In economics, demand is the desire and ability of a consumer to buy a product or service. Demand is the driving force behind economic expansion. Demand is the driving force behind all business.
The Key Takeaways
- In economics demand is the amount of a product or service that consumers will buy for a certain price.
- According to the law of demand, as prices increase, demand will generally fall, and vice-versa.
- Demand curves can be used to plot the law of demand on a graph for a product or service.
- Demand can either be elastic (meaning that it changes in proportion to price changes) or inelastic (meaning that demand is fairly constant regardless of price changes).
Law of Demand
The Law of Demand governs how the relationship between quantity demanded and price is determined. This economic principle describes what you intuitively understand. When prices increase, people will buy less. In the opposite situation, people will also buy more. People will buy more if the price falls.
The price isn’t the only factor. The law of supply is true only if other factors remain constant.
Note:
This is known as ceteris parebus in economics. The law of demand states, ceteris parebus that the quantity demanded is inversely proportional to the price.
Determinants of demand
Five factors determine demand. The price of the product or service is the most important. Second, the price of similar products is important.
The next three factors are determined by the circumstances. First, the consumer’s income or their ability to spend money. Second, buyers’ preferences or tastes in terms of what they would like to buy. Demand for Humvees may drop if buyers prefer electric vehicles in order to save gasoline. Third, their expectation of whether prices will increase. If they are worried about future inflation, they will buy now and drive current demand.
Demand Schedule
The demand schedule is either a table, or a formula that shows how many units will be required at various prices. ceteris parebus. This is an example demand schedule.
| Quantity of Beef Purchased at Each Price Point | |
|---|---|
| PRICE/LB. | Quantity (in LBS) ) |
| $3.46 | 10.0 |
| $3.55 | 9.8 |
| $3.69 | 9.5 |
| $3.80 | 9.4 |
| $3.85 | 9.3 |
| $3.88 | 9.3 |
| $3.88 | 9.3 |
| $4.01 | 9.1 |
| $4.09 | 8.9 |
| $4.45 | 8.5 |
Demand Curve
You can create a curve of demand by plotting how many units you will buy at various prices. It displays the information that has been detailed in a schedule of demand.
Note:
The chart shows the price on the left axis and the quantity purchased on the right. At P2, a higher price, consumers will only purchase Q0, a lower quantity. If the price drops down to P1, the quantity purchased will increase to Q1.
If the demand curve is flat, people will still buy more even if prices change a little. If the demand curve is steep, the amount demanded does not change much even if the price changes.
Elasticity in Demand
Demand elasticity is the amount that demand changes more or less when prices change. This is measured specifically as a percentage. The percentage change is the difference between the price and the quantity demanded.
Three levels of demand elasticities exist:
- When demand changes exactly by the same percentage as price, it is called unit elastic.
- Elasticity is the result of a demand change that is greater than the price change.
- When demand changes less than price, it is said to be inelastic.
Amount of Demand
Market demand is the aggregate demand of a group. Five factors determine individual demand. The number of buyers on the market is also a sixth factor.
A country’s aggregate demand can be calculated. The world’s population is interested in the amount of goods and services that a country produces. It is made up of the same five components as Gross Domestic Product.
- Consumer spending
- Investment in business
- Spending on Government
- Exports
- Subtraction of imports from GDP and aggregate demand
Demand is the lifeblood of business
All businesses strive to understand consumer demand and guide it. Market research is used to try and understand the consumer demand. Marketing, such as public relations and advertising, is used to try and guide the process.
Companies that have a advantage attract more demand. Being the lowest-cost provider is an advantage. Costco, for example, offers bulk purchases at low unit prices. A second is to be innovative. Apple raises prices when they launch new products first.
Note:
Businesses make more money when something is in demand. The price will increase if they cannot produce more quickly enough. Inflation is when the price increases continue over time.
Businesses will lower their prices if demand falls. The businesses hope this will be enough to divert demand away from their competitors, and gain more market share. If this doesn’t work they will invent and create a new product. If the demand doesn’t improve, companies will reduce production and layoff workers. This can lead to an economic contraction if it happens all over the place. This phase of the business cycles creates a depression.
Demand and Fiscal Policy
Federal government also attempts to manage the demand in order to prevent inflation or recession. Goldilocks is the name given to this ideal economic situation.
Note:
Fiscal policy is used by policymakers to increase demand during a recession, or reduce it in periods of inflation.
It can either reduce taxes or purchase more goods and services to boost demand. It can also provide subsidies to businesses and benefits to individuals, such as unemployment benefits. It creates enough jobs and increases confidence to increase demand. Government spending on mass transit, education and other government programs is the most effective way to create jobs.
Congress can reduce demand by increasing taxes, cutting spending or withdrawing subsidies and benefits. Beneficiaries are often angry and the elected officials are forced out of office.
Demand and Monetary policy
The Federal Reserve and its monetary policy are responsible for the majority of inflation-fighting. Raising interest rates is the Fed’s best tool to reduce demand. The Fed can reduce lending by reducing the money supply. Consumers and businesses may want to spend more but have less money.
The Fed has other powerful tools that it can use to increase demand. The Fed lowers interest rate and increases money supply. Businesses and consumers will be able to buy more with more money. 1
Even the Fed has limits in increasing demand. If unemployment is high for an extended period, consumers will not have enough money to meet their basic needs. They can’t benefit from low interest rates because they are unable to take advantage of loans at low cost. They need work to give them income and future confidence. The Congress needs to step in and implement an expansionary fiscal strategy.
FAQs (Frequently Asked Questions)
What is Demand-Side Economics?
Demand-side economy is another term for Keynesian theory. John Maynard Keynes, a British economist who lived through the Great Depression in the 1930s, promoted the idea that demand was the driving force of an economy. 3 He thought that stimulating demand could improve economies in trouble. Supply-side economics is the opposite.
What is excessive demand in Economics?
There is an excess of demand when there’s not enough supply at the current price to meet demand.
