A function explains the relationship between two or more variables. If two or more variables are related in such a way that for each set of values of some variables (called the independent variables) there corresponds a value of some other variables (the dependent variable), then the dependent variable is called the function of the independent variable.
In Economics, a number of functions such as demand function, production function, cost function, etc., are discussed. Thus, the word ‘function’ refers to the factors on which demand, production or cost depends.
The demand function for a good is the relation between the various amounts of the commodity that might be bought and the determinants of those amounts in a given market and in a given period of time. As stated earlier, to constitute demand, desire must be backed by the necessary purchasing power to purchase the commodity.
While the desire to purchase is revealed by tastes and preferences, income reveals the capability to purchase. Further, since household spends this income to purchase a number of commodities, demand for a particular commodity depends upon its price and the prices of other commodities.
Thus, the factors on which demand for a commodity depends (determinants of demand) are: (a) the price of the commodity, (b) the prices of related goods (substitutes or compliments), (c) the income of the consumers, (d) the tastes and preferences of the consumers, and (e) the expectations about the future prices of the commodity.
These determinants of demand provide analysis of consumer behaviour. They affect both the direction and proportion of change in demand. Demand analysis seeks to identify and measure the forces (size as well as intensity) that determine demand. For demand analysis, reference should be made to sources of demand, uses of the items demanded, the structure of the market, where the firm is located.
The demand function may be expressed symbolically as Q = f (P, P Y, T, E,0)
Where ‘Q’ stands for the quantity demanded of the commodity, ‘P’ for the price of the commodity, ‘Pr‘ for prices of the related goods, ‘Y’ for income of the consumer, ‘T’ for tastes and preferences of the consumer, ‘E’ for the expectations about the future prices and ‘O’ stands for other factors.
Now, we explain, how demand for the commodity is affected by each of these determinants. Alfred Marshall developed partial equilibrium analysis to study the influence of each of these factors in isolation on the quantity demanded.
1. Price of Commodity:
Price of the commodity is the most important determinant of demand. Generally, it is expected that with the fall in the price, the quantity demanded of the commodity increases and with the increase in the price, the quantity demanded of the commodity decreases.
Thus, there is an inverse relationship between the price of a commodity and its quantity demanded. That is, ∂Q/∂P > 0. The inverse relationship between price and quantity demanded of a commodity is commonly known as the ‘law of demand’. The relation between price and quantity demanded of a commodity is also called the price demand or simply demand.
2. Prices of Related Goods:
The demand for a commodity also depends upon the prices of the goods related to it. In Economics, two types of relations between goods are discussed. These are complimentary and substitutability of goods.
How the prices of the related goods affect the price of the commodity under consideration depends upon whether the related goods are complimentary or substitutes. If the two goods are used together to satisfy a given want, they are said to be complimentary
goods, such as tea and sugar, ball pen and refill, car and petrol, etc.
When two or more goods are simultaneously required to satisfy a want, their demand is called as joint demand. A fall in the price of a commodity raises the demand for its complimentary goods. That is, ∂Q/∂P > 0. if commodities ‘x’ and ‘y’ are complementary.
For example, with the fall in the price of petrol, demand for car will go up. This happens because, with the fall in the price of petrol, its quantity demanded increases. Increased quantity of petrol can be used with more cars. Similar is the relation between the price of tea and demand for sugar. A fall in the price of tea causes increase in the demand for sugar.
On the other hand, those goods which can be used in place of one another are called substitutes. For example, tea and coffee, scooter and motor cycle, etc. Existence of alternative goods (substitutes) to satisfy a given demand divides the total demand among different goods.
The larger the number of substitutes, the smaller will be demand for any one of them. Further, the level of prices of different goods influences the demand for their substitutes. A fall in the price of a good results in the decrease in the demand for its substitutes and an increase in the price of good results in the increase in the demand for its substitutes. That is, ∂ ∂Q/∂P> 0, if commodities ‘x’ and ‘z’ are substitutes. With the increase in the price of coffee, demand for tea increases, because people start using more of tea and less of coffee.
In other words, tea is substituted for coffee. Further, a rise in the price of cars by Maruti Udyog will raise the demand of rival producers like Daewoo Motors, Hyundai, TELCO, etc. On the contrary, with the decrease in the price of coffee, demand for tea will come down. Thus, we can see a direct relation between the price of a good and demand for its substitute.
The relation between the price of one commodity and demand for another commodity is called the cross demand. Fig. 1.3 (a) shows the cross demand curve that shows the relation between the price of petrol and the demand for car (complimentary goods). It has a negative slope. With the decrease in the price of petrol from OP to OP2, demand for car has gone up from OQ1 to OQ2. Fig. 1.3 (b) shows the cross demand curve for tea and coffee (substitute goods).It is upward sloping, showing the direct relation between the price of coffee and demand for tea. With the increase in the price of coffee from OP1 to OP2, the demand for tea has gone up from OQ1 to OQ2. This is so because with the increase in the price of coffee, people start substituting tea for coffee.
3. Income of Consumer:
The demand for goods also depends upon income of the consumer, on which management has no control. With the increase in the income, his purchasing power increases and he is in a position to afford more goods.
Consequently, the demand for goods increases. Thus, increase in income has a positive effect on the demand for goods. That is, ∂Q/∂ Y > 0. The relation between income and demand is called income demand.
Generally income of the people is directly related to their demand. So, the income demand curve is upward sloping (Fig. 1.4 (a)). Such goods are called normal goods for which income effect is positive, i.e., when income goes up, demand for such goods also goes up and when income falls, demand also falls. However, for certain goods called necessities; demand is not related to income either way.
That is, ∂Q/∂ Y = 0. Here, an example of salt may be given. The demand for salt does not increase with the increase in income and it does not decrease with the decrease in income. The curve showing the relation between the income of the consumer and the demand for salt is vertical as shown in Fig. 1.4 (b).
It is also possible that arise in income of the consumer may lead to a fall in the quantity demanded of the good, That is, ∂Q/∂ Y < 0. This is the case with inferior goods. A good is said to be an inferior good, if its demand falls with the increase in the income of the consumer. There is an inverse relationship between income and demand of inferior goods, i.e., income effect is negative.
Examples of inferior goods are vegetable ghee, gur, coarse grain such as bajra, etc. Fig. 1.4 (c) illustrates the income demand curve for an inferior good. Such goods are distinguished from the normal goods on the basis of income change, holding price of the commodity constant.
Sometimes, it may even happen that demand of a commodity increase initially. But, after a certain level of income, demand remains same or even falls. (Fig. 1.5). Since a famous German Statistician Engel made extensive studies on the relationship between income and consumption (demand), the curve showing such relationship is called as Engel curve. Further, if we income to expenditure on the commodity, the curve we get is called Engel expenditure curve.
Demand is positively influenced not only by changes in current income, but also by discounted value of accumulated income of the preceding periods from work or property (wealth, W). That is, ∂Q/∂W > 0. This is regarded as the real wealth effect on demand. If marginal propensity to consume by the consumer is high (i.e., low marginal propensity to save), a large portion of additional income earned will be used to buy goods and little will be saved and vice-versa.
This change in propensity to consume (or save) brings about a change in the demand for goods. Further, sometimes the demand may be influenced by the income of the household relative to his neighbour’s income and his purchase pattern. Thus, the household may spend more, when his neighbour incurs expenditure. This is called demonstration effect.
4. Tastes and Preferences of Consumer:
Another important factor which affects the level of demand of a commodity in the market is the tastes and preferences (both rational as well as irrational) of the consumer. Tastes and preferences often change, which affect the level of demand for various goods.
The demand for a good is more, which is liked by consumers and for which they have a preference. Consumer’s tastes and preferences may change because of a change in the fashion or as a result of the advertisement for various products.
This is the only determinant of demand, on which management can exercise some control through advertisement, product quality, service, etc. It is advertisement that to a large ex tent has affected the demand for Babool tooth paste. Many a times, films are responsible for the creation of fashion, which affect the demand of the various existing products. Sometimes, consumers become habitual or accustomed to the use of certain goods and they may not change the use of such goods, unless sufficient impetus is applied.
Consumer preferences are also moulded by changes in customs, conventions and habits. These socio-psychological determinants of demand often defy any theoretical construction. On the contrary, when some goods go out of fashion or tastes and preferences of people no longer remain favourable to them, the demand for them falls.
5. Expectations about Future Prices:
Consumers’ expectations about the future prices of the goods also affect their demand particularly for consumer durable goods, since purchases of durables can be postponed and preponed more easily than those of non-durables. If for some reason, consumers expect prices of certain goods to rise in the near future, they tend to demand more in the present.
Consequently, demand for these goods whose prices are expected to rise goes up. We often experience a rise in the demand for T.V., refrigerators, air conditioners in the month of February due to fear of rise in their prices, when new budget is announced. On the other hand, if they expect the prices to fall in the near future, they will demand less of it in the present.
Further, if consumers hope that in the future they will have good income, they will increase their purchases in the present. The present demand for goods will rise as a result. On the other hand, retiring people cut on non-essential expenses due to falling expected future income.
Educational backgrounds, social status, marital status, age, place of residence (urban or rural) are some of the sociological factors, which affect consumer demand. Changes in climate and weather conditions also influence consumer’s demand. Advertisement, sales promotion measures, availability of credit also affects consumer’s demand. The market demand for a good is obtained by adding up the individual demands at various prices. It is influenced by three additional factors. These are:
6. Size and Regional Distribution of Population:
The greater is the number of consumers of a good, the greater is the market demand for it. Thus, the demand for a commodity is directly related with the population, which is determined by birth and death rates. Population is also affected by migration and immigration. Regional distribution of the population also affects the demand.
7. Composition of Population:
If there are more children, demand for baby food, toys, biscuits, sweets, etc. will be more. Similarly, if there are more old people, spectacles, artificial teeth, sticks, tonics, fruits etc. will be more in demand. Predominance of young people in the population will raise the demand for cosmetics, sport goods, jeans, etc. Similarly, sex composition also affects the demand for a number of commodities.
8. Distribution of Income:
If income is equally distributed among the different sections of the society, all of them will be in a position to demand good. But, there will be more demand for goods purchased by relatively poorer people, like wheat, rice, fans, etc.
But, if the income is unevenly distributed, majority of the people will get small portion of the national income and so the demand for commodity will be limited. Most of the demand in this case will come from rich people for luxuries. Further, in this case, relatively greater portion of the income will be saved (by rich people).