Chapter 3

DEMAND FOR GOODS AND SERVICES

 Individuals buy goods and services to satisfy primarily their basic needs like food, clothing and
shelter
 Individual demand for goods and services depends on the income of buyers and the prices of
goods and services.
 Lower Price = High purchasing power of goods and services.
 Higher Price = Lower Purchasing power of goods and services.
 Quantity demanded fluctuates in response to changes in the prices of goods and services.
o When Prices (P) increase, quantity demanded decreases. Conversely,

P = QD

o When Prices (P) decrease, quantity demanded increases. Nevertheless, such responses
of buyers to price changes differ depending on the importance of the goods and services
and the presence of substitutes.

P = QD

 Quantity 1 - White sugar P = QD

 Quantity 2 (Substitute) – Brown Sugar P = QD

DEMAND DEFINED

Demand is defined as the schedule of various quantities of commodities which buyers are uniting and
able to purchase at a given price, time and place.

QUANTITY DEMANDED

Quantity demanded refers to the amount of a particular product that households wish to buy in
some time period. When a person has the willingness and ability to buy the goods and services he needs,
he has an effective demand. This is the real meaning of demand in economics.

INDIVIDUAL DEMAND SCHEDULE

A table showing the quantity demand for a

product at various prices. It indicates the inverse
relationship between price and quantity demanded. That
is more units are bought at lower prices.
INDIVIDUAL DEMAND CURVE

A Graphical illustration of the inverse relationship

between price and quantity demanded.

DETERMINANTS OF DEMAND

Demand may be classified as individual demand and market demand.

They can increase or decrease demand for goods and services. Here are determinants of Demand:

INCOME - Individuals tend to purchase more goods and services when their incomes increase.

INCOME = PURCHASING POWER; leads to more demand.

On the other hand, if their incomes fall, their purchasing power also falls. That is they can buy less
number of goods and services. Obviously, individuals with more incomes consume more goods and
services than those with fewer incomes.

POPULATION - People consume goods and services. Clearly, more people means more demand for
goods and services.

POPULATION = DEMAND

TASTES AND PREFERENCES - When people prefer certain goods to other goods, demand for such
preferred goods rises. Such tastes or preferences are greatly influenced by fashions. Goods which are
out of fashion have very low demand — even if their prices have been lowered.

PRICE EXPECTATION - When people expect the prices of goods, particularly essential commodities, like
rice, cooking oil or sugar, to increase in a few days’ time, they buy more of these goods. On the other
hand, if they expect a fall in the prices of said products in a few days period, they reduce their purchases.

PRICES OF RELATED GOODS. These are close substitutes, like Pepsi cola, Coca cola and Pop cola. For
example, if the prices of Coca cola increases, people tend to buy a close substitute like Pepsi cola. Thus,
demand for coke falls while that of Pepsi rises. Complimentary goods, the price of one good and the
demand for the other good is directly opposite. That is, if the price of one good increases, the demand
for the other good decreases.

Complementary goods are those that go together like bow and arrow, or phonograph and records. But
for independent goods, the change in price of one has no effect on the demand for the other good.
LAW OF DEMAND
Individuals are most likely to buy more goods and services as prices decrease, and buy less goods and
services as prices increase. This is the law of demand. Such general tendencies of consumers may be
explained by two effects:

INCOME EFFECT. Even at a constant income, an individual has increased his purchasing power when
prices of goods and services fall. For the same amount of money, he can buy more goods and services at
lower prices than at higher prices.

SUBSTITUTION EFFECT. Consumers tend to buy goods and services with lower prices. Whenever the
price of the product they have been buying increases, they look for substitutes with lower prices.

INCOME / SUBSTITUTION EFFECT ON NORMAL AND INFERIOR GOODS

As Income (I) increases, with Price (P) being constant, the purchase of goods and services also increases.
In the same direct relationship, the consumption of goods and services falls as income declines. Such
consumer behavior applies to normal goods.

I = P = Purchasing Power

But in the case of 'inferior goods, the income effect is opposite that of normal goods. That is, as income
increases, the consumption of inferior goods decreases.

The relationship between money income (like monthly salary) and the consumption of goods and
services is illustrated by the Engel carve. The assumption is that prices remain constant with an increase
in income.

ENGEL CURVE –
Graphical illustration of the direct relationship between
money income and consumption of normal good.

Graphical illustration of the inverse relationship between money

income and the consumption of inferior goods.
VALIDITY OF THE LAW OF DEMAND

The law of demand states: as price increases, quantity demanded decreases, and as price decreases,
quantity demanded increases. Such theory is only true if the assumption of celeris paribus is applied. It
means "all other things equal or constant: The law of demand is correct if the determinants of demand
are held constant. That is there is no change in income, taste, or population.