remain unchanged. The price-demand relationship assumes a much
greater significance in the oligopolistic market in which outcome of price war
between a firm and its rivals determines the level of success of the firm. The
firms have to be fully aware of price elasticity of demand for their own
products and that of rival firm's goods.
2. Price of
the Related Goods or Products
The demand
for a good is also affected by the change in the price of its related goods.
The related goods may be the substitutes or complementary goods.
Substitutes
Two goods
are said to. be substitutes of each other if a change in price of one good
affects the deinand for the other in the same direction. For instance goods X
and Y are considered as substitutes for each other if a rise in the price of X
increase demand
for Y, and vice versa. Tea and coffee, hamburgers and hot-dog, alcohol and
drugs are some examples of substitutes in case of consumer goods by definition,
the relation between demand for a product and price of its substitute is of
positive nature. When, price of the substitute of a product (tea) falls (or increase),
the demand for the product falls (or increases). The relationship of this
nature is shown in Figure 2.1 and 2.2.
Complementary Goods
A good is said to be a
complement for another when it complements the use of the other or when the two
goods are used together in such a way that their demand changes (increases or
decreases) simultaneously. For example, petrol is a complement
to car and scooter, butter and jam to bread, milk and sugar to tea and 1
coffee, mattress to cot, etc. Two goods are termed as complementary to each
other -i if an increase in the price of one causes a decrease in demand for the
other. By definition, there is an inverse relation between the demand for a
good and the price of
its complement. For instance, an increase in the price of petrol causes a
decrease in the demand for car and other petrol-run vehicles and vice versa
while other thing's remaining constant. The nature of relationship between the
demand
for a product and the price of
its complement is given in Figure 2.2.
3.
Consume's Income
Income is the basic determinant
of market demand since it determines the purchasing power of a consumer.
Therefore, people with higher current disposable income spend a larger amount
on goods and services than those with lower income. Income-demand relationship
is of more varied nature than that between demand and its other determinants.
While other determinants of demand, e.g., product's own price and the price
ohts substitutes, are more significant in the short-run, income as a determinant
of demand is equally important in both short run and long run. Before
proceeding further to discuss income-demand relationships, it will be useful to
note that consumer goods of different nature have different kinds of
relationship with consumers having different levels of income. Hence, the
managers need to be fully aware of the kinds of goods they are dealing with and
their relationship with the income of consumers, particularly about the
assessment of both existing and prospective demand for a product.
For the
purpose of income-demand analysis, goods and serv:ices maybe grouped under four
broad categories, which ate: (a) essential consumer goods, (b) inferior goods,
(c) normal goods, and (d) prestige or luxury goods. To understand all these
terms, it is essential to understand the relationship between income and
different kinds of goods.
Esscntial
Consumcr Goods (ECG):
The goods and services of this category are called 'basic needs' and are
consumed by all persons of a society such as food-grains, salt, vegetable oils,
matches, cooking fuel, a minimum clothing and housing. Quantity demanded for
these goods increases with increase in consumer's income but only up to certain
limit, even though the total expenditure may increase in accordance with the
quality of goods consumed, other factors remaining the same. The relationship
between goods of this category and consumer's income is shown by
the curve ECG in Figure 2.3. As the curve shows, consumer's demand for
essential goods increases only until his income rises to OY2. It
tends to saturate beyond this level of income.
Inferior goods: Inferior goods are those goods whose demand decreases
with the increase in consumer's income. For example millet is inferior to wheat
and rice; bidi (indigenous cigarette) is inferior to cigarette, coarse,
textiles are inferior to refined ones, kerosene is inferior to cooking gas and
travelling by bus is inferior to travelling by taxi. The relation between
income and demand for an inferior good is shown by the curve IG in Figure 2.3
under the assumption that other determinants of demand remain the same demand
for such goods rises only up to a certain level of income, i.e., OY1
and declines as income increases beyond this level.
Normal goods: Normal goods are those
goods whose demand increases with increaseiri the consumer income. For example,
clothings, household furniture and automobiles. The relation between income and
demand for normal goods is shown by the curve NG in Figure 2.3. As the curve
shows, demand for such goods increases with the increases in consumer income
but at different rates at different levels of income. Demand for normal goods
increases rapidly with the increase in the consumer's income but slows down
with further increase in income. It should be noted froms Figure 2.3 that up to
certain level of income (YI) the relation between income and demand
for all type of goods is similar. The difference is of only degree. The
relation becomes distinctly different beyond YI level of income.
Therefore, it is important to view the income-demand relations in the light of
the nature of product and the level fconsumer's income.
· Prestige
and luxury goods: Prestige goods are those goods, which are consu!TIed
mostly by rich section of the society, e.g., precious stones, antiques, rare
paintings, luxury cars and such other items of show-bff. Whereas luxury goods
include jewellery, costly brands of cosmetics, TV sets, refrigerators,
electrical gadgets and cars. Demand for such goods arises beyond a certain
level of consumer's income, i.e., consumption enters the area of luxury goods.
Producers of such goods, while assessing the demand for their goods, should
consider the income changes in the richer section of the society and not only
the per capita income. The relation between income and demand for such goods is
shown by the curve LG in Figure 2.3.
4.
Consumer's taste and preference
Consumer's
taste and preference play an important role in detennihing demand for a
product. Taste and preference depend, generally, on the changing. life-style,
social customs, religious values attached to a good, habi of the people, the
general levels of living of the society and age and sex of the consumers.
Change in these factors changes consumer's taste and preferences. As a result,
consumers reduce or give up the consumption of some goods and add new ones to
their consumption pattern. For example, following the change in fashion, people
switch their consumption pattern from cheaper, old-fashioned goods to costlier
‘mod’ goods, as long as price differentials are proportionate with their
preferences. Consumers are prepared to pay higher prices for 'mod goods' even
if their virtual utility is the same as that of old-fashioned goods. The
manufacturers of goods and services that are subject to frequent change in
fashion and style, can take advantage of this situation in two ways: (i) they
can make quick profits by designing new models of their goods and popularising
them through advertisement, and (ii) they can plan production in abetter way
and can even avoid over-productiorlifthey keep an eye on the changing fashions.
5. Advertisel11ent
Expenditure
Advertisement costs are
incurred with the objective of increasing the demand for the goods. This is
done in the following ways:
·
By
informing the potential consumers about the availability of the goods.
·
By
showing its superiority to the rival goods.
·
By
influencing consumers' choice against the rival goods, and
·
By
setting fashions and changing tastes.
The impact of such effects
shifts the demand curve upward to the
right.
In
other words, when other factors' remain same, the expenditure on advertisement
increases the volume of sales to the same extent. The relation between advertisement
outlay and sales is shown in Figure 2.4.
Assumptions
Therelatiqnship between demand
and advertisement cost as shown in Figure 2.4 is based on the following
assumptions:
·
Consumers are fairly sensitive and responsive
to various modes
of
advertisement.
·
The rival firms do not react to the advertisements
made by a
firm.
·
The
level of demand has not already reached the saturation point. Advertisement
beyond this point will make only marginal impact on demand.
·
Per
unit cost of advertisement added to the price does not make the price
prohibitive for consumers, as compared particularly to the price of
substitutes.
·
Others
determinants of demand, e.g., income and tastes, etc., are not operating in the
reverse direction.
In the absence of these
conditions, the advertisement effect on
sales may be unpredictable.
6. Consumers’ Expectations
Consumers’ expectations
regarding the future prices, income and supply position of goods play an
important role in determining the demand for goods and services in the short
run. If consumers expect a rise in the price of a storable good, they would buy
more of it at its current price with a view to avoiding the possibility of
price rise future. On the contrary, if consumers expect a fall in the price of
certain goods, they postpone their purchase with a view to take advantage of
lower prices in future, mainly in case of non-essential goods. This behaviour
of consumers reduces the current demand for the goods whose prices are expected
to decrease in future. Similarly, an expected increase in income increases the
demand for a product. For example, announcement of ‘dearness allowance’, bonus
and revision of pay scale induces increase in current purchases. Besides, if
scarcity of certain goods is expected by the consumers on account of reported
fall in future production, strikes on a large scale and diversion of civil
supplies towards the military use causes the current demand for such goods to
increase more if their prices show an upward trend. Consumer demand more for
future consumption and profiteers demand more to make money out of expected
scarcity.
7. Demonstration Effect
When new goods or new models of
existing ones appear in the market, rich people buy them first. For instance,
when a new model of car appears in the market, rich people would mostly be the
first buyer, Colour TV sets and VCRs were first seen in the houses of the rich
families some people buy new goods or new models of goods because they have
genuine need for them. Some others do so because they want to exhibit their
affluence. But once new goods come in fashion, many households buy them not
because they have a genuine need for them but because their
neighbors have bought the same goods. The purchase made by the latter category
of the buyers are made out of such feelings' as jealousy, competition, equality
in the peer group, social inferiority and the desire to raise their social
status. Purchases made on account of these factors are the result of what
economists call 'demonstration effect' or the 'Band-wagon-effect.' These
effects have a positive effect on demand. On the contrary, when goods become
the thing of common use, some people, mostly rich, decrease or give up the
consumption of such goods. This is known as 'Snob Effect'. It has a negative
effect'on the demand
for the related goods.
8. Consumer-Gredit
Facility
Availability
of credit to the cansumers fram the sellers, banks, relatians and friends
encourages the conSumers to buy more than what they would buy in the aosence of
credit availability. Therefore, the consumers who can borrow more can consume
more than those who cannot borrow. Credit facility affects mostly the
demand"for durable goods, particularly those, which require bulk payment
at the time of purchase. The car-loan facility may be one reason why Delhi has more cars than Calcutta, Chennai and Mumbai. Therefore, the
managers who are assessing the prospective demand for their goods should take
into account the availability of credit to the consumers.
9.
Population of the Country
The Jotal
domestic demand for a good of mass consumption depends also on the size' of the
population. Therefore, larger the population larger will be the demand for a
product, when price, per capita income, taste and preference are given. With an
increase or decrease in the size of population, employment percentage remaining
the same, demand for the product will either increase or decrease.
10.
Distribution of National Income
The
level of national income is the basic determinant of the market demand for a
good. Therefore, pig her the national income higher will be the demand for all
normal goods and services. Apart from this, the distribution pattern of the
national income is also an important determinant for demand of a good. If
national income is evenly distributed, market demand for normal goods will be the
largest. If national income is unevenly distributed, i.e., if majority of
population belongs to the lower income groups, market demand for essential
goods, including inferior ones, will be the largest whereas the demand for
other kinds of goods will be relatively less. 
