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

Demand Definition

Investopedia / Paige McLaughlin

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.

Key Takeaways

  • The law of demand concerns consumers' changing desire to purchase goods and services at given prices.
  • Demand can refer to either market demand for a specific good or aggregate demand for the total of all goods in an economy.
  • Demand and supply determine the actual prices of goods and the volume that changes hands in a market.
  • Businesses study demand to price products to meet demand and generate profits.
  • The demand curve demonstrates visually how the decreasing price for a product increases the quantity purchased.
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What is 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.

Demand elasticity relates to how sensitive the demand for a product is as the price for it changes. For example, if there's a big change in demand due to a small change in price, demand elasticity is said to be high. Shoppers may choose attractive substitute products if the price for their usual product has increased somewhat. That could indicate high demand elasticity and is useful for businesses to know.

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.

Demand Curve

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.

What Is Meant by Demand?

The economic principle of demand concerns the quantity of a particular product or service that consumers are willing to purchase at various prices. Demand looks at a market's pricing and purchases from a consumer's point of view. On the other hand, the principle of supply underscores the point of view of the supplier of the product or service.

What Is the Demand Curve?

The demand curve is a graphical representation of the law of demand. It plots prices on a chart. The line that connects those prices is the demand curve. The vertical axis represents prices of products. The horizontal axis represents product quantity. Typically, the curve starts on the left side high up the vertical axis and descends across the chart to the right. The slope indicates that as prices decrease, demand, as shown by growing number of products purchased, increases.

What Is the Importance of Demand?

Economically speaking, the principle of demand has importance 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.

Article Sources
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  1. Board of Governors of the Federal Reserve System. "About the FOMC."

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