Theory of Demand: Basics and Applications

Demand is defined as the quantity of a commodity that a Consumer is capable of buying and is willing to pay the given price for it at the given time. The Theory of Demand is a Law that states the relationship between the quantity Demanded of a product and its price, assuming that all the other factors affecting the Demand are constant. According to the Law of Demand Theory, the quantity Demanded of a commodity is inversely related to its price in the market. Through this article, we will try to comprehend the Theory of derived Demand, the factors affecting Demand, the Demand curve and the application of Demand Theory.

Theory of Derived Demand

We have got an idea about “what is the Theory of Demand”. So now let us try to understand the Theory of derived Demand with the help of an example: a Consumer Demands a piece of clothing, let’s say a shirt, which is a finished product that came into existence after undergoing various processes. First, the land for building the plant was acquired by the manufacturing Company and then the labour was employed by the entrepreneur using the Company’s Capital. The Demand for all these resources (factors of production) was indirectly created when the Consumer posed a Demand for the shirt. This is called the Theory of derived Demand.

Factors Affecting Demand

After having discussed the Theory of Demand economics and the Theory of derived Demand, we will now talk about the various factors affecting the quantity Demanded of a product.

1. Price of the Commodity: As stated in the Law of Demand Theory, the price of a commodity shows an inverse relationship with its quantity Demanded. As the price of the product falls, its Demand increases.

2. The Number of Consumers: It is directly related to the quantity Demanded of a commodity. The more the number of Consumers, the more is the Demand for that product.

3. Price of Related Goods: There are two types of related goods: Substitutes and Complementary goods. For example, for milk, the juice is a substitute whereas biscuits are complementary products. If the prices of milk fall, the Demand for juice (substitute) will increase and that for biscuits (complementary goods) will lessen.

4. Income: With the increment in a Consumer’s income, he will become capable of buying more of a particular commodity, and thereby, his Demand will also rise.

5. Consumer Expectation: If a Consumer expects that the price of a certain commodity will go up in the future, he will buy more of that product at present, which will lead to a hike in its Demand.

6. Tastes and Preferences: It has a direct relation with the quantity Demanded.

Solved Example

Q. Explain the Demand Curve.

Ans: We now know “what is the Theory of Demand” and the factors that determine the quantity Demanded. Let us move on to the characteristics of a Demand curve. On the x-axis, we have taken the price of the commodity, and on the y-axis, the quantity Demanded.

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The first graph here shows the movement along the same Demand curve. This downward-sloping curve is in accordance with the Law of Demand Theory as when the price falls from P1 to P2, the quantity Demanded increases from Q1 to Q2.

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In this graph, we can see that there is a shift in the Demand curve from D to D1 at the same price P. For the curve D, the quantity Demanded is Q which is lesser than Q1 (for D1 curve). This right-shift in the Demand curve is due to all the factors affecting the Demand except the price of the commodity (which is responsible for movement along the curve). These are the same factors that are kept constant while explaining “what is the Theory of Demand”.

Application of Demand Theory

After having learned about “what is the Theory of Demand” and how a Demand curve looks like, we will now become familiar with the application of Demand Theory in real life. The Theory of Demand is useful in determining the force of various determinants or factors that affect the quantity Demanded. The application of Demand Theory for estimating the ups and downs in the equilibrium prices of various commodities is important for investors and entrepreneurs.

Fun Fact

Named after Sir Robert Giffen, Giffen goods are considered inferior goods that do not obey the Law of Demand Theory. According to the Theory of Demand, the Demand for a particular commodity diminishes with an increase in its price, but for Giffen goods, it increases with the rise in price. A historical example of the Giffen goods concept is the Irish Potato Famine of the 19th century. When the price of potatoes (Giffen goods) inflated, people cut their expenses by buying fewer luxury goods like meat and bought more potatoes.