What are the Determinants of Demand?
Determinants of demand are factors, such as price, income, and taste, that affect the amount of a good or service consumers will purchase.
For example, in 2021, the demand for bank loans decreased in the USA since the emergence of covid 19 pandemic. It might be due to the negative impact of the pandemic on income-generating capabilities. In this scenario, income will be considered the determinant of demand.
The three variables of supply, demand and price are interrelated. They form the basis for most economic transactions. When one of these variables changes, it affects how much consumers will buy.
- Determinants of demand are the major factors that affect the consumer’s purchasing desire.
- Price is a prominent determinant of demand that impacts sales volume. A high price means less room for profit, resulting in lower sales volumes than if prices were lower.
- Advertising and promotion activities also affect demand for products and services.
- Marketing research helps determine effective advertising methods, an appropriate time for marketing, and budgets.
Determinants of Demand for Economy
- Price is one of the most important factors when determining whether consumers can purchase a product in sufficient quantities.
- Generally, as the price of a good or service increases, the demand for it will decrease, and vice versa. The demanded quantity of a good/service is inversely related to its price.
- For instance, suppose Apple launches a new iPhone. Thus, the prices of its old models will decline, and in turn, lead to an increase in their demand.
Buyers’ Real Incomes or Wealth
- When real incomes rise, people have more money to spend on goods and services.
- The increase in demand can lead to higher prices for these goods and services.
- On the other hand, when real incomes fall, people have less money to spend, which can lead to lower prices.
- For example, the majority of people lose their jobs during recessions, which results in a decrease in their incomes. Therefore, they prefer to spend on necessary goods, which then impacts the demand of various other goods/services.
- The customer’s satisfaction with the quality of the product is a prominent factor.
- If a consumer is satisfied with the quality of a product (i.e., if they believe it will meet their needs), they may be willing to pay more.
- Suppose Microsoft increases their pricing for the Windows OS. As around 70% of the world population uses windows and relies on its quality, they’ll pay the extra amount without another thought.
- Income distribution can affect the demand for certain types of goods and services.
- For example, if income distribution is even, there may be greater demand for luxury goods and services.
- On the other hand, if income is more concentrated, demand for necessities such as food and housing may be higher.
- For instance, the price for a luxury good ‘X’ is $100. People from high-income society can easily afford the goods, thus the demand for good X is higher in their region. At the same time, low-income societies cannot afford the price, therefore refrain from buying it, reducing the good’s demand in their region.
Price of Substitute Goods
- Substitute goods are goods or services that one can use in place of each other. A price change in substitute goods can affect the demand for the original one.
- For instance, if the substitute’s price decreases, the demand for the original goods may decrease, as consumers may switch to the cheaper substitute.
- On the other hand, if the price of a substitute good increases, the demand for the original good may increase, as consumers may choose to stick with the actual product instead of paying a higher price for the substitute.
- For example, Zerodha and Groww are both trading platforms that offer similar services. However, Zerodha has an annual fee while Groww does not. This significant difference can influence customers to use the Groww platform.
Buyer’s Tastes and Preferences
- Buyers’ tastes and preferences significantly determine the economy’s demand for goods and services.
- Various factors, such as cultural, social, and personal values, as well as the availability of substitutes for a particular product, can influence these tastes and preferences.
- For example, suppose a consumer prefers organic and environmentally-friendly products. In that case, they may be more likely to demand these types of goods, even if they are more expensive.
Expectations of Buyer’s Future Income and Wealth
- If consumers expect their income or wealth to increase, they may be more likely to demand more expensive or luxury goods.
- On the other hand, if consumers expect their income or wealth to decrease in the future, they may be more cautious with their spending.
- Thus, the demand may lean towards cheaper or more valuable goods.
- Suppose a company is expecting to make double profit in the next month, it may choose to switch to better raw material and equipment. Therefore, the demand for better goods might increase.
Expected Future Price
- Expected future price is the price that consumers expect a good or service to be at in the future, and it can affect the demand for the good or service in the present.
- If consumers expect a good/service’s price to increase, they may be more likely to demand it now than in the future.
- For instance, when petrol or diesel prices are set to rise in the future, the public might want to buy more than enough of the fuel in the present. It will result in an instant increase in the good’s demand.
Number of Buyers
- All else equal, the greater the number of buyers, the higher the demand for the good or service.
- Each buyer can potentially increase the need for the good or service.
- The number of buyers in a market depends on population size, income levels, and the availability of substitute goods.
- For instance, during the holiday season there are numerous people visiting the tourist spots. They purchase local goods/services, improving their demand. Nonetheless, during off-seasons, the demand falls dramatically due to less number of buyers.
- Government policies can significantly impact the economy’s demand for goods and services.
- These policies can include tax, regulatory, and trade policies.
- For example, if the government imposes a high tax on a particular good or service, the demand for it may decrease, as consumers may be less willing to pay the higher price. In contrast, if they provide subsidies, the demand may increase.
- In addition to consumer demand, climate change can affect the production and distribution of goods and services, impacting demand.
- For example, extreme weather events and natural disasters caused by climate change can disrupt supply chains and the availability of specific goods and services, leading to a decrease in demand.
How do Determinants of Demand Work?
Demand is the relationship between the quantity consumers purchase and the price of that product. Many factors affect demand for a particular product, including its price, quality, and availability.
Suppose only a few options or available options are relatively expensive or inconveniently located. Consumers may wait to buy something until another option becomes available or prices decrease.
In this scenario, we say that an equilibrium point exists where the marginal cost equals marginal revenue, in which producers will maximize profits by producing at this level until demand falls below the equilibrium level.
Examples of Determinants of Demand
Mia is the sole earner in her family. Due to the recession, she loses her job. Thus, she can now only use her savings to purchase the necessity. Moreover, she would not spend her money on luxury or unnecessary goods/services.
Similarly, if most people lose their jobs, their income (determinant) declines, reducing demand for unnecessary or luxury goods.
Company XYZ uses a particular type of wood as a raw material for manufacturing furniture. They sell their product at reasonable market rates. Due to a scarcity and price increase in the raw material, the company starts selling its final product for a higher price.
However, other companies are still producing furniture and selling it at a comparatively lower price. Therefore, the demand for XYZ’s furniture reduces due to the cost of a substitute good (determinant).
Determinants of Demand for Elasticity
Demand elasticity measures how responsive the quantity demanded is to a change in price. Understanding the determinants of demand elasticity can be important for businesses in terms of pricing strategies and demand forecasting.
There are several determinants for demand elasticity, which include:
The availability of substitutes:
- If several substitute goods or services are available, the demand for a particular good/service may be more elastic as consumers have more options.
Income spent on the good or service:
- If a good or service represents a large proportion of a consumer’s income, its demand may be more elastic, as price changes will have a greater impact on the consumer’s budget.
- If a good or service is considered a necessity, its demand may be less elastic, as consumers will continue to demand it even if the price increases.
The degree of habit or custom:
- If a good or service has become a habit or custom for consumers, the demand for it may be less elastic, as consumers may be less likely to change their consumption patterns.
The time frame:
- Demand elasticity can vary over time.
- In the short term, the demand for a good or service may be less elastic, as consumers may be less able to adjust their consumption patterns quickly.
- In the long term, the demand may be more elastic, as consumers have more time to adjust their consumption patterns in response to changes in price.
What is the law of demand?
- The law of demand is the fundamental economic principle that states that even when everything is equal, the rise in the price of a good or service can lead to a drop in demand.
- It is one of the most fundamental concepts in economics and underlies the entire field of supply and demand analysis.
- The law of demand is also an essential building block for many other economic principles and theories.
Determinants of Demand – Advantages and Disadvantages
|The determinants of demand help in better understanding the demand for a product.||The determinants of demand are often assumed to be constant, but they are not.|
|They are useful in predicting future demand for a product.||They are generally not included in production decisions.|
|They can help analyze the relationship between various factors that influence demand for a product.||They can sometimes be difficult to measure or predict accurately.|
|They are easier to predict the demand for a product or service because it is based on human behaviors and desires.||They are often challenging to understand, especially for business managers who need simple rules about how demand varies with changes in price, income, and other factors.|
|They give us a more accurate picture of what people want. Businesses can use it to increase sales and profits.||Time and market conditions can change their values, causing them to vary over time and across markets.|
Several factors can affect demand which is known as determinants of demand. These include price, quality of the product, advertising, and competitors. It is important to note that we must consider each factor to understand how they affect demand.
Frequently Asked Questions (FAQs)
Q1: What are the determinants of demand?
Answer: The determinants of demand are the factors that influence the quantity demanded by consumers. They generally help economists and businesses determine the future demand for a product. These factors include consumer preferences, income, and tastes.
Q2: Which are non-price determinants of demand?
Answer: Non-price determinants of demand are the factors other than price that contribute to change in demand for a good or service. Some examples of non-price determinants include the number of buyers in the market, government policies, climate change, and income distribution. The consumer’s income, tastes and preferences, and future income or wealth expectations are also factors.
Q3: What are the determinants of aggregate demand?
Answer: The following are determinants of aggregate demand: consumer spending, investment, and government spending. Some other determinants are exports, changes in the money supply, and changes in the price level.
Q4: How does demand change concerning price?
Answer: The higher the price of a good or service, the less likely consumers will buy it (demand goes down). Conversely, when the price of a good or service goes down, consumers are more likely to buy it (demand goes up).
Q5: What determines the price of a good sold?
Answer: The price of a good depends on several factors. Some of these factors include the market price of other goods sold in the same market, the cost of producing that good, and whether there are any associated taxes.
This is an EDUCBA guide to the determinants of demand. You can view EDUCBA’s recommended articles for more information,