Basic Economics: Demand Theory Explained

The whole Economics literature is based on the theory of demand and supply, and how their interaction creates efficient markets, by incentivizing production and consumption. For anyone attempting to understand either management or public policy, it is essential that she understands these concepts of demand and supply in the first place. We begin with demand.
Basic Economics: Demand Theory Explained
Source - Wikimedia Commons (https://commons.wikimedia.org/wiki/File%3AEconomics_demand_curve.jpg)

The Concept of Demand in Economics

Demand is the fulcrum of the whole theory of economics. Without fully understanding it, one cannot take even a single step in mastering the art of economic sciences.

The concept of demand postulates that the quantity of any object or good that a person demands or wants to purchase in a free market is not fixed. It changes with many factors, most important of which is the price of that good. In simple words, if the price of a good falls, then we may want to buy a larger quantity. On the other hand, when the

price of that good rises, we tend to consume and demand less of it.

Take a simple example. Imagine you are walking through a lonely isolated place and you are feeling just a bit hungry. Suddenly you come across a shop, where some cakes are available. Though you wish to have two or three cakes, however, if you find that the price charged is exorbitant, you may buy only one or none at all. So at a higher price your demand is lower, while at a lower price, you demand will be higher.

Thus, when the prices of any good or service rises, the demand for that good starts falling. One contemporarily relevant example is real estate. When prices of houses become too high, and people are no more able to afford it, the demand for such expensive houses falls, and so housing sales begin to stagnate.

Factors Affecting Demand of a Good

However, price of the good is not the only factor that affects the demand.

The income and wealth of the buyer is also an important determinant of demand. When the income of people rises, they are willing to pay more for the same good. This is the reason why, people are generally willing to pay much more in developed countries compared to poorer countries where individual incomes are smaller.

Another factor that affects the demand for any good is the price of other goods that can substitute this good. For example, if there are two brands of beer that are similar in flavour, and the price of one brand suddenly rises, people may shift to the other, cheaper brand, whose demand will rise even though its price remains unchanged.

The Concept of Elasticity of Demand

Lastly, there is also a related concept of Elasticity of Demand. There are some goods whose demand does not vary much with change in price (or other factors), like life saving medicines, drugs and tobacco. Their demand is said to be inelastic. When a life saving medicine is required, people will buy it irrespective of its price, so far as they can somehow afford to buy it.

This, in very short, is what is meant by demand. Demand and Supply are two basic pillars of the theory of free market and capitalism. It is impossible to understand the concept of markets without understanding these basics.



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