DEMAND ANALYSIS.

The theory of demand and supply enables us to understand the determination of prices and
quantities in different markets. For example, why the prices of agricultural commodities such
as tomatoes, apples, mangoes and cabbages increase and decrease at certain times of the year,
why have the prices of computers, music systems and television sets been steadily declining
over time. An understanding of the working of the price system provides us with the answers
to some of these questions. The price system provides the basis for determining the prices of
factors of production.
Definition of Demand
Demand refers to the quantity of a commodity that consumers are willing and able to
purchase at any given price over a given period of time, holding other factors constant. It is
important to realize that demand is not the same thing as want, need or desire. Only when
want is supported by the ability and willingness to pay the price does it become an effective
demand and have an influence on the market price. Hence demand in economics means
effective demand. It is different from desire in that it has to be supported by the ability to
purchase the product/service.
The price of a commodity is most important factor/determinant of demand. All factors
affecting demand other than the price are referred to as conditions for demand. While
analyzing the relationship between price and quantity of demand economists assume that all
factors affecting demand remain constant. An individual demand for a given good can be
presented in a form of a demand schedule. A demand schedule is a table showing quantity of
a commodity that could be purchased at various prices. The Table 2.1 shows an individual’s
demand for commodity X.

From the table, 65 units of commodity X will be demanded per week if the price is
Kshs 6 per unit.

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A demand schedule can be represented in the form of a graph known as a demand curve.
Figure 2.1 shows the demand curve for commodity X. The curve shows graphically the
relationship between quantity demanded and the price of the commodity. A demand curve
has a negative slope. It slopes downwards from left to right showing that as the price of a
commodity falls demand increases. The inverse relationship between the price of a
commodity and the quantity demanded is what is referred as the law of demand.

This law states that, “ceteris paribus (other things remaining constant), the lower the price of
a commodity the greater the quantity demanded by the individual and vice versa”.
Exceptions to the Law of Demand
There are some demand curves that slopes upwards from left to right showing that as
the prices of a product rise more is demanded and vice versa. This type of demand
curve is known as regressive, exceptional or abnormal demand curve and occurs in
the following situations:
1. When there is fear of a more drastic price changes in the future. This will cause
consumers to increase their quantity demanded to avoid paying a higher price in the
future. This situation is often found in the stock exchange where there is often an
increase in the demand of shares of a company if its shares are expected to increase.
2. In the case of giffen goods. This refers to basic foodstuffs that constitute a high
proportion of the budget of low-income families. When the price of a giffen good
rises, the proportion of the total income of individuals who consumes these giffen
goods rises and since such consumers are worse off in real terms, they can no longer

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 afford to consume other more expensive commodities like meat and fruits. To make
up for the goods they can no longer afford to buy, they are more likely to purchase
more of basic foodstuffs; conversely when the price of basic foodstuffs falls. They
become better off in real terms and are likely to buy more or relatively more
expensive foodstuffs and less basic foodstuffs. i.e. ugali and meat.
3. Goods of ostentation (Veblen goods). These are commodities whose prices falls in the
upper price ranges and that have a snob appeal. The wealthy are usually concerned
about status. Believing that only goods at high prices are worth buying and worth the
effect of distinguishing them from other consumers. In the case of such commodities,
a firm increasing its prices may find that the sales of its product increase and at lower
prices less of the commodity may be bought as the commodity is rejected as being
substandard. Consumers often in making comparisons between similar products with
different prices opt for relatively more expensive product believing it to be better. As
prices increase demand increases this is referred to as snob effect. Examples of goods
of ostentation are expensive perfume, jewelry, cars clothes, etc. The demand curve
will be positively slopping as indicated in Figure 2.2.

4.inferior goods- these are goods assumed to be of low quality compared to others
available that can be used to satisfy same want.an increase in price of an inferior good
may be taken to mean an improvement in quality. Demand for such commodities will
hence tend to increase with increase in prices.
5. Expectation of future shortages
6. Necessities-they are necessary for life. Demand will not change even if prices go
up.
7.Habitual goods and services-a consumer will consume certain goods and services at
same quantity at any price because these goods have become habitual and one can’t
do without them e.g. addictive’s i.e. drugs.

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The Determinants of Demand
The demand of the product can be considered from the standpoint of either individual
demand or market demand. Demand for any commodity can be considered from two points
of view:
(a) Individual demand is the amount the individual is willing and able to buy at a given price
and over a given period of time. Factors affecting individual demand are;
1. The price of the product.
When deciding whether or not to buy a particular product, an individual will compare
the price of the product and the amount of utility or satisfaction expected to be
received from the product. If the price is considered worth the anticipated utility the
individual will buy the product and if not will not buy. A decrease in the price of a
product will probably increase individual’s demand for it since the amount of utility
obtained is likely to be worth the lower price. Conversely a rise in the price of a
product will probably result in a fall in demand, as the amount of utility received is
less likely to be worth the higher price to be paid. An example of this phenomenon is
the hotel industry in Kenya. There is usually an increase in domestic tourism during
the low season when many Kenyans consider the lower hotel prices to be worth the
level of satisfaction they are receiving. During the high season when the hotel prices
are high, many do not consider the satisfaction they are receiving to be worth. If the
amount a consumer is willing and able to purchase due to change in the price, a
change in the quantity demanded is said to take place. If on the other hand the amount
the consumer is willing and able to purchase changes because of a change in the price
of a given commodity leads to a change in the quantity demanded will be undertaken
later in utility analysis and indifference curve analysis.
2. The prices of related goods.
The demand for all goods is interrelated in that they are competing for consumer’s
limited income. Two peculiar interrelationships can be; Substitutes goods such as tea
and coffee butter and margarine, beef and mutton, a bus ride and a matatu ride, a
mango and an orange, CDs and cassettes. Two goods, X and Y are said to be
substitutes if a rise in the price of one commodity, say Y, leads to a rise in the demand
of the other commodity X. If the price of tea increases consumers will find coffee
relatively cheaper to tea as a result demand for coffee increases. Substitutes are
commodities that can be used in place of other goods. This phenomenon is illustrated
in Figure 2.3. The graph shows the relationship between the prices of tea over the
quantity for coffee. If the price of tea increases from P1 to P2 the quantity of coffee
demanded increases from Q1 to Q2.

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 Compliments goods such as shoe and polish, pen and ink cars and petrol, computers
and software, bread and margarine, hamburgers and chips, tapes and tape recorders.
Demand for some commodities can also be affected by changes in the prices of the
complementary if a rise in the price of one of the goods, say A leads to the fall in the
demand of another food, say B. Complimentary goods are usually jointly demanded in
the sense that the use of one requires or is enhanced by the use of the other. Figure 2.4
illustrates the relationship between complementary goods graphically. For example, if
the price of cars is lowered demand for petrol increases because more cars will be
bought/demanded. The curve shows the relationship between the price and of a car
and quantity demanded for petrol. If the price of cars falls from P2 to P1 the quantity
demanded for petrol increases from Q1 to Q2.
3. Changes in disposal real income.
An individual’s level of income has an important effect on the level of demand for
most products. If income increases demand for the better-quality goods and services
increases. This relationship however, depends on the type of goods and level of
consumers‟ income. The three types of are goods; Normal goods these are goods
whose demand increases as income increases. The demand for normal goods increases
continuously with increase in income. It tends to become gently as people reach the
desired level of satisfaction.

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 Inferior goods refer to goods for consumers with low income levels such that as
income increases its demand falls. At low level of income, these individuals will tend
to consume large amount of these goods but as income increases they buy other goods
which they consider superior thus demanding less of the inferior goods. At very low
level of income an inferior good behave like a normal good only to behave inferior as
income increases. Necessities these are goods which consumers cannot do without
such as salt, match boxes among others. Their income demand curve tends to remain
constant other than at the lowest levels of income as indicated in Figure 2.5

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 4. Changes in consumer tastes, preferences and fashion
Personal tastes play an important role in governing the consumer’s demand for certain
goods. For example, preferring to consume imported commodities despite them being
extremely expensive. Prevailing fashions are an important determinant of tastes. The
demand for clothing for example, particularly is susceptible to changes in fashion.
5. Level of advertising is also an important determinant of demand. In highly
competitive markets, a successful advertising campaign will increase the demand of a
particular product while at the same time decreasing the demand for competing
products. Increase in advertising will increase demand in the following ways;
- it helps inform about the product of a firm
- Can introduce new products to the market.
- Induce individuals to frequently use the product/service
Factors affecting advertising policies
- cost of advertising
- mode of advertising
- impact of advertising on the demand of the product
- The target group (old, young)
- number of competitors and quality of their products
- The market share of the firm and the degree of competition
- Future expectations in price changes
- Government policies and taxes
- Appropriate time to make advertisements
- Cultural background
- Language
6.The availability of credit consumers.

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This factor especially affects the demand for durable consumer goods which are often
purchased on credit. For example, a decrease in availability of credit or the introduction of
more stringent credit terms is likely to lead to a reduction in the demand of some durable
consumer goods.
7.The government policy
The government may influence the demand of a given commodity through legislation. For
example, making it mandatory for everyone to wear seatbelts. The consumers inevitably get
to purchase more seatbelts as a result. Subsidies it’s the opposite of taxation. When the
government grants subsidies prices of goods fall leading to increase in demand and vice
versa. Price controls and legislations are also government methodologies that will affect
demand
8.Climate change demand of various goods varies depending on weather. For instance, there
is high demand for woolen clothes during rainy reasons
(b) MARKET FACTORS AFFECTING INDIVIDUAL DEMAND
It’s a horizontal demand sum of the demands for individual consumers. It refers to quantity
demanded in the market at each price by individual consumers. For this reason, all the factors
affecting individual demand will affect market demand. The market demand for a commodity
can be derived graphically as in Figure 2.6.

Where P1, P2 and P3 are individual prices Q1, Q2 and Q3 are individual quantities
demanded. Pmk is the market price qmk is market quantity demanded. Other factors affecting
market demand Change in population market demand is influenced by the size of the
population, the composition of the population in terms of age sex as well as geographical
distributions. Distribution of income more evenly distribution of income may increase
demand for normal goods while at the same time it may lower the demand for luxuries.
Movement Along and Shift in Demand Curve
Demand is a multi- variant function in the sense that it is influenced by so many factors such
as the price of the commodity, the price of other related commodities, consumer incomes etc.
The price of the commodity is the most important determinant of demand and its relationship
with the quantity demanded give rise to a demand curve. Movement along demand curve is
demonstrated by a change in the price of a good as shown in Figure 2.7 by movement from
one point to another on the same demand curve.

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A change in price of a good from P1 to P2 causes a movement from point A to B along the
demand curve. This movement along demand curve shows a change in quantity demanded
which is an increase or a fall in the quantity demanded. A shift in the demand curve is caused
as a result of a change in any factor affecting demand other than price such as changes in
consumer income tastes and preferences. For this reason, all other factors affecting demand
other than price of the product are also referred to as shifting factors as illustrated in Figure
2.8 Any change in the shifting factors will cause changes in demand (an increase or a fall in
demand). A shift to the right (dd to d1d1) shows an increase in demand while a shift from (dd
to d2d2) shows a decrease in demand.

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TERMS USED IN DEMAND
(a) Joint demand it is the demand whereby two commodities are always demanded together.
One good cannot be demanded in the absence of the other such as car and petrol.
(b) Competitive/rival goods it is the demand for goods which are substitutes such tea and
coffee.
(c) Derived demand where goods are demanded in order to provide goods such as cotton is
required to produce cotton wool
(d) Composite demand (several uses) where some goods are used for different purposes such
as steel for cars machine etc.
Elasticity of Demand
It can be defined as the ratio of the relative change of a dependent variable to changes in
another independent variable. Elasticity can be analyzed in terms of demand and supply. It
can also be defined as a measure of responsiveness of quantity demanded of a good in to
changes in income or prices of other related goods. There are three types of elasticity; price
elasticity of demand, cross elasticity of demand and income elasticity of demand. Price
elasticity of demand it’s the measure of responsiveness of the quantity demanded of a
commodity to changes in its own price. It is also referred to as own price elasticity. It
abbreviated as PED/ED. It is calculated as follows

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If changes in prices cause more than proportionate change in quantity demanded it is said to
be price elastic, in this case ED >1. If changes in the price causes less than proportionate
change in quantity demanded, then demand is said to be price inelastic this is represented by
ED < 1. If changes in price causes proportionate change in quantity demanded then, demand
is said to be unit elastic or unitary elastic where ED= 1
To illustrate price elasticity, consider the Table 2.3 which shows demand schedule of
commodity X.

This price elastic because 3 >1 The price elasticity of demand is classified into two:
(i) Point elasticity
(ii) Arc elasticity
The point elasticity of demand measures elasticity at a particular point along the demand
curve. It is calculated using the formulae

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 Calculate the point elasticity of demand given that Qd= 4P +2p3 -3 Q = 4+2-3
=3Where P =1

Calculate point elasticity of demand given Qd = 1/p = P2 + 1 when P = 2

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Arc Elasticity of demand
This measures the elasticity of demand between two points on the demand curve. Arc
elasticity is the coefficient of the price elasticity between two points on the demand curve. It
is therefore an estimate of the elasticity along a range of the demand curve. This estimate
improves as the arc becomes small and approaches a point in the limit. Arc elasticity can
calculated for both linear and non-linear demand curves using the following formula: It is
illustrated as in Figure 2.26

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Mr. Ochung’@Zetech
 The demand for a commodity is 5 units when the price is Sh.1000 per unit. When the
price per unit falls to Sh.600 the demanded rise to 6 units. Calculate the arc and price
elasticity of demand

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 TYPES OF ELASTICITY
There are five types of elasticity of demand.
(i) Perfectly elastic demand. Demand is said to be perfectly elastic when the
consumers are willing to buy an amount of a commodity at a given price, but non at a
slightly higher price. In this case elasticity of demand is equally to infinity. The will
be a horizontal straight line as illustrated in Figure 2.28. This is a case of a commodity
in a perfectly competitive market. Where an increase in price may lead to a loss of all
customers.

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 (ii) Elastic demand. Demand is said to be price elastic when a charge in price causes
more than proportionate change in quantity demanded. In this case the value of
elasticity of demand is greater than 1 and the demand curve will be gently sloped as
indicated in Figure 2.29. This implies that if prices increase from P1 to P2 the
quantity demanded falls in greater proportion from Q1 to Q2 and vice versa. This is a
case of luxury commodity which consumes can do without or a case of a substitute

(iii) Unity elastic demand. Demand is said to unit elastic if changes in price cause
proportionate change in quantity demanded. If price increase quantity falls in the
same proportion and vice versa. ED = 1 and the demand curve will be rectangular
hyperbola as illustrated in Figure 2.30. This is a case of a good that lies between a
luxury and necessity such as soap opera film or movie

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 (iv) Inelastic demand. Demand is said to be price inelastic if changes in price causes
less than proportionate change in quantity demanded. If prices increase the quantity
falls in less proportion and if the prices fall the quantity demanded increases in less
proportion ED < 1 as illustrated in Figure 2.31. This is a case of a good which is a
necessity. These are goods which consumers cannot do without but need not be
consumed in fixed amount like an absolute necessity such a staple food like ugali and
milk. It also applies in the case of habit-forming goods like beer and cigarettes

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(v) Perfectly inelastic demand. Demand is said to be perfectly price inelastic if changes in
price has no effect on the quantity demand (ED= 0). In this case the demand curve will be
vertical straight as illustrated in Figure 2.32. This is a case of a good which is an absolute
necessity. A good that consumes cannot do without and have to consume in fixed amounts
such as salt.

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

(i) Substitutability. If a substitute is available in the relevant price range, quantity demanded
will be elastic. The demand for a particular brand of cigarettes maybe considered being
elastic because if there is existence of other brands that are close substitutes. However, the
total demand for cigarettes may be inelastic because there are no close substitutes for
cigarette. It can hence be said that the greater the number of substitutes for a given
commodity, the greater will be its price elasticity of demand.
(ii) The proportion of a consumer’s income spent on the commodity. If this proportion is very
small as in the case of match boxes, the quantity demanded will tend to be inelastic. On the
other hand, if this proportion is relatively large as for example in the case of meat, demand
will tend to be elastic. This implies that the greater the proportion of income which the price
of the product represents, the greater price elasticity of demand will end to be.
(iii) The extent to which the product is habit forming. Habit forming products like cigarettes
or alcohol have a low-price elasticity of demand. In the case of in addiction to, say drugs, the
price elasticity of demand is likely to be even lower.
(iv) The number of uses of a commodity. The greater the number of uses of the commodity,
the greater the price of elasticity. The elasticity of aluminum for example is likely to be much
greater than of butter because butter is mainly used as food while aluminum has hundreds of
uses such as electrical wiring and appliances.

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(v) The length of adjustments. The longer the period allowed for adjustment in the quantity
demanded as a commodity the greater its price elasticity is likely to be. This is because it
usually takes some time for new prices to be known and for consumers to make the actual
switch. Consumers adjust buying habits slowly.
(vi) The level of prices. If the ruling price is at the upper end of the demand curve, quantity
demanded is likely to be more elastic than if it was towards the lower end. This is always true
for a negatively sloped straight line demand curve.
(vii) Necessities and luxuries Demand for luxury is likely to be price elastic while the
demand for necessities is generally price inelastic. However, this depends with availability of
close substitutes.
(viii) Width/size of the market the wide definition of the market of a good, the lower is the
price elasticity of demand. Thus, for wide markets demand will tend to be price inelastic
while for a small market demand will tend to be price elastic.
(ix) Time demand for most goods and services tend to be more elastic in the long run as
compared to the short run period. This is because consumers will take some time to respond
to price changes. For instance, if the price of petrol falls relative to diesel, it will take long for
motorists to respond because they are locked in existing investment in diesel engines.
(x) Durability of the commodity durable goods have low elasticity of demand or they are
price elastic while perishable goods are price inelastic.

Importance of price elasticity of demand/economic application of the concept of

elasticity
(a) The consumer needs knowledge of elasticity when spending income where more income
is spent on goods whose elasticity of demand is inelastic and vice versa.
(b) The government imposes taxes with inelastic demand and vice versa. Devaluation when a
country devalues or lowers the value of its currency. The currency is made cheaper relative to
other currencies. This makes a country’s exports cheaper for foreigners. Its import expensive
for the residents. For a country to benefit by increasing exports, the elasticity of demand must
be high.
(c) Business/producers They use elasticity of demand on deciding on whether to charge high
or lower prices or even deciding on commodities to bring to the market especially those
which are price inelastic.
Income Elasticity of demand
It is the measure of responsiveness of demand due to change in income.
YED = ΔQ ∕Q/ ΔP∕Y
Where income elasticity is positive this is a normal good. Where income elasticity is negative
this is an inferior good. When the demand of a good does not change with increase in income
then income elasticity is zero. In wealthy countries for instance basic clothes will tend to have
low income elasticity of demand while foreign will have high elasticity of demand as income

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increases. In poor countries basic commodities will have high income elasticity compared to
manufactured expensive etc.
IMPORTANCE OF INCOME ELASTICITY OF DEMAND
(i) Business firms- if demand of a commodity is elastic to price, its possible to revenue by
reducing prices. Businesses use specific information to know which price to increase to
eliminate shortages or which price to reduce to eliminate surpluses.
(ii) Government uses elasticity to determine the yield of indirect taxes. Inelastic commodities
are highly taxed. However, if demand of a commodity is elastic an increase in tax will hinder
production
(iii) Price elasticity is relevant for a country considering devaluation as a means of rectifying
balance of payment disequilibrium. Devaluation decreases imports and increases exports.
However, this will depend on demand of import and export elasticities.
(iv) It helps to explain price instabilities in the agricultural sector
(v) Monopolists apply price discrimination by understanding the demand elasticities. High
price is charged to those markets with lower price elasticity
FACTORS AFFECTING INCOME ELASTICITY OF DEMAND
(i) Nature of the need that the commodity covers. For certain goods and services the
percentage of income spent declines as income increases such as food.
(ii) The initial level of income of a country (level of development) TV sets, refrigerators,
motors vehicles are considered as luxuries in underdeveloped countries while they are
considered as necessities in countries with high per capita income.
(iii) Time period. The demand for most goods and services will tend to be income elastic in
the long run as compared to short run period. This is because the consumption pattern adjusts
with time and also with change in income.
CROSS ELASTICITY OF DEMAND
It is the measure of responsiveness of quantity demanded of a good due to changes in the
price of another related good. It is abbreviated as EXY where X and Y are to goods. It is
calculated as follows:
EXY = Proportionate change in quantity demanded of a good X/ Proportionate change in
quantity demanded of a good Y
ΔQx .Py ΔPy Qx The sign of cross elasticity of demand is positive if the good X and Y are
substitutes and negative if X and Y are complimentary. The higher the absolute value of cross
elasticity of demand the stronger the degree of substutability or complimentaribility. The
main determinant of cross elasticity is the nature of the commodity relative to their uses. If
two goods can certify equally the same need the cross elasticity will be high and vice versa.

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IMPORTANCE OF CROSS ELASTICITY OF DEMAND
(i) Protection of local industries. If the government imposes a tariff on a good with the
intention of protecting a local industry then the local product and the imported product must
be close substitutes for the government to achieve its objectives
(ii) If a firm is in a competitive market, there a high positive elasticity of demand between its
products and those of competitors. For such a firm, it will not be in its interests to increase the
price of its product as this may result to more than proportionate reduction in its sales.
However, it might consider lowering the prices of its products in the hope of attracting
customers from other firms.
(iii) For product with high degree of complementarity, a fall in price of one of the goods due
to increase in supply will benefit the producers of a compliment product due to an increase in
sales. E.g. if there is a fall in prices of vehicles, due to an increase in supply the suppliers of
fuel experience an increase in sales because more cars will be bought.

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