What is Demand Theory?

Demand theory refers to a theory that studies the relationship between the demand of consumer goods and their prices. It is the premises of the demand curve that creates a link between the quantity demanded and price for a product. With more supply of a product or service, its demand declines followed by the equilibrium price.

Back to:ECONOMIC ANALYSIS & MONETARY POLICY

Why is Demand Theory Important?

Demand refers to the quantity of a product or service that users are desirous and capable of purchasing at a said price in a given timeframe. In order to fulfil their desires and wants, people tend to have demand for goods and services. The product demand available at a specific price showcases how much satisfied a user would be after using the product. The level of satisfaction that a consumer receives from a product is referred to as utility. The level of utility derived from a product varies from one user to another. Two factors that influence the demand of a product include its utility for satiating customers wants or desires, and the spending capacity of a consumer. Real demand takes place when the willingness to satiate a need is covered by the paying capacity of the customer. Demand is affected by several factors such as preferences, tastes, and interests of consumers. For ensuring that the business can compete and expand in the industry, it is important to ascertain consumer demand in the market. The forces of demand and supply regulate the market which ultimately help in ascertaining the prices of products and services. When the demand and supply are equal to each other, prices reach the equilibrium stage. In case, demand is more than supply, prices are hiked in order to bring the demand down. On the other side, if demand is less than supply, prices are reduced to show the surplus. The law of demand demonstrates a negative relationship between the price of a product or service and its demand. So, if the price of a product experiences an increase, its demand would decrease, keeping other variables constant. And, with a decrease in the price of the product or service, there will be an increase in demand. This relationship can be demonstrated with the help of demand curve in a graphical manner. The slope of the demand curve is negative moving downward from left to right. This movement shows the negative relation between the quantity demanded of a product or service and its price for a given time period. The substitution effect or income effect result in expanding or contracting of the demand curve. If the price of a normal good declines, the consumer gets to fulfil the similar level of his or her wants at a reduced price. Here, within a specific price limit, the consumer gets to buy more units of the goods. This is referred to as the income effect. The substitution effect takes place when consumers tend to substitute from highly priced products to less priced products. When more consumers tend to buy products at less prices, it causes an increase in their demand. There are times when demand of consumers for a product or service gets affected by many other variables besides price. This phenomenon is known as a change in demand that makes the demand curve shift to left or right as per the changes in consumers interests, income, preferences, etc. For instance, with a rise in income, a person would have more amount of money for buying goods and services available in the market, no matter if prices reduce, causing the demand curve shift to the right. The law of demand has an exception concerned with giffen or inferior goods. Giffen goods are also known as inferior goods which experience more consumption with an increase in prices, and less consumption with a decline in prices. Giffen goods lack feasible replacements, and thats why, the income effect rules over the substitution effect in their case. Microeconomics covers one of the most important theories named demand theory. It offers information about the cravings of people for things, and how various income levels and satisfaction affect demand. Firm tend to make adjustments in the price of products and their supply depending on the estimated utility of products and services.

Related Concepts

• Demand Curve
• Giffen Good
• Veblen Good
• Inferior Good

Other Related Topics

• Law of Supply and Demand
• Supply Curve
• Increasing, Constant, and Decreasing Returns to Scale
• Supply Schedule
• Demand Theory
• Demand Schedule
• Pent Up Demand
• Demand Curve
• Supply Demand Analysis
• Hubbert's Peak Theory
• Equilibrium
• Equilibrium Price
• Equilibrium Quantity
• Competitive Equilibrium
• Walras' Law
• Recursive Equilibrium
• Scarcity Principle
• Disequilibrium
• Excess Supply
• Excess Demand
• Law of Supply and Demand