5 Determinants of Demand

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The 5 Determinants of Economic Demand

Economic demand refers to how much of a good or service one is willing, ready and able to purchase. Economic demand depends on a number of different factors.

For example, people probably care about how much an item costs when deciding how much to purchase. They might also consider how much money they make when making purchasing decisions, and so on.

Economists break down the determinants of an individual's demand into 5 categories:

  • Price
  • Income
  • Prices of Related Goods
  • Tastes
  • Expectations

Demand is then a function of these 5 categories. Let's look more closely at each of the determinants of demand.

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Price

Price, in many cases, is likely to be the most fundamental determinant of demand since it is often the first thing that people think about when deciding how much of an item to buy.

The vast majority of goods and services obey what economists call the law of demand. The law of demand states that, all else being equal, the quantity demanded of an item decreases when the price increases and vice versa. There are some exceptions to this rule, but they are few and far between. This is why the demand curve slopes downwards.

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Income

People certainly look at their incomes when deciding how much of an item to buy, but the relationship between income and demand isn't as straightforward as one might think.

Do people buy more or less of an item when their incomes increase? As it turns out, that's a more complicated question than it might initially seem.

For example, if a person were to win the lottery, he would likely take more rides on private jets than he did before. On the other hand, the lottery winner would probably take fewer rides on the subway than before.

Economists categorize items as normal goods or inferior goods on exactly this basis. If a good is a normal good, then the quantity demanded goes up when income increases and the quantity demanded goes down when income decreases.

If a good is an inferior good, then the quantity demanded goes down when income increases and goes up when income decreases.

In our example, private jet rides are a normal good and subway rides are an inferior good.

Further, there are 2 things to note about normal and inferior goods. First, what is a normal good for one person may be an inferior good for another person, and vice versa.

Second, it is possible for a good to be neither normal nor inferior. For instance, it is quite possible that the demand for toilet paper neither increases nor decreases when income changes.

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Prices of Related Goods

When deciding how much of a good they want to purchase, people take into account the prices of both substitute goods and complementary goods. Substitute goods, or substitutes, are goods that are used in place of one another.

For example, Coke and Pepsi are substitutes because people tend to substitute one for the other.

Complementary goods, or complements, on the other hand, are goods that people tend to use together. DVD players and DVDs are examples of complements, as are computers and high-speed internet access.

The key feature of substitutes and complements is the fact that a change in price of one of the goods has an impact on the demand for the other good.

For substitutes, an increase in the price of one of the goods will increase demand for the substitute good. It's probably not surprising that an increase in the price of Coke would increase the demand for Pepsi as some consumers switch over from Coke to Pepsi. It's also the case that a decrease in the price of one of the goods will decrease demand for the substitute good.

For complements, an increase in the price of one of the goods will decrease demand for the complementary good. Conversely, a decrease in the price of one of the goods will increase demand for the complementary good. For example, decreases in the prices of video game consoles serve in part to increase demand for video games.

Goods that don't have either the substitute or complement relationship are called unrelated goods. In addition, sometimes goods can have both a substitute and a complement relationship to some degree.

Take gasoline for example. Gasoline is a complement to even fuel-efficient cars, but a fuel-efficient car is a substitute for gasoline to some degree.

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Tastes

Demand also depends on an individual's taste for the item. In general, economists use the term "tastes" as a catchall category for consumers' attitude towards a product. In this sense, if consumers' tastes for a good or service increase, then their quantity demanded increases, and vice versa.

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Expectations

Today's demand can also depend on consumers' expectations of future prices, incomes, prices of related goods and so on.

For example, consumers demand more of an item today if they expect the price to ​increase in the future. Similarly, people who expect their incomes to increase in the future will often increase their consumption today.

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Number of Buyers

Although not one of the 5 determinants of individual demand, the number of buyers in a market is clearly an important factor in calculating market demand. Not surprisingly, market demand increases when the number of buyers increases, and market demand decreases when the number of buyers decreases.