Supply and demand are the most basic and important concepts in economics. They explain how prices of goods and services are determined in a market and how quantity bought and sold is decided.
Demand refers to the quantity of a good or service that consumers are willing and able to buy at different prices during a given period of time, assuming other factors remain constant. It is not just desire; it must be supported by purchasing power and willingness to spend.
Demand Curve and Law of Demand
The demand curve shows the relationship between price and quantity demanded of a commodity. Normally, the demand curve slopes downward from left to right, showing an inverse relationship between price and quantity demanded. This means when the price of a commodity falls, its quantity demanded increases, and when the price rises, quantity demanded decreases.
This inverse relationship is explained by the law of demand. The law of demand states that, other things remaining the same, quantity demanded of a commodity increases when its price falls and decreases when its price rises. The assumption “other things remaining the same” is very important and includes income of consumers, tastes, prices of related goods, and expectations.
Forces Behind the Demand Curve
The downward slope of the demand curve is not accidental. It is influenced by several economic forces that explain why consumers behave in this manner.
One important force is the law of diminishing marginal utility. Marginal utility refers to the additional satisfaction a consumer gets from consuming one more unit of a good. As consumption increases, the additional satisfaction from each extra unit declines. Because consumers get less satisfaction from additional units, they are willing to pay a lower price for extra units. This leads to a downward-sloping demand curve.
Another force is the income effect. When the price of a good falls, the real income or purchasing power of the consumer increases. With the same income, the consumer can now buy more of the good. This increase in purchasing power encourages higher quantity demanded at lower prices.
The substitution effect also plays a major role. When the price of a good falls, it becomes relatively cheaper compared to its substitutes. Consumers tend to substitute the cheaper good for costlier alternatives. As a result, demand for the cheaper good increases when its price falls, reinforcing the downward slope of the demand curve.
In addition, consumer psychology and common sense behaviour also support the law of demand. Generally, consumers prefer to buy more when prices are low and restrict their purchases when prices are high.
Movement Along the Demand Curve
A movement along the demand curve occurs when quantity demanded changes due to a change in the price of the good itself, while other factors remain constant. When price falls and quantity demanded increases, it is called expansion of demand. When price rises and quantity demanded decreases, it is called contraction of demand. In both cases, the demand curve remains the same, and only the point on the curve changes.
Shifts in Demand
A shift in demand refers to a change in demand due to factors other than the price of the commodity. In this case, the entire demand curve shifts either to the right or to the left.
When demand increases at the same price, the demand curve shifts to the right. This is known as an increase in demand. On the other hand, when demand decreases at the same price, the demand curve shifts to the left, known as a decrease in demand.
Factors Causing Shifts in Demand
Several factors can cause a shift in the demand curve.
One major factor is change in income of consumers. For normal goods, an increase in income leads to an increase in demand, shifting the demand curve to the right. A decrease in income reduces demand, shifting the curve to the left. However, in case of inferior goods, demand may decrease when income increases.
Change in tastes and preferences also affects demand. If a product becomes fashionable or preferred due to advertising, social trends, or lifestyle changes, demand increases even if price remains unchanged. Similarly, if consumer preference shifts away from a product, its demand decreases.
Prices of related goods play a significant role. Related goods include substitutes and complementary goods. An increase in the price of a substitute increases the demand for the given good, shifting the demand curve to the right. For example, if the price of tea increases, demand for coffee may increase. In case of complementary goods, an increase in the price of one good decreases the demand for the other. For example, an increase in petrol prices may reduce demand for cars.
Expectations about future prices and income also influence demand. If consumers expect prices to rise in the future, they may buy more now, increasing current demand. Similarly, expectations of higher future income can increase present demand, while fear of income loss can reduce demand.
Population changes are another important factor. An increase in population generally increases demand for goods and services, especially essential items such as food, housing, and banking services. A decrease in population has the opposite effect.
Government policies such as taxation, subsidies, and regulations can also shift demand. A reduction in taxes or increase in subsidies increases disposable income, leading to higher demand. Higher taxes reduce disposable income and lower demand.
Difference Between Change in Quantity Demanded and Change in Demand
Change in quantity demanded occurs due to a change in the price of the commodity itself and is represented by movement along the same demand curve.
Change in demand occurs due to factors other than price, such as income, tastes, or prices of related goods, and is represented by a shift of the entire demand curve.
Relevance for Banking and Economic Analysis
Understanding demand and its shifts is extremely important for banking professionals. Demand analysis helps banks forecast credit demand, consumer spending patterns, and business investment behaviour. It also helps in understanding inflationary pressures and changes in market conditions.
For example, during economic growth, rising incomes increase demand for loans, housing, and consumer goods. During a slowdown, reduced demand affects business profitability and loan repayment capacity. Therefore, demand analysis plays a vital role in credit planning, risk assessment, and policy formulation.
Conclusion
In conclusion, demand and its behaviour form the foundation of price determination in a market economy. The demand curve slopes downward due to forces like diminishing marginal utility, income effect, and substitution effect. Changes in price cause movement along the demand curve, while changes in other factors cause shifts in the demand curve.