To understand exactly how the market works, it is necessary that a manager understands the theory of demand closely. He can take significant decisions based on this knowledge.
Demand theory- Definition
It is one of the most important principles in economics that focuses on the relationship between the prices of commodities as well as consumer demand. Demand theory is represented using demand curves. A demand curve slopes downwards horizontally (when the price of a commodity goes up as the quantity goes down and vice-versa).
Let’s delve deeper into the theory of demand!
Let us first understand what demand stands for. It is the number of services or goods the consumers want to buy at a particular price in a specific set of times. It hints toward the willingness of the customer to purchase that commodity and consume it for the given price. The goods can belong to various categories such as luxuries, necessities and so on.
Examples of necessary goods include water, shelter, healthcare, food etc. Generally, the cost of the products tends to be feasible. However, luxuries such as designer bags, clothing, lavish mansions etc. come at a premium price, and not everyone can afford the same.
There are two significant factors which influence the demand for a product- the ability to pay for a specific product and the utility of the product.
These two factors often coincide with each and affect the purchasing decision of the customers. Demand basically is the culmination of the utility of a product supported by the efficiency of the consumer to pay for it.
The ultimate aim of demand is to portray how badly consumers wish to purchase certain products. The utility of the products, as well as their income, decides the level of demand.
In case a product gets immensely popular because of its high level of utility, there will initially be a scarcity in the supply of that product. This will lead to a rise in the price of the product and a corresponding shift in the supply curve. Later on, they will work on increasing production. Soon the prices will go down, and the supply curve will be back at its earlier position.
Different factors that impact the demand for commodities and services
Below given are the various factors that impact the demand:
- Choices
- Preferences of the consumers
- Income
- Related commodities
- Taste
Since so many factors affect the demand for commodities, it is necessary that businesses analyse the demand closely. This ensures that the companies stay in the competition by catering to the expectations of consumers.
Demand and the market system
Both demand and supply affect the overall price within the market. When the demand for a specific commodity is high as compared to the price, it leads to scarcity in the market. When the supply is equal to demand, the price stays in an ideal state of equilibrium. And if the supply goes higher than the demand for the commodities, the price is bound to crash because of surplus products.
Law of Demand
As you study the law of demand closely, you will realise that there is an inverse relationship between the demand for the service/goods and the price. When the price of the product increases, the demand goes down. And when the price goes down, the demand for the product increases, given that other factors remain the same.
Let us help you understand the same with the help of an example.
If A has a higher disposable income, then he is in a position to spend more on the commodities. In case the price of product X goes up, he will consider switching to another product B, which gives the same value but costs less. But when the price of the X goes down, he will again resume using X because now he can afford it again.
Contraction and expansion of demand
Contraction or expansion of demand may take place because of the substitution effect.
When a product gets cheaper, a consumer may seem satisfied to spend lesser than before. He will be in a position to purchase more of the same commodity because of the low price. This situation is also called as income effect.
The substitution effect can take place when a customer shifts from product A to B, A being a costly product and B being a cheaper one offering the same value. When more and more consumers switch to product B, then the demand for product A goes down gradually.
Conclusion
Demand is affected by multiple factors. Once you understand and study these factors individually, it gets easier to understand the demand-supply situation of specific products as per market trends.