Demand and Its Determinants

What Is a Competitive Market?

Before delving into the theory of demand, it is necessary to understand what a market is and how it functions. A market is any mechanism by which buyers and sellers interact to exchange goods and services. It is not necessarily a physical location: the stock exchange, the online platform Amazon, or even an informal agreement between neighbors to buy and sell vegetables — all these are markets.

A competitive market possesses the following characteristics:

• Many buyers and sellers — no single agent can significantly influence the market price
• Each firm is a price taker — it accepts the market price as given and cannot dictate it
• Consumers decide what to buy themselves, and firms decide what to produce themselves
• Prices are formed as a result of the interaction between demand and supply

Real markets are rarely perfectly competitive (we will discuss this in the module on market structures), but the competitive market model is an indispensable analytical tool for understanding the basic principles of pricing.

Price Mechanism

In a free market economy, the coordination of millions of individual decisions occurs through the price mechanism — the process by which prices convey information, create incentives, and allocate resources. It is one of the most elegant mechanisms in economics, and its significance cannot be overstated.

The price mechanism works as follows:

• When there is a shortage — demand exceeds supply — prices rise. Price increases send two signals: to consumers — buy less, to producers — produce more.
• When there is a surplus — supply exceeds demand — prices fall. Price decreases signal consumers to buy more, and producers to reduce output.

Real-life example: the mask market during COVID-19. At the beginning of the pandemic (March 2020), demand for medical masks rose tenfold. Supply could not quickly increase — there were few factories. A severe shortage arose. The price mechanism operated instantly: mask prices increased 5–10 times. This seemed “unfair,” but high prices fulfilled important functions: 1) they limited excessive consumption (people bought 2–3 masks, not 100), 2) they stimulated production (dozens of companies switched to mask manufacturing, attracted by high profits), 3) they attracted imports from other countries. Within a few months, supply sharply increased, and prices returned to normal levels.

Another example: the avocado market. In 2017, a poor avocado harvest in Mexico (the world’s largest supplier) led to a reduction in supply. Avocado prices worldwide increased by 100–200%. This prompted farmers in Peru, Kenya, and Colombia to expand avocado plantings, and consumers to partially switch to other fruits. After two years, supply recovered and even increased, and prices stabilized.

Effect of Increased Demand Through the Price Mechanism (Chain of Consequences)

Let us trace how the price mechanism operates when demand increases, using the market for electric vehicles as an example:

1. Environmental awareness among consumers rises → demand for electric vehicles increases
2. Demand (D) exceeds supply (S) → shortage of electric vehicles → prices rise
3. High prices → attract new producers (Rivian, Lucid, BYD) and stimulate existing ones (Tesla, VW) to expand production
4. Increased production of electric vehicles → increased demand for lithium and cobalt (raw materials for batteries)
5. Demand for lithium exceeds supply → lithium shortage → lithium price rises
6. High prices for lithium → stimulate exploration and development of new deposits in Chile, Australia, Argentina
7. Gradually, supply increases → prices stabilize

This entire process happens automatically, without central planning. No official decided how much lithium to mine — market prices directed resources to where they were most needed. This is exactly what Adam Smith meant when he spoke of the “invisible hand” of the market.

What Is Demand?

Demand is the quantity of a good that consumers are willing and able to purchase at a given price over a specific period of time. This definition contains several key elements, each of which is important:

1. “Willing” — the consumer has the desire to acquire the good
2. “Able” — the consumer has the financial means to buy
3. “At a given price” — demand is always tied to a specific price
4. “Over a specific period of time” — demand is measured per unit of time (per day, per month, per year)

Why is this important? Demand is not just a “wish.” Millions of people would like to have a Ferrari, but demand for Ferraris consists only of those who both want and can buy it (at the current price). Similarly, many people would like to live in a penthouse in Moscow, but market demand for penthouses is determined not by the number of aspirants, but by the number who are willing and able to pay 50–100 million rubles.

Individual and Market Demand

• Individual demand — the amount of a good one particular consumer is willing and able to buy at different prices
• Market demand — the sum of individual demands of all consumers in the market

Assume there are three consumers in the apple market. At a price of 100 rubles/kg Anna is willing to buy 2 kg, Boris — 3 kg, Vera — 1 kg. Market demand at a price of 100 rubles/kg = 2 + 3 + 1 = 6 kg.

Law of Demand

The law of demand is one of the few statements in economics considered nearly universal: as the price rises the quantity demanded falls, and vice versa (ceteris paribus — all other conditions constant). The demand curve has a negative slope (downward from left to right).

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Why? There are two fundamental effects underlying this:

Income Effect

When the price of a good rises, the consumer’s purchasing power decreases — their real income effectively declines, even if nominal income does not change. The consumer “feels poorer” and is forced to cut consumption.

Specific example: A student receives a stipend of 15,000 rubles per month and normally buys 5 kg of chicken breast at 300 rubles/kg (1,500 rubles per month). If the price increases to 500 rubles/kg, the same 5 kg would cost 2,500 rubles. The student simply does not have enough money for the same quantity (or will have to sacrifice other purchases). He or she reduces chicken consumption to 3 kg.

Substitution Effect

As the price increases, the good becomes more expensive relative to substitutes, and consumers switch to cheaper alternatives.

Specific example: If the price of chicken breast increases to 500 rubles/kg, while the price of pork remains at 350 rubles/kg, chicken becomes relatively more expensive. Some consumers switch to pork, fish, or legumes — substitutes for chicken. Demand for chicken drops.

Example: Potato Market (Monthly)

Note: when the price doubles from 20 to 40 rubles/kg, demand fell from 700 to 500 thousand tons (down by 200). But when the price doubles from 50 to 100 rubles/kg, demand fell from about 400 to 100 thousand tons (down by 300). The response of demand to price changes differs at various price ranges — this is related to demand elasticity, which we will consider in detail later.

Determinants of Demand

Price is the main factor determining the amount of demand, but far from the only one. Many other factors affect demand, and understanding these is necessary for market analysis and business planning.

1. Tastes and Preferences of Consumers

Fashion, trends, advertising, cultural changes — all these influence consumer preferences. The emergence of a healthy lifestyle trend in the 2010s led to increased demand for avocado, quinoa, organic products, and fitness services, while at the same time demand for fast food and sweet carbonated drinks decreased. The COVID-19 pandemic changed preferences: demand grew for home workout equipment, food delivery services, and video conferencing (Zoom), while demand for office clothing and airline tickets sharply fell.

2. Consumer Income

Increased income usually increases demand for most goods (so-called normal goods). When people get richer, they buy more restaurant food, travel, electronics, branded clothing.

However, there are exceptions — inferior goods. When incomes rise, demand for them falls, as consumers switch to more high-quality alternatives. Classic examples: instant noodles (as incomes rise, people switch to normal food), bus rides (as incomes rise, people buy cars or use taxis), second-hand clothing.

Example in China: Rapid income growth in China over the past 30 years has led to a large-scale change in demand structure. Rice consumption per capita has decreased (an inferior good at high incomes), while demand for meat, dairy products, cars, and overseas tourist trips — has sharply increased.

3. Prices of Substitute Goods

Substitutes are goods that satisfy similar needs. If the price of a substitute rises, consumers switch to our good, and its demand increases.

Example: Coca-Cola and Pepsi. If Pepsi raises its price by 20%, some consumers will switch to Coca-Cola — demand for Coca-Cola rises. These companies understand this very well and closely monitor each other’s pricing policy. Similarly: if airline tickets become more expensive, demand for train tickets increases; if gasoline becomes more expensive, demand for electric vehicles increases.

4. Prices of Complementary Goods (Complements)

Complements are goods that are consumed together. An increase in the price of one complement lowers demand for the other.

Example: Smartphones and mobile internet. If the cost of mobile internet rises sharply, demand for smartphones may fall (a smartphone without internet is less useful). Other examples: cars and gasoline, printers and cartridges, game consoles and games, coffee and sugar. Gillette strategically used this relationship: it sold razors at cost (or even at a loss), earning on refill blades — a complementary good with high margin.

5. Expectations of Future Prices

If consumers expect prices to rise in the future, they increase current purchases (build up stocks). Conversely: expecting lower prices defers purchases.

Example: Real estate market. When people expect housing prices to rise, they try to buy an apartment as soon as possible, increasing current demand and effectively accelerating price growth (self-fulfilling prophecy). This is one of the mechanisms that creates “bubbles” in the real estate market. Before the increase of VAT in Japan in 2014, consumers massively bought goods, creating a short-term surge in demand.

6. Number of Consumers in the Market

Population growth or influx of new consumers increases market demand. Urbanization, migration, demographic changes — all these affect the number of consumers.

Example: The growth of the middle class in India (from about 50 million in 2000 to more than 300 million in the 2020s) led to a sharp increase in demand for cars, smartphones, branded clothing, and restaurants. International companies (Apple, Samsung, Hyundai) actively expand their presence in India, understanding that population and income growth create a huge new market.

Movement Along vs. Shift of the Demand Curve

This distinction is one of the most important in economic theory, and misunderstanding it is one of the most common mistakes.

Movement Along the Demand Curve

Occurs when the price of the good itself changes. We “move” along the existing demand curve from one point to another. The curve remains in place. If the price rises — movement up and to the left along the curve (quantity demanded decreases). If the price falls — movement down and to the right (quantity demanded increases).

Example: Apple reduces the price of the iPhone 15 from 100,000 to 80,000 rubles. With the same demand curve the number of buyers increases — this is movement along the curve.

Shift of the Demand Curve

Occurs when any factor other than the price of the good itself (income, tastes, prices of substitutes/complements, expectations, number of consumers) changes. The entire curve shifts to the right (increase in demand) or to the left (decrease in demand).

Example 1 (shift right): A celebrity recommends a particular brand of sneakers on Instagram. Demand for these sneakers rises at every price — the demand curve shifts right. This is not movement along the curve, because the price of the sneakers has not changed — consumer preferences have changed.

Example 2 (shift left): A study is published on the harm of red meat for health. Many consumers reduce meat consumption at every price — the demand curve for meat shifts left.

Example 3 (shift right): The government raises the minimum wage. Low-paid workers’ incomes grow, they start spending more → demand for many goods increases → demand curves shift right.

Key rule: change in the price of the good itself → movement along the curve. Change in anything else → curve shift. Confusion of these two concepts is one of the most common mistakes in economic analysis.

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Practice Problems

Problem 1: Demand and Supply — Defining Equilibrium

Question: Market demand and supply are given:

(a) Determine equilibrium price and equilibrium quantity. (b) Determine what arises at price £2 — shortage or surplus?

Solution: (a) Equilibrium occurs when quantity demanded = quantity supplied. From the table, at price £4 demand = 60 and supply = 40 (not equal), at price £6 demand = 40 and supply = 60 (not equal). Interpolating: at a price between £4 and £6 — that is, at £5 — demand and supply intersect.

More precisely: demand curve: Qd = 100 - 10P, supply curve: Qs = 10P. In equilibrium Qd = Qs: 100 - 10P = 10P → 100 = 20P → P = £5, Q = 50 units.

(b) At price £2: Qd = 80, Qs = 20. Demand exceeds supply by 60 units — this creates a shortage. Consumers want to buy more than producers are willing to sell. This creates upward pressure on the price.

Problem 2: Demand and Supply Shifts

Question: Consider the gasoline market. For each scenario, indicate: demand shift (left/right), supply shift (left/right), or movement along the curve (no shift).

(a) Increase in prices for electric vehicles (b) New tax on gasoline producers (c) Decline in household incomes (d) Significant improvement in gasoline engine efficiency (e) Increase in the price of gasoline

Solution: (a) Demand shift right. Electric vehicles are substitutes for gasoline vehicles. If electric vehicles become more expensive, consumers switch back to gasoline vehicles → demand for gasoline increases.

(b) Supply shift left. The tax increases the cost of gasoline production → at every price producers are willing to supply less → the supply curve shifts left.

(c) Demand shift left. Gasoline is a normal good. Decline in incomes → people drive less, save on fuel → demand for gasoline decreases.

(d) Demand shift left. More efficient engines use less gasoline per kilometer → for the same number of trips gasoline consumption decreases → demand decreases.

(e) Movement along the curve (no shift). Change in the price of the good itself causes movement along the demand and supply curves, not their shift. When the price of gasoline rises, the quantity demanded decreases (movement up the demand curve), and the quantity supplied increases (movement up the supply curve).