The Theory of Demand

Demand refers to the quantity of goods and services that consumers are willing and able to buy at various prices over a specific period, assuming all other factors remain constant (ceteris paribus).

a. Meaning and Determinants of Demand

i. Meaning of Demand

Demand is defined as the quantity of a good or service consumers are willing and able to purchase at different price levels within a given period. It incorporates the ability to pay, not just the desire to have the product.

ii. Determinants of Demand

• Price of the Good: As the price increases, demand decreases (inverse relationship).
  Example: If the price of rice increases from ₦5000 to ₦6000 per bag, fewer people may buy rice.
• Income of Consumers:
  • Normal Goods: Demand increases as income increases (e.g., branded clothes).
  • Inferior Goods: Demand decreases as income rises (e.g., second-hand clothes).
• Prices of Related Goods:
  • Substitutes: A rise in the price of Pepsi may increase the demand for Coca-Cola.
  • Complements: A rise in the price of cars may decrease the demand for fuel.
• Tastes and Preferences:
  Example: Increased awareness of health benefits may increase the demand for organic foods.
• Future Expectations:
  Example: If consumers expect the price of petrol to rise, they might buy more petrol now.
• Population Size and Composition:
  Example: A higher youth population may increase demand for smartphones and entertainment.
• Seasonal Factors:
  Example: Demand for umbrellas rises during the rainy season.

iii. Demand Schedules and Curves

Demand Schedule: A table showing the relationship between the price of a good and its quantity demanded.

Price (₦)	Quantity Demanded (Units)
100	50
200	40
300	30
400	20

Demand Curve: A graphical representation of the demand schedule. It slopes downward from left to right, showing the inverse relationship between price and quantity demanded.

iv. Change in Quantity Demanded vs. Change in Demand

Change in Quantity Demanded: Refers to movement along the same demand curve due to a change in the price of the good.
Example: A reduction in the price of bread from ₦500 to ₦400 increases the quantity demanded from 20 to 30 loaves.

Change in Demand: Refers to a shift of the entire demand curve due to changes in other factors like income or preferences.
Example: An increase in income causes a rightward shift in the demand curve for luxury cars.

b. Types of Demand

• Composite Demand: When a good is demanded for multiple purposes.
  Example: Demand for corn arises for food, animal feed, and biofuel production.
• Derived Demand: Demand for a good that arises because it is used to produce another good.
  Example: The demand for steel is derived from the demand for cars and buildings.
• Competitive Demand: Demand for goods that can replace each other.
  Example: Demand for butter competes with demand for margarine.
• Joint Demand: Demand for goods that are used together.
  Example: Cars and fuel; an increase in the price of cars may reduce the demand for fuel.

c. Elasticity of Demand

Types and Nature of Elasticity

Price Elasticity of Demand (PED): Measures the responsiveness of quantity demanded to changes in price.

PED = (Percentage Change in Quantity Demanded) / (Percentage Change in Price)

Example: If the price of a product increases by 10% and the quantity demanded decreases by 20%, PED = 20% ÷ 10% = 2 (elastic demand).

Income Elasticity of Demand (YED): Measures the responsiveness of demand to changes in consumer income.

YED = (Percentage Change in Quantity Demanded) / (Percentage Change in Income)

Example: If income increases by 10% and demand for a luxury car increases by 50%, YED = 50% ÷ 10% = 5 (high-income elasticity).

Cross Elasticity of Demand (CED): Measures the responsiveness of demand for one good to changes in the price of another good.

CED = (Percentage Change in Quantity Demanded of Good A) / (Percentage Change in Price of Good B)

Example: If the price of tea increases by 20% and demand for coffee increases by 10%, CED = 10% ÷ 20% = 0.5 (substitute goods).

Determinants of Elasticity

• Availability of substitutes.
• Proportion of income spent on the good.
• Necessity vs. luxury nature of the good.
• Time period for adjustment to price changes.

d. Importance of Elasticity of Demand

• To Consumers: Helps in budget planning.
  Example: If electricity prices rise and demand is inelastic, consumers must allocate more of their income to electricity.
• To Producers: Guides pricing strategies to maximize revenue.
  Example: For goods with inelastic demand, producers can increase prices to generate more revenue.
• To Governments: Helps in designing tax policies.
  Example: The government can impose higher taxes on goods like alcohol and tobacco, which have inelastic demand, to generate more revenue.

JAMB Economics Questions on the Theory of Demand

Question 1

Which of the following factors is most likely to cause a change in demand for a good?
A. A change in the price of the good itself.
B. A change in consumer income.
C. The introduction of a price ceiling by the government.
D. A change in production costs.

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Question 2

The table below shows the demand schedule for oranges:

Price (₦)	Quantity Demanded (Units)
10	50
20	40
30	30
40	20

If the price increases from ₦10 to ₦20, what is the change in the quantity demanded?
A. 10 units
B. 20 units
C. 30 units
D. 40 units

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Question 3

When the demand for bread decreases because of an increase in the price of butter, the type of demand exhibited is:
A. Competitive demand
B. Joint demand
C. Composite demand
D. Derived demand

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Question 4

Which of the following describes a perfectly inelastic demand curve?
A. A downward-sloping straight line.
B. A vertical straight line.
C. A horizontal straight line.
D. A curve that slopes upward.

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Question 5

If the price elasticity of demand for a product is 2, and its price increases by 10%, what will be the percentage change in the quantity demanded?
A. 2%
B. 10%
C. 20%
D. 50%

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Question 6

The government imposes a high tax on cigarettes, which have inelastic demand. What is the most likely effect of this action?
A. A large decrease in quantity demanded and reduced tax revenue.
B. A small decrease in quantity demanded and increased tax revenue.
C. An increase in demand for cigarettes.
D. No change in quantity demanded or tax revenue.