ECON100 CONCEPT OF THE DAY: DEMAND
As part of our dual mandate to rebrand the dismal science’s moniker into the ‘decision’ making science as well as to lower the barrier to understand and access economic concepts without a formal economics degree, we’re rolling out a definition of the day (or week) to further these goals. Today’s concept of the day (or week) is: demand.
WHAT EXACTLY IS DEMAND?
Demand is all about the consumers in a market. The demand side of the market refers specifically to those who are willing (and able) to participate in the market. Consumers participate because the benefit or value to them exceeds the opportunity cost (explicit opportunity costs like the price + implicit opportunity costs such as whatever else it took to acquire the good). Demand for a particular good and the price of a particular good have an inverse relationship meaning they run opposite directions. When prices are high for a good ,the quantity demanded for that good is low and vice-versa. A drop in the price will lure some consumers back into purchasing. So we can see that the price has an effect on the quantity demanded, but it doesn’t always- there are other ways the quantity demanded for a good can change. We can also make a visual representation of this relationship inside of a table called a demand schedule. So we can see that the price has an effect on the quantity demanded, but it doesn’t always- there are other ways the quantity demanded for a good can change.
| Demand Schedule | |
|---|---|
| Price | Quantity Demanded |
| $30 | 10 |
| $25 | 125 |
| $20 | 200 |
| $15 | 450 |
| $10 | 600 |
| $5 | 750 |
| $0 | 1000 |
Shifts in demand
- A change in income. The wealth effect will shift the demand curve for an individual buyer to the right (increase) because all else equal, having more money will increase demand at all price points. One caveat: this effect will only occur for all goods which are normal, meaning they are positively related to increase in income, meaning when income increases, so does consumption of these goods. Goods that are substituted away for something else are called inferior goods. For example, consider the Art market. 2021 was historic for auction houses Sotheby’s and Christie’s. Across the board, most categories experienced higher participation in person and online, higher transactions and more frequent transactions resulting in annual consolidated sales of 7.3 and 7.1 billion, respectively¹. So where did this money come from? Blame millennials². As the WSJ’s reported, most of the success of the auction houses involved expanding their reach via technology to draw in wealthy millennials and other first time bidders. According to Christie’s 2021 Annual Report, 32% of new buyers at the famed auction house were millennials. Sotheby’s and Christies also expanded in categories outside of contemporary art. Technology also brought international bidders, many from booming economies such as China into the fray.
| Income ⬆︎ | Income ⬇︎ | |
|---|---|---|
| Normal | INCREASE | DECREASE |
| Inferior | DECREASE | INCREASE |
| Table shows how quantity demanded for a good changes in response to changes in income | ||
- A change in the number of buyers in a market. The market demand curve for a good is the sum of all the individual demand curves in a market. If buyers enter or exit the market, this will have an effect on the market demand curve causing it to shift to the left (decrease) or to the right (increase).
- Price of substitutes. Internal combustion vehicles versus hybrid and electric vehicles. Used college textbooks versus new textbooks. Used tires versus new tires. In general, when substitute goods are readily available in a market then the quantity demanded for the substitute shares a negative relationship to the price of the other good.
- Price of complements. Complements are tethered to each other. If one becomes more expensive, all else equal, the law of demand tells us that quantity demanded will fall for that good. Because of its relationship, quantity demanded will also fall for its complement. For example, consider rental bowling shoes and a round of bowling at the local bowling alley. They are complements because they are often purchased together (unless you’re very serious about bowling, or you cringe at the thought of sharing bowling shoes with other strangers’ weird feet). Likewise, if the price drops for a good, quantity demanded will increase for the particular good, as well as its complement. Grocery stores mark down items known as loss leaders, to generate traffic into their stores, with the intention that consumers will also purchase not only the goods which are marked down, but their complementary goods as well. Examples of pairs of complementary goods include; milk and cereal, hot dog buns and hot dogs, and the classic rotisserie chicken³ with its complementary side dishes.
| Price for good X | Demand for good Y | |
|---|---|---|
| Substitutes | INCREASE | INCREASE |
| Complements | INCREASE | DECREASE |
- Tastes. Changing consumer tastes for a good will shift demand for the good either to the left in the case of an increase, or to the left in the case of a decrease. Two examples over the last century, first, cars. America’s favorite form of transportation enjoyed many different kinds of audio entertainment. As each new advancement in technology emerged demand shifted away from the incumbent technology, with the exception of the doomed as soon as it launched, mid 1950’s Chrysler’s Highway Hifi in-car record player4. Currently, in-car entertainment consists of internet connected devices that stream your favorite content into the car’s speakers. The second example, one which we prefer, is one we can eat. Yogurt. From the time when it crossed the Atlantic after WWII to the late 1990’s, yogurt wasn’t fully embraced by the American palate. The breakthrough finally occurred in the early 2000’s at a time when Americans began focusing on healthier eating5. Today, chances are the yogurt aisle at your local grocery store or supermarket chain is nearly dominated by Greek-style yogurts.
- Buyers expectations about the price. If buyers believe a good they value will increase in price in the future, those buyers will choose to consume that good at the current lower price. When the entire market behaves that way demand will increase (shift to the right).
WHY SHOULD WE CARE ABOUT DEMAND?
Because the demand side of the market is filled with kernels of wisdom about how the overall market operates. As Tom Hanks’ character in Castaway learns chasing after Wilson, rip tides amongst the tidal waves of changing market trends distances firms from their customer base. Failure to identify and respond to those trends separates the customer base from the firm. Distancing from customers invites competitors to wrangle away market share, or worse, put a firm out of business. Firms become ghost ships, lost and adrift in the squall. Part 1 of Kroger’s 10-k filing from 2021 shows their degree of keen focus on changing demand:
“We see three major trends shaping the industry post-pandemic: e-commerce, cooking at home and prepared foods to go. If we do not appropriately or accurately anticipate customer preferences or fail to quickly adapt to these changing preferences, or if trends shift more quickly to food away from home, our sales and profitability could be adversely affected.6”
It is critically important that firms properly forecast and meet market demand because once the firm commits resources to a product, the product receiving the firm’s scarce resources should be as profitable as possible. Reuters reported Paul Jacobson, General Motors (GM) Chief Financial Officer (CFO), predicts their line of electric vehicles (EV) will be profitable by 2025 – in the low to mid single digits. This transition could be risky, mainly because GM’s current lineup of gas-powered cars and trucks fetch double digit margins7. Furthermore, missteps in forecasting demand metastasize into costly mistakes such as the Bullwhip effect, which might force firms throughout the supply chain to deal with excess inventory. As we noted with Chrysler’s Highway HiFi, not every product will meet (or inspire) market demand. Regardless, forecasting demand is a critical and interesting mix of art and science, representing one of the future projects we intend to take on in 2023.
OK, SO WHAT DOES DEMAND MEAN FOR YOU?
Understanding the demand side of the market means you can connect the dots of how consumers in a market value or benefit from participating in a market. Once you gain this insight, you can change the dynamics of the market by changing the characteristics of the market; competition, barriers to entry, as well as the product for sale all impact the demand curve. You will also have one half of the tools you’ll need to find the market’s equilibrium point. Keep following for more examples of demand and the demand side of the market.
REFRENCES
- Crow, Kelly. “Priciest Picasso, Record-Breaking Beeple: Christie’s Sells $7.1 Billion in Art.” The Wall Street Journal, 21 December 2021, https://www.wsj.com/articles/christies-sells-7-1-billion-in-art-the-highest-in-five-years-11640020357. Accessed 16 November 2022.
- Crow, Kelly. “Sotheby’s Sells $7.3 Billion in Art, Fueled by Moneyed Millennials.” The Wall Street Journal, 15 December 2021, https://www.wsj.com/articles/sothebys-sells-7-3-billion-in-art-fueled-by-moneyed-millennials-11639581146. Accessed 15 November 2022.
- Gasparro, Annie. “Rotisserie Chickens: The ’90s Gift to Supermarkets That Keeps on Giving.” The Wall Street Journal, 4 January 2018, https://www.wsj.com/articles/rotisserie-chickens-the-nineties-gift-to-supermarkets-that-keeps-on-giving-1515061801. Accessed 15 November 2022.
- Sheldon, Andrew. “A Timeline of Car Radio History – Your AAA Network.” Your AAA Network, 16 May 2022, https://magazine.northeast.aaa.com/daily/life/cars-trucks/auto-history/a-timeline-of-car-radio-history/. Accessed 17 November 2022.
- Krishna, Priya. “Chobani, Skyr, Dannon: How yogurt took over the dairy aisle.” Vox, 27 May 2020, https://www.vox.com/the-goods/21270426/yogurt-america-chobani-fage-skyr. Accessed 15 November 2022.
- The Kroger Co. Notice of 2022 Annual Meeting of Shareholders 2022 Proxy Statement and 2021 Annual Report on Form 10-K. 2022. https://s1.q4cdn.com/137099145/files/doc_financials/2021/ar/Notice-of-2022-Annual-Meeting-of-Shareholders-2022-Proxy-Statement-2021-Annual-Report-on-Form-10-K.pdf
- White, Joseph. “GM promises profitable EVs, with a boost from Washington.” Reuters, 17 November 2022, https://www.reuters.com/business/autos-transportation/gm-sees-profitable-evs-by-2025-2022-11-17/. Accessed 17 November 2022.
Check out the video below to see how retailers across different US brands respond to changing market demand over the summer.