Based on the general demand function, applicable in the long run, following important determinants of the demand can be highlighted:
Determinant # 1. Price of the Commodity:
Price of the commodity is the most important determinant of the demand. As it is well known, there is an inverse relationship between the price of a product and its demand. That is, a fall in price of the product will result in an increase in demand by a buyer and vice versa. More on this relationship is explained under the law of demand.
Determinant # 2. Prices of Related Goods:
Another variable of high significance is the prices of the related goods, which may be a substitute or a complement. They are collectively known as related goods.
Determinant # 3. Substitute Goods:
A substitute is a goods that can be used in place of a particular goods as it provides same kind of utility. For example, a train-ride is a substitute for a bus-ride; a pear for an apple and, a gel pen for a ball pen. If the price of a substitute increases and price level of the product remain same, than the demand for the product will rise as it will become relatively cheaper.
To explain this, let us presume that the price of the product X and its substitute is equal at Rs.4 per unit, to begin with. So, the sum required to procure,
1 unit of product X = 1 unit of substitute
Subsequently, the price of substitute doubles to Rs.8 per unit. Now, for the consumer,
2 units of product X = 1 unit of substitute
This implies that the product X has become relatively cheaper vis-a-vis its substitute. This will increase the demand of the product X despite no change in its price.
It means that the price of a substitute and the demand of a given product move in the same direction. That is, if the price of a substitute increases, the demand of the given product will increase and vice versa. This is shown graphically in the Figure-4.1 by an upward looking positively sloped curve AB.
In case of gel pen and ball pen, for instance, if the price of gel pen increases then the demand for ball pen will increase. Conversely, if the price of a substitute (gel pen) decreases, the demand for the product (ball pen) will also decrease.
This happens because an increase in price of substitute will make the product relatively cheaper and the buyer will demand more of cheaper goods than its expensive substitutes. Similarly, if price of substitute falls, it will make the product expensive vis-a-vis its substitute and, hence, its demand will fall.
Further, the effect of change in price of a substitute occurs no matter what is the price of the product. As a consequence, a change in price of the substitute will change the entire demand schedule and causes the demand curve of the product to shift, as shown in Figure-4.2. The figure shows that an increase in the price of the substitute will lead demand curve of the product to shift upward while a fall in the price of the substitute leads its demand curve to shift downwards.
Determinant # 4. Complement Goods:
A complement is a commodity which has to be used in conjunction with the given commodity. For example, petrol and car, bricks and cement, ink-pen and ink are to be consumed jointly. This property of consumption implies that if one of them becomes expensive the demand for the other will decrease and vice versa.
An increase in the price of ink, for example, will reduce the demand for ink-pen. In nutshell, demand of a product is inversely related to the price of its complement, as shown by a negatively sloped demand curve AB in the Figure-4.3.
Determinant # 5. Income of the Consumer:
Buyer’s income is another important determinant of demand of a product. It represents purchasing power of the buyer. When income increases, buyer demands more of normal goods and vice versa. There is, thus, a direct relationship between income and demand of a normal or superior goods.
The Figure-4.4(a), shows an upward shift in demand curve of a normal goods when income rises and a downward shift when it falls. An upward shift in demand curve will show that at each given price consumer will demand more of the product at higher income. Similarly, a downward shift in demand curve will mean a fall in demand on each price when income of the buyer falls.
The behaviour of inferior goods will be just reverse of a normal goods. Demand of an inferior product will fall as income of the buyer rises and vice versa. Such behaviour is exhibited in Figure-4.4(b).
In the Figure-4.4(a), at income level Y, price-quantity relationship is exhibited by the demand curve Dd. When income rises to Y2, the demand curve moves upward and assume the position at D1d1. Thus, at each price level, the expected demand of the product will be more at income level than the Y2 than that of at income level Y. Similarly, when income falls to Y1 from Y, the demand curve moves downwards and assume the position at D2d2. As a result, demand will be less at each possible price level.
However, the inferior and Giffen goods will not behave in this fashion. Their demand will fall as the income rises, as shown in the Figure-4.4(b). When income rises from Y to Y2, the demand curve has shifted downward to D2d2 and when income falls from Y to Y1, it shifted to D1d1. An upward shift in demand curve will mean more demand at same price and vice versa.
It also implies higher demand for inferior goods when income falls and lower demand when income rises, price remaining the same. This happens because the consumer will move on to some superior product as his buying power increases and, therefore, demand for inferior product will fall. The reverse will happen when income of the buyer falls.
If a direct relationship is established between income and demand, as shown in Figure-4.5, at a given price P1 then we get a positively slopped curve for a normal goods while a backward slopping curve in case of an inferior goods.
These curves show that when income of the consumer rises from Y1 to Y2, demand for a normal product will go up [Figure-4.5 (a)] while that for an inferior product will go down once income exceed OY1 level [Figure-4.5 (b)].
This is also called as income demand of a buyer expressed as, Qx = f (Y).
Determinant # 6. Wealth of the Consumer (W):
Wealthy persons are characterized by high income level. Their propensity to consume is low and they save a larger proportion of their income. They spent a lesser proportion on consumables. The overall demand of a rich person is, thus, less vis-a-vis resources available at his disposal.
If the value of wealth erodes, say due to inflation in the economy, the rich person will save more to restore the total value of assets. As such, their demand will further fall down. This adversely affects the total demand in an economy. Moreover, their total demand constitutes more of luxury goods than that of necessities.
Determinant # 7. Tastes, Preferences and Fashion:
Tastes, preferences and fashion also make a significant impact on demand. Generally speaking, if tastes and preferences of a buyer move away from a product, its demand curve shifts downward and if the buyer prefers a particular product in terms of taste and preferences, its demand curve shifts upward (Figure-4.6). For this, one can observe that demand for fashion goods is usually high.
However, no logical generalization can be made with respect to this factor for being a subjective one. That is, a product may be preferred by a consumer while another consumer, at the same time, may dislike it.
For example, under the influence of western culture, demand for the traditional Indian male dress, Dhoti-kurta, has gone down considerably in urban areas while in rural areas, majority of people still wear them. Demand for western food items, like burgers, pizzas and, pasta, are on the rise among the youth in metro cities while others still enjoy only traditional ethnic food.
For being subjective and qualitative in nature, this determinant is often kept out in demand estimating or analyzing exercises. Incidentally, it is the only variable in the demand function that represents non-quantifiable subjective variables while other independent variables are quantifiable.
Determinant # 8. Price Expectations:
If the price of the product is expected to rise in future, for whatsoever the reasons, consumer will demand more to stock the product and vice versa. In this way, he will save himself from the future price hikes or extract benefits by postponing purchases in the anticipation of price fall. Thus, price expectations will also make a significant impact on demand pattern of a buyer.
Determinant # 9. Population:
Size of population affects the market demand or demand at an aggregate level. Market demand for food grains and pulses, for example, will be more if the size of population of a country is more. In short, larger the population more will be the market demand and smaller the population lesser will be the market demand.
Determinant # 10. Size and Distribution of National Income:
Larger the size of the national income more will be the demand of goods and services. Further, an even distribution of national income will push demand of necessities up while an uneven distribution will boost demand of luxury goods.
Determinant # 11. Availability of Credit:
An easy access to credit will push the demand up. People with smaller budget will also able to purchase the expensive products, consumer durables in particular, and pay in monthly instalments afterwards.
It will add new consumers leading the market demand to rise. In fact, firms in the business of goods like LCD television sets, automatic washing machines, refrigerator, and luxury cars widely use this instrument for increasing their market demand and sales.
Determinant # 12. Demonstration Effect:
International demonstration effect of Ragnar Nurkse explains developing nations imitating consumption patterns of developed nations. This is more clearly visible when a developing nation follows globalization policies aggressively.
Likewise, middle income population of a developing nation is often found of imitating the rich in terms of life style. All these, which are part of demonstration effect, push demand, especially of luxury goods, up in the developing societies.
Determinant # 13. Sale Promotion Strategies of Firms:
All firms in a market driven economy introduce measures to increase their respective sales which include advertisement, appointing sales representatives, granting concession to buyers under different schemes, free gifts etc. All such measures encourage buyers to buy more, as also new buyer to buy the product. This affects the aggregate demand of a product to a significant extent.
Determinant # 14. Taxation and Subsidies:
Government taxation also affects demand of a product. A tax concession will lead price of a product to fall and its demand to rise while imposition of a new tax or increase in tax burden will lower the demand. Similarly, government subsidies also increase demand of products. In short, lower tax and higher subsidies will enhance demand of a product and vice versa.
Determinant # 15. Role of Different Determinants:
Apart from the variables discussed above, there may be many more determinants affecting demand of a product though to a varying extent. Conceptually speaking, demand function need to be written separately with respect to each product and for each buyer in which different variables will play a different role. To be precise, some factors may be important for one product but the same variables could be insignificant for other. Similarly, importance of different variables may be different across buyers. Nonetheless, some generalization can still be attempted.