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The factors that impact individual consumer demand in the real world are complex, but economic theory simplifies this to five determinants of demand. This article explores those five things and how they can affect your business’s bottom line.
Many of us have heard phrases like “there’s a huge demand for product XYZ in the market.” But what does this mean? What constitutes the demand that we speak of, and how do our determinants influence it, affecting a company’s output over time? Let us learn about some key concepts to get you started!
What is Demand?
In economics, demand can be explained as consumers’ willingness and ability to purchase or consume a given item/good. Therefore, the determinants of this demand are crucial for explaining the consumer’s behavior towards any particular good. The market is made up of buyers and sellers. Buyers are represented by demand, which describes all quantities of a good or service they would be willing to purchase at each price point within the market.
For example, if the price of a good increases, then buyers will most likely buy less. Similarly, when the selling or cost price decreases, people would probably want to buy more from that company.
The inverse relationship between the price of an article and its demand is known as the law of demand. A downward sloping line can represent this on a graph, where the quantity demanded decreases with increasing prices.
The graphical representation of demand is often called the “demand curve” because it shows how many units consumers would be willing and able to purchase at a given price. Thus, the determinants for economic demands cause fluctuations in consumer purchasing behavior, impacting market prices.
The demand curve shows the relationship between price and quantity. If one of these variables changes, this entire relationship shifts: if a lot happens when prices change regarding how much is demanded, then we have elastic demand; however, if regardless of price, there’s not much response – that would be considered inelastic demand.
Demand Equation or Function
The demand for a good is determined by five factors, which are represented in the equation below:
- qD = f
Here, in the above demand equation
- qD = represents quantity demanded.
- F = represents the determinant of demand as (price, income, prices of related goods, tastes, expectations).
The whole equation represents the relationship between two factors. Thus, the quantity demanded (qD) changes if any factor changes.
The Five Determinants of Demand
The main factors that affect an individual’s demand are known as the determinants of demand. Therefore, to understand why certain products have higher demands than others, we need to know these variables and how they influence our decisions.
For instance, people might consider how much money they make when deciding what to purchase. They also care about the cost of an item and their income level before buying something.
Economists break down the factors that influence an individual’s demand into five categories:
- Prices of Related Goods or Services
Demand is a function of the five categories. Let’s look at each of the determinants of demand to understand their impact better.
The determinants of demand are:
1. Price of Goods or Services
The law of demand states that all else being equal, the quantity demanded decreases when price increases and vice versa. This is why the demand curve slopes downwards. There are some exceptions to this rule, such as luxury items where more expensive ones may increase demand for it due to having better quality or exclusivity.
When people think about spending money, they tend to look at their income as a factor. However, the relationship between income and demand isn’t straightforward.
Does an increase in income lead to more purchases of a particular item or less? As it turns out, the answer is trickier than you might think.
A change in income will affect the quantity demanded, but people can only consume so much of a good or service. This is called the marginal utility, and it helps explain why an increase or decrease in income may not always lead to equivalent changes in demand for goods that were once consumed regularly.
I bet the first slice of cake tastes good. After that, you might want another piece, but after that, your marginal utility starts to decline, and you don’t feel like eating any more than a few more bites.
Economists categorize items as normal goods or inferior goods based on how the demand for that good changes with income.
- Normal goods – If a good is a normal good, then its quantity demanded goes up when income increases and down when it decreases. Examples of normal goods are automobiles, furniture and clothes, and automobiles.
- Inferior goods – If an item is an inferior good, however, this relationship reverses. Second-hand clothing is an example of a good whose demand decreases when the consumers’ income increases. This happens because their quality falls with the availability of higher quality alternatives, and thus people opt to buy more expensive clothes instead.
3. Price of Related Goods or Service
When people decide how much a good they want to purchase, they consider both substitute and complementary goods’ prices. Substitute goods are used in place of one another, while complimentary goods work together or increase each other’s value.
A key feature of substitutes and complements is that a change in price for one good impacts the demand for the other good.
A rise in the price of one product will cause an increase in demand for a substitute product. There is a relationship between the price of one product and the demand for its substitute. To put it another way, a substitute good can be used in place of an original item. If McDonald’s prices increase, their customers may go somewhere else like Burger King or KFC due to this phenomenon called “substitute good.”
Direct substitutes goods have some attributes in common. There are many examples of direct substitute goods. For example, Coca-Cola and Pepsi are within the soda and close substitutes market because consumers switch between the two easily with little resistance.
The high cross-elasticity of demand for a product shows a direct substitute good. For example, when the price of Coca-Cola goes up and its sales fall by 5 percent, the sales of Pepsi increase by close to 5 percent. In other words, if the correlation is high, then they can be considered direct substitute goods.
Direct Substitute Examples:
- McDonald’s and Burger King
- Coca-Cola and Pepsi
- Playstation and Xbox
- iPhone and Samsung Galaxy
In-direct substitute goods have different industries or categories, but they’re often the same quality. So, if bowling becomes too expensive and customers switch to video games instead, these products are from two different industries (bowling vs. video games). Yet, people may still prefer them as substitutes because they provide the same kind of entertainment value for a lower price point.
In-direct substitutes are not too common, so they have a low cross-elasticity of demand. For example, an increase in the price of bowling and a decline in sales of 20 percent may only increase video game sales by 2 percent. Therefore, the relationship between both items remains weak even though marketers need to consider this because it has implications for their marketing strategies.
In-direct Substitute Examples:
- Bowling and dancing
- Video games and bowling
A complementary good, or complements, is a product or service that enhances the value. If a price change in an item goes along with another product, the demand for one of those products can also increase or decrease. When the price of bread increases, it causes a decrease in demand for butter. They are complementary goods; when one goes up or down, so does the other.
Sometimes, a complementary good is necessary. For example, this is the case with petrol and cars. In addition, however, a complementary good can enhance the quality of an initial product—for example, iPhone and iPhone cases.
Strong Complementary Goods
Strong complementary goods are related to relying on the other to add value. So, for example, we have mobile phones and sim cards — these items go hand-in-hand because they’re pretty useless without each other’s presence.
The complementary goods relationship between mobile phones and sim cards is very elastic. This means that when the price of a telephone rises, sales for their accompanying card will fall as well. So we can say there’s a negative cross-elasticity between them — if you look at any product that cannot be sold without another item to complement it — they are likely strong complementary goods.
Weak Complementary Goods
Weak complementary goods are not very responsive to changes in prices. This means that they only have a limited impact on the price of other related products. However, there is some connection between them.
Complementary Goods Examples:
- Tennis Balls and Tennis Racket
- Mobile Phones and Sim Cards
- Petrol and Cars
- Pencils and Notebooks
4. Tastes and Preferences of Consumers
Many factors affect consumer behavior, but one of the most important is preferences. The main idea is that if there’s a change in preferences, demand will change. For example, this can happen with yoga because it became popular recently, and people were promoting its benefits more than before, which led to the increased need for yoga classes.
In addition to this determinant influencing the marketplace directly, there are also indirect influences on how much demand a product gets, e.g., celebrities endorsing certain brands, which leads their followers to want to purchase them.
5. Consumer Expectations
Consumers’ expectations of future prices, incomes, and the price of related goods can also influence today’s demand.
The expectations determinant refers to consumer behavior that has not yet happened but may happen in the future depending on different factors such as economic conditions or political decisions (e.g., Brexit). This determinant affects consumer behavior by influencing how much consumers spend today before these events occur, resulting in either too many or not enough resources at some point in the future.
What are the other factors that affect the demand?
Branding. By using advertising, product differentiation, and high-quality products. Sellers can create such strong brand images that buyers prefer the seller’s goods over others similar to them.
Market size. The increase in the market size would cause an increase in demand for products. For example, suppose a country’s birth rate suddenly increased. In that case, there will be an influx of baby-related demands such as diapers and formula milk because more babies are born every year, leading to higher numbers of buyers. The number of buyers in a market is an essential factor that affects the demand for goods. When there are more consumers, it means greater market demand and vice versa.
Seasonality. If we look at how the seasons affect consumer demand, one can see that it plays a significant role in business. For example, high demand exists during Spring and Summer because people like to do outdoor activities such as gardening or picnics in parks; however, Fall sees low sales levels due to fewer individuals engaging in these activities.
Demographics. The demographics of a population can influence the demand for specific products. For example, an aging population will increase the demand for arthritis drugs, while a younger generation may sell more sporting goods.
With all these demand determinants in mind, it’s clear that there is no single way to drive sales. This means you need a marketing strategy for every economic climate and situation. The takeaway from this blog post is simple- when making decisions about marketing, pricing, or production strategy, keep what drives people to buy at the forefront of your thoughts.
We hope you’ve enjoyed this article on the five factors that impact individual consumer demand. Now that you know how to create demand in the real world, we encourage you to share and subscribe! There is a lot more information coming your way soon about sales strategy for small businesses and how to use digital marketing effectively.
Frequently Asked Questions
What are the five determinants of demand?
The five determinants of demand are the following:
– Price or Price of the Product.
– Prices of Related Goods or services.
– Tastes or preferences of consumers.
– Expectations or Consumer Expectations.
What are the five non price determinants of supply?
The 5 nonprice determinants of supply are as follows:
– Taxes & subsidies.
– Number of sellers.
– Price of other products.
What are the determinants of demand and supply?
The determinants of demand and supply are as follows:
– Tastes, preferences, and popularity.
– The number of buyers.
– The income of buyers.
– Price of a substitute good.
– Price of complementary goods.
– Expectations of the future prices of goods.
What are the 7 determinants of demand?
The seven determinants of demand are the following:
– A change in buyers’ real incomes or wealth.
– Buyers’ tastes and preferences.
– The prices of related products or services.
– Buyers’ expectations of the product’s future price.
– Buyers’ expectations of their future income and wealth.
– The number of buyers or, say, the population.
– Income Distribution.
What are three Demand Determinants?
Three Demand Determinants are the following:
– Price of the Product.
– The income of the Consumers.
– Prices of related goods or services.