Determinants of Demand

The knowledge of the determinants of market demand for a product or service and the nature of relationship between the demand and its determinants proves very helpful in analyzing 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 or service. In general, following factors determine market demand for a product or service:

  1. Price of the product
  2. Price of the related goods-substitutes, complements and supplements
  3. Level of consumers income
  4. Consumers taste and preference
  5. Advertisement of the product
  6. Consumers expectations about future price and supply position
  7. Demonstration effect or ‘bend-wagon effect’
  8. Consumer-credit facility
  9. Population of the country
  10. 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 demand 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).
  • 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 coffee, mattress to cot, etc. Two goods are termed as complementary to each other. 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.

3. Consumers 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 of its 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 services 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.

  1. Essential Consumer 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. Consumer’s demand for essential goods increases only until a particular income level. It tends to saturate beyond this level of income.
  2. 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; 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 under the assumption that other determinants of demand remain the same demand for such goods rises only up to a certain level of income, and declines as income increases beyond this level.
  3. Normal goods: Normal goods are those goods whose demand increases with increase in the consumer income. For example, clothing’s  household furniture and automobiles. 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. Up to certain level of income the relation between ­income and demand for all type of goods is similar. The difference is of only degree.Therefore, it is important to view the income-demand relations in the light of the nature of product and the level of consumer’s income.
  4. Prestige and luxury goods: Prestige goods are those goods, which are consumed mostly by rich section of the society, e.g., precious stones, antiques, rare paintings, luxury cars and such other items of show-off. 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.

4. Consumer’s Taste and Preference

Consumer’s taste and preference play an important role in determining demand for a product. Taste and preference depend, generally, on the changing life-style, social customs, religious values attached to a good habit of the people. 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:

  1. They can make quick profits by designing new models of their goods and popularizing them through advertisement, and
  2. They can plan production in a better way and can even avoid over-production if they keep an eye on the changing fashions.