Demand theory is an economic principle relating to the relationship between consumer demand for goods and services and their prices in the market. Demand theory forms the basis for the demand curve, which relates consumer desire to the amount of goods available. As more of a good or service is available, demand drops and so does the equilibrium price.
Demand theory highlights the role that demand plays in price formation, while supply-side theory favors the role of supply in the market.
Demand is simply the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period. People demand goods and services in an economy to satisfy their wants, such as food, healthcare, clothing, entertainment, shelter, etc. The demand for a product at a certain price reflects the satisfaction that an individual expects from consuming the product. This level of satisfaction is referred to as utility and it differs from consumer to consumer. The demand for a good or service depends on two factors:
(i) Its utility to satisfy a want or need
(ii) The consumer’s ability to pay for the good or service. In effect, real demand is when the readiness to satisfy a want is backed up by the individual’s ability and willingness to pay.
Demand theory is one of the core theories of microeconomics. It aims to answer basic questions about how badly people want things, and how demand is impacted by income levels and satisfaction (utility). Based on the perceived utility of goods and services by consumers, companies adjust the supply available and the prices charged.
Built into demand are factors such as consumer preferences, tastes, choices, etc. Evaluating demand in an economy is, therefore, one of the most important decision-making variables that a business must analyze if it is to survive and grow in a competitive market. The market system is governed by the laws of supply and demand, which determine the prices of goods and services. When supply equals demand, prices are said to be in a state of equilibrium. When demand is higher than supply, prices increase to reflect scarcity. Conversely, when demand is lower than supply, prices fall due to the surplus.
- Demand theory describes the way that changes in the quantity of a good or service demanded by consumers affects its price in the market,
- The theory states that the higher the price of a product is, all else equal, the less of it will be demanded, inferring a downward sloping demand curve.
- Likewise, the more demand that occurs, the greater the price will be for a given supply.
- Demand theory places primacy on the demand side of the supply-demand relationship.