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There are several agreed product categories, as not all products seem to give rise to the same consumer behaviour when it comes to demand.
Normal Products
Goods/services that see a rise in their aggregate demand as incomes (this is seen to be real purchasing power) rise are seen as normal products. Family Cars would fit this category.
Inferior Products
Goods/services that see a decrease in their aggregate demand as incomes rise, are seen as inferior products. Examples of this might be junk food, because as purchasing power increases then consumers might very well decide to purchase better quality food and decrease their fast food purchases.
In this instance, there is likely to still be an overal increase in demand due to a larger positive substitution effect than negative income effect.
Giffen Products
There is a special class of inferior products, that shows increased demand as prices rise.
An example here, would be in 19th Century Ireland. When the price of potatoes rose people were unable to purchase the more expensive meat and fish and so purchased more potatoes. This is actually one of the main causes to famine and malnutrition in developing world.
So in this instance the income effect of price change far outweighs the substitution effect seen.
Veblen Products
This is the Luxury Goods classification, and shows that as price increase so does the demand. Normally there is 0 demand up to a price, and then demand increase rapidly. This is known as the ‘snob effect’.
again…. some more of my notes & revision from the Principles of Business Economics by Joseph G. Nellis and David Parker.
The Analysis of Consumer Demand is a crucial aspect of successful business management. Without an understanding of this, and its implications it is unlikely that a firm will be around for very long.
Consumer demand is affected by many things, some within the control of the managers, and some not. Uncontrollable conditions are those things that affect consumer demand, but that are not under the control of the firm itself such as the weather.
It is also understood that sometimes, consumers can act as theorised to maximise utility, but with imperfect information. A great example of this, would be an individual buying a car who later regretted his/her choice as the car was unreliable. If the consumer had had perfect information regarding the car’s engine it would be safe to say he/she would not have purchased it. This is known as Boundless Rationality.
The Market Demand Curve
Economist use the term ‘demand’ to mean the ‘effective demand‘ for a product in the market place. This is the amount consumers are willing to buy at a given price and over a given period of time. We can aim to visualise this with the use of a ‘Consumers Demand Curve’, which relates the quantity an individual consumer is willing to buy of a certain product over a range of conceivable prices.
We can then build the more useful Aggregate/Market Demand Curve for a good/service which shows the ‘total’ effective demand for a product over a given period of time. This can be achieved by summing the individual demand curves of consumers horizontally for any given price.
At any given price : Adam’s demand + Eve’s demand = Market Demand
The Law of Demand
As stated the Demand Curve shows the relationship between the Market Demand over a range of prices for the good/service, and thus the amount a company can expect to sell. It is understood that in general there is an inverse relationship between an increase in price and the aggregate demand for that product in the market place, assuming ceteris paribus (all other factors are held constant).
So why do people consume more of something the cheaper it becomes? Well, when people consume more of something in a given time period the total utility will tend to rise. However it should be noted that the marginal utility will tend to decrease with each purchase. This decline of marginal utility as units purchased increases can be attributed to the Law of Diminishing Marginal Utility. Therefore, we can assume that consumers will tend to maximise their utility buy spreading their purchases over many products (how much more can you get from your 10th car, than you got from your 9th?).
At some point the consumer will reach what is known as Consumer Equilibrium, that is to the say, the point where they are unable to redistribute their spending to acquire a higher utility.
Let us assume two goods, a and b and that consumer Equilibrium has been reached:
MUa/Pa = MUb/Pb
If the price of a increases then
MUa/Pa < MUb/Pb
Therefore the consumer will purchase more of b so as to restore to Consumer Equilibrium. This will result in the Marginal Utility of ‘a’ will increase and the Marginal Utility of ‘b’ will decrease (Law of Diminishing Marginal Returns in effect) until once again
MUa/Pa = MUb/Pb
The Paradox of Values is seen when the cost of goods/services that are seen as necessary are actually lower than those that are not vital. A good example is how expensive diamonds are, but water is cheap.
Consumer Surplus
This is the increase in the price a consumer would be willing to pay for a good, rather than go without the good, than is actually paid for by the consumer. This can also be referred to as the ‘consumers rent’. However, in an auction based market place, where each person can bid to the maximum price he/she gives marginal utility of owning that product, eliminates Consumer Surplus, and gives rise to a Discriminating Monopolist.
As mentioned above it is vital for a business to understand the behaviour of demand, and there are some other determinants of demand that should be looked at. These include:
The conditions of demand are seen as those conditions, other than Po, that affect the demand curve.
The demand function is as follows:
Qd = f(Po, Ps, Pc, Aa,b,c, Yd, W, T, C, E, POP)
When Po changes it is expected that demand will move along the demand curve. However, when any other determinants of demand are altered, we would see a movement OF the demand curve.
It should also be noted….
The Income Effect
As Own Price (Po) of a product decreases, the consumer’s purchasing power increase as though their income was increasing. The opposite effect also applies, even though their income in unchanged.
The Substitution Effect
As Po falls, this product becomes cheaper than many competitors, and so consumers will begin to choose this over other products. This is know to the Substitution Effect.
Free Market advocates, such as Milton Friedman, will argue that Governments should interact with the business world as little possible so that the ‘invisible hand’ of the market (the price mechanism and bankruptcies of badly managed firms) can occur with no guidance from external bodies. They would argue this is the fully ‘liberal’ approach to trade, and that any interference is ‘not free’. I do in part agree with this ‘laissez-faire attitude’ but it can be seen that this form of capitalism does not always proviide a fair and adequate distribution of scare resources, and that it can be seen to have poor human welfare implications.
In 1930, as the US of A braced itself for something that was not seen as a normal recession (the Great Depression) it was Keynes who advocated that Government was needed to fix the economic engine. Keynes described the problem as an ‘economic alternator problem’, which implied there was no fundamental issue with the system but that it needed intervention to ‘kick start’ the machine. World War II was this spark.
I believe that Government should be as small as possible, but that it is absolutely vital to the fair distribution of economic wealth. Governments are there, in my opinion, to protect the little people, and to ensure the rules of the game are fair for all and adhered to. I am dubious and reluctant to say that one of its roles is to provide full employment or income for all (ie the Welfare State), but that there should be some support for those less fortunate or educated to be encouraged into work, so that they have the opportunity to work, make a living and find a purpose in life.
I do believe the Governments functions are to provide education, protection i.e. police and army, a legal and judicial system, the regulation and limitation of negative effect externalities of business (ie a chemical firm dumping toxins into a water supply) and in part health services (here in the UK the Government funds the NHS – which i am not 100% sure is the best way to provide free and adequate health care to the poorest in our societies – but that is another discussion altogether!!).
The Government is responsible, in the UK, for fiscal and monetary control, and can use regulation, taxes and subsidies to affect the prices and availability of goods and services in the private sector. More Governmental control is normally justified due to ‘Market Failure’, as in the 1930’s US Depression. Keynesian followers see the role of Government as Macroeconomic Managers, and not Microeconomic Regulators. The two main tools for this, as suggested above are:
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