Effective Demand: Bridging Desire and Purchasing Power | Economics SHS 1 SEM 1 WEEK 4 (WASSCE & NaCCA Aligned)

Understanding the Core Difference: Want vs. Demand

In everyday language, ‘want’ and ‘demand’ are often used interchangeably. However, in economics, they represent vastly different concepts. A want is simply a desire for a good or service. For example, every student may ‘want’ a brand new, expensive sports car. But for that desire to become an economic demand, two crucial conditions must be met: Willingness and Ability.

Effective Demand, therefore, is the desire for a product backed by the necessary purchasing power (the financial ability to pay). If Nii wants a phone priced at GH¢ 1,800 but only has GH¢ 1,500, he possesses willingness but lacks the ability. His desire is a mere want, not an effective demand, because the transaction cannot be completed.

The Role of the Buyer: Rational Decision Making

Buyers are rational actors in the economy who seek to maximize their utility (satisfaction) given their limited budgets. When a buyer enters the market, they face constraints, which necessitates making choices and trade-offs. The decision process involves weighing the cost of one item against the benefit of what must be given up.

• Budget Constraint: The limit on the consumption bundles that a buyer can afford. Nii’s GH¢ 1,500 represents his budget constraint.
• Trade-Offs: The act of giving up one thing to gain another. By choosing the GH¢ 1,500 phone (Brand B), Nii trades off the potential savings (GH¢ 300 left over from Brand A) for better features, but also trades off the superior features of Brand C because he cannot afford it.

The Role of the Seller: Maximizing Profit

Sellers are the suppliers in the market, aiming to maximize their profit. They determine what to produce, how much to produce, and at what price to sell it, based on demand and competition. Adjoa, selling baskets and jewelry, must set her prices carefully.

• Pricing Strategy: Adjoa must price her crafts high enough to cover her costs (materials, time, effort) and yield a profit, but low enough to attract sufficient buyers.
• Competition: If other sellers offer similar products at a lower price, Adjoa might lose customers unless she differentiates her product (quality, service, marketing).
• Market Interaction: The market is the platform where buyers (Nii) and sellers (Adjoa) meet, and the interaction of their willingness and abilities determines the final price and quantity exchanged.

Defining Demand in Economics

Demand is formally defined as the quantity of a good or service that consumers are willing and able to purchase at various prices during a specific period of time.

It is crucial to note that demand is not a single point, but a relationship showing how quantity purchased changes as price changes. Generally, as the price of a good falls, the quantity demanded rises, assuming all other factors remain constant (the Law of Demand).

Factors Influencing the Quantity Demanded (Determinants)

While price is the main factor, other non-price determinants can cause the entire demand relationship (the demand curve) to shift:

• Income of the Buyer: Changes in income significantly impact demand, leading us to classify goods.
• Price of Related Goods: If the price of a substitute good (e.g., rice instead of banku) drops, the demand for the original good (banku) will likely fall. If the price of a complementary good (e.g., fuel for a car) rises, the demand for the original good (the car) will likely fall.
• Tastes and Preferences: Current trends or changing needs can boost or reduce demand.
• Expectations: If buyers expect prices to rise in the future, they may increase current demand.

Income and Goods Classification

Economists classify goods based on how a change in buyer income affects the demand for them:

Normal Goods

Demand for a Normal Good increases as the buyer’s income increases. Most goods, such as new clothes, smartphones, and higher education, fall into this category. As students transition from using ‘school money’ to real employment, their demand for higher-quality items rises.

Inferior Goods

Demand for an Inferior Good decreases as the buyer’s income increases. These are typically cheaper, lower-quality substitutes that people rely on when their income is low. For example, if a family traditionally relies heavily on cheap packaged sachet water, once their income rises significantly, their demand for sachet water might fall as they switch to bottled mineral water. Similarly, a student might swap eating cheap gari and groundnut soup (inferior) for high-quality rice dishes (normal) when their allowance increases. Understanding these classifications is key to predicting how consumer behavior changes with economic prosperity.