What Is Demand?
Demand is an economic concept that captures the consumer’s desire to purchase a good or service by paying a specific price for it. Fundamentally, an increase in the price of a good or service will lead to a decrease in the quantity demanded for that product or service. Similarly, a decrease in the price of a good or service will increase the quantity demanded. This principle will keep the market in equilibrium.
Demand is a concept that isn’t restricted to economic theory only. Both producers and consumers are quite familiar with the principle of demand as it occurs naturally in their everyday business. For example, there will be more buyers for a product when the product’s prices are low. In this case, we say that the demand for the product has gone up. Alternatively, if something happens that raises the prices, such as a change of season, there will be fewer buyers or perhaps none at all. In this case, we say that the demand for the product has gone down.
Generally, there are two main types of demand: market demand and aggregate demand.
Market demand is the quantity of a given good demanded by the consumers in a market. Aggregate demand is the total demand for all goods and services in an economy.
Understanding Demand
Businesses often invest a considerable amount of money to determine the demand for their products and services. More specifically, they are interested in assessing how many of their goods will they be able to sell at a given price.
Accurate estimations are crucial: underestimating the demand can result in lost sales while overestimating the demand can result in excess inventory and financial losses. Demand is a crucial aspect of profitability, and therefore, it is an important concept in economics.
Demand is closely related to another critical concept in economics: supply. While consumers try to pay the lowest prices they can for goods and services, suppliers aim to maximize profits.
If a product is priced too high, the quantity demanded drops, and the suppliers may not sell enough product to earn sufficient profits. Conversely, if the product is priced too low, the quantity demanded increases but lower prices may not cover suppliers’ costs or allow for profits.
Hence, the optimal supply and the optimal demand of a product of service is achieved at what is called a market equilibrium (more on this below).
Determinants of Demand
The demand for a good or service is mainly driven by 5 key factors:
- Price of the good or service
- Prices of substitute goods or services
- Buyer’s income
- Consumer preferences
- Consumer expectations for a change in price
A change in these factors will result in a change in the demand for the good or service.
The Law of Demand
As we have discussed earlier too, the law of demand states that other factors being constant (cetris paribus), the demand and price of a good or service are inversely related: when prices rise, demand falls, and when prices fall, demand rises.
The Demand Curve
A demand curve is a visual representation of the law of demand, and graphically displays the inverse relationship between demand and price. Essentially, the demand curve shows the change in demand for a good or service resulting from a change in its price.
The demand curve can be a useful representation for businesses as it can show them the prices at which consumers start buying more or less of a product. The demand curve can also point out prices at which a company can maintain consumer demand and support reasonable profits.
On the demand curve graph, the vertical axis, or the y-axis, denotes the price, while the horizontal axis, or the x-axis, denotes the quantity demanded.
Once plotted, the demand chart will be downward sloping, from left to right. As prices fall, consumers demand more of the good or service.
In contrast, the supply curve is upward-sloping. As the price of a good increases, the supplier will be willing to provide more of the good or service.
Market Equilibrium
The market equilibrium refers to the point where supply and demand curves intersect. This is how it works:
An increase in demand will shift the demand curve to the right: the buyer is willing to pay a higher price at each given demand level. The two curves now intersect at a higher market equilibrium price, which means consumers are willing to pay more for the product.
Market equilibrium prices usually change for most goods and services because factors affecting supply and demand are always changing. Free, competitive markets tend to push prices toward market equilibrium.
Market Demand vs. Aggregate Demand
The difference between market demand and aggregate demand essentially outlines the difference between microeconomics and macroeconomics.
Microeconomics is concerned with the demand and supply of a specific good or service in an economy. And therefore, the demand that we have understood so far pertains to microeconomics or market demand. In that sense, the market demand refers to the demand of a product or service in an economy.
On the other hand, macroeconomics is concerned with the total demand and supply of all goods and services in a country. And thus, aggregate demand becomes a macroeconomic concept. In essence, the aggregate demand refers to the demand for all goods and services in the economy.
Moreover, since the aggregate demand includes all goods and services in an economy, it is not sensitive to competition or substitution of goods or changes in consumer preferences between various goods or services.
Macroeconomic Policy and Demand
Managing aggregate demand is an essential part of macroeconomic policy-making by fiscal and monetary authorities, such as the government or the central bank.
Essentially, to reduce demand in the country, the government or the central bank will increase interest rates or prices by curtailing the growth of the money supply.
On the contrary, to increase aggregate demand, the government or the central bank can lower the interest rates or increase the money supply in the economy, giving consumers and businesses more money to spend, and thereby increasing demand.
That said, there are certain cases where the government is unable to influence the aggregate demand. For instance, when unemployment is high, people will not be able to afford to spend more or to take on cheaper debt, even with lower interest rates.
Frequently Asked Questions about Demand
What is meant by demand?
In economics, demand refers to the quantity of a particular product or service that consumers are willing to purchase at a certain price. Demand looks at a market’s pricing and purchases from a consumer’s point of view.
What Is the Demand Curve?
The demand curve is a graphical representation of the law of demand. It plots the demand for a specific product at any given price point. The line that connects those points is the demand curve. The vertical axis represents the prices of products. The horizontal axis represents the quantity. The demand curve is downward sloping, indicating an inverse relation between price and demand quantity, i.e. as prices decrease, demand for the product increases.
What Is the Importance of Demand?
Economically speaking, the principle of demand is important for both consumers and businesses that sell products and/or services. For businesses, understanding demand is vital when making decisions about inventory, pricing, and aiming for a particular profit. Consumers who have an understanding of demand can make confident decisions about what products to buy and when to buy them.
KEY TAKEAWAYS
The law of demand explains how consumers react to price changes
Demand can refer to either market demand for a specific good or service or the aggregate demand for all goods and services in an economy.
Demand and supply work together to set prices and determine sales volume in the market.
Businesses analyze demand to set prices that attract customers and generate profits.
The demand curve demonstrates how price influences the quantity of goods sold. A price increase will lead to a decrease in demand for the good.