Demand: How It Works Plus Economic Determinants and the Demand Curve

What Is Demand?

Demand is an economic concept that relates to a consumer's desire to purchase goods and services and willingness to pay a specific price for them. An increase in the price of a good or service tends to decrease the quantity demanded. Likewise, a decrease in the price of a good or service will increase the quantity demanded.

Demand is a concept that consumers and businesses are very familiar with because it makes sense and occurs naturally in the course of practically any day. For example, shoppers with an eye on products that they want will buy more when the products' prices are low. When something happens to raise the prices, such as a change of season, shoppers buy fewer or perhaps none at all.

Generally speaking, there is market demand and aggregate demand. Market demand is the total quantity demanded by all consumers in a market for a given good. Aggregate demand is the total demand for all goods and services in an economy. Multiple stocking strategies are often required to handle demand.

Understanding Demand

Businesses can spend a considerable amount of money to determine the amount of demand the public has for their products and services. How many of their goods will they actually be able to sell at any given price?

Incorrect estimations can result in lost sales from willing buyers if demand is underestimated or losses from leftover inventory if demand is overestimated. Demand helps fuel profits and the economy. That's why it's an important concept.

Demand is closely related to the concept of supply. While consumers try to pay the lowest prices they can for goods and services, suppliers try to maximize profits.

If suppliers charge too much for a product, the quantity demanded drops and suppliers may not sell enough product to earn sufficient profits. If suppliers charge too little, the quantity demanded increases but lower prices may not cover suppliers’ costs or allow for profits.

Some factors affecting demand include the appeal of a good or service, the availability of competing goods, the availability of financing, and the perceived availability of a good or service.

Determinants of Demand

There are five main factors that drive demand:

• Product/service price
• Buyer's income
• Prices of substitute goods
• Consumer preferences
• Consumer expectations for a change in price

As these factors change, so can the demand for a product or service. In fact, they change all the time, so demand can be constantly in flux.

The Law of Demand

The law of demand states that when prices rise, demand will fall. When prices fall, demand will rise.

The law of demand is simply an expression of the inverse relationship between price and demand. It involves price only. None of the other drivers of demand mentioned above are involved. If they do come into play, the functioning of the law can be affected. Demand can be seen to change for reasons other than price.

Demand Curve

A demand curve is a graph that displays the change in demand resulting from a change in price. It's a visual representation of the law of demand.

The demand curve can be a useful tool for businesses because it can show them the prices at which consumers start buying less or more. It can point out prices at which a company can maintain consumer demand and support reasonable profits.

On the demand curve graph, the vertical axis denotes the price, while the horizontal axis denotes the quantity demanded. A demand schedule, or table created by a business that lists the quantity of a product that consumers will buy at particular price points, can provide the figures for the demand curve chart.

Once plotted, the demand curve slopes downward, from left to right. As prices increase, consumers demand less of a good or service.

A supply curve slopes upward. As prices increase, suppliers provide more of a good or service.

Market Equilibrium

The point where supply and demand curves intersect represents the market clearing or market equilibrium price. An increase in demand shifts the demand curve to the right. The two curves then intersect at a higher price, which means consumers are willing to pay more for the product.

Equilibrium prices typically 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 market for each good in an economy faces a different set of circumstances, which vary in type and degree. In macroeconomics, we also look at aggregate demand in an economy.

Aggregate demand refers to the total demand by all consumers for all goods and services in an economy across all the markets for individual goods. Since aggregate demand includes all goods in an economy, it is not sensitive to competition or the substitution of goods. Nor is it to changes in consumer preferences between various goods. Demand in individual goods markets can be affected by these factors.

Macroeconomic Policy and Demand

Fiscal and monetary authorities, such as the Federal Reserve, devote much of their macroeconomic policy-making to managing aggregate demand.

If the Fed wants to reduce demand, it can raise interest rates and increase prices by curtailing the growth of the money supply and credit. If it needs to increase demand, the Fed can lower interest rates and increase the money supply, giving consumers and businesses more money to spend.

In certain cases, even the Fed can’t fuel demand. When unemployment is on the rise, people may not be able to afford to spend or take on cheaper debt, even with low interest rates.