According to economic theory, the law of demand states that the relative demand for a good or service is inversely correlated with the cost associated with acquiring it. This law is commonly expressed as a function of money prices, but the law of demand would hold true even if no money existed. The law of demand flows logically from two "a priori" epistemological statements: that resources are scarce, and that human beings employ those scarce resources to achieve purposeful ends. These are the only "factors" that influence the law of demand. However, many other factors can influence specific instances of demand.

Defining Demand

The quantity demanded of a good or service is defined by the number of consumers who will trade for it at its current cost. As those costs rise, consumers will demand less of it than they otherwise would have. When costs drop, consumers will demand more of it than they otherwise would have.

This makes the law of demand relative, not absolute. Consider a scenario where the price of a blue hat rises from $20 to $30. If no other factors change, then consumers buy fewer blue hats at the higher price. What happens if, at the same time, the government passes a law requiring all people to wear blue hats? The sale of blue hats is likely to increase even with the price change.

Factors That Influence the Demand for a Good or Service: An Example

That blue hat scenario highlighted two important factors that can influence demand: the price and government policy (regulation, fiscal policy and monetary policy). Economists have identified other factors as well, including consumer income, consumer tastes, the price of substitute goods, the number of consumers in the market and expectations about the future.

Suppose a consumer is considering purchasing a dinner at a fancy restaurant.

The dinner will cost him $100. Ultimately, according to the subjective theory of value, he'll pay for the dinner if he values the food and dining experience more than the $100. That valuation will never be constant -- it will change from time to time based on many circumstances.

First, the consumer has to have $100 to spend. His income and level of savings are important. If he only has $100 to his name, it's unlikely that he wants to waste it on an expensive meal. Alternatively, if he's a millionaire then he likely values the $100 less.

The rational theory of expectations means his expectations are also important. What if he doesn't value the food so much but believes that his date will really like the experience? What if the restaurant gets terrible reviews from the community or recently failed a code violation?

He must also consider the substitutes available to him. He's less likely to demand that dinner if there is another fine dining experience of equal quality available for $80 next door. That restaurant might be full, though, because there are lots of other consumers with similar tastes. What if there are no other food options available for miles and the consumer is dying of starvation?

At the microeconomic level, demand is a function of all these factors at once. Movements in these factors change the total subjective cost that consumers face before making a decision about whether to trade.

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