Economic Demand: Definition, Determinants and Types
Updated July 21, 2022
Economic demand is what drives commerce. Without consumer demand, companies are unwilling to supply products, as there is no revenue or profitability by entering a market. As a job seeker or an employee, finding industries with high consumer demand can further your job prospects and provide a way to utilize your skill set.
What is the definition of economic demand?
Economic demand is a principle that refers to a consumer’s demand for a particular product, as well as the price they’re willing to pay for that product. While demand is highly variable due to outside factors, the basic concept is that economic demand will decrease as price increases.
As a graphical representation, the demand curve slopes downward from left to right, indicating low demand at high prices and high demand at low prices. The economic demand curve is inverse to the supply curve, which slopes upward from left to right, signaling an increase in supply as the price gets higher. This is due to the fact that businesses will produce more of a product or item when it leads to increased profitability.
Why is economic demand important to your job?
If you work in finance, accounting or economics, economic demand is the reason you have a job and that your company is in business. Understanding economic demand requires a bit of study, but once you have the principles down, you can apply your knowledge to help you excel in an interview, explain rudimentary ideas to colleagues and improve your understanding of your job.
Another central tenet of economic demand that pertains to a position you may hold or want is that it enables you to forecast how much of a good to produce or when it’s best to scale back production. This can save your company money in the short-term and long-term, improving company financials and increasing cash flows to other areas of the business outside production.
In addition to the above impacts of economic demand on your job, determining economic demand is one of the major expenses of corporations and businesses. If projections of economic demand are incorrect, it can throw off forecasts, cause increased overhead or result in a net loss. In a simpler sense, demand dictates the market for your company’s products. This makes comprehension of economic demand a necessity for many professionals across a range of industries.
Determinants of economic demand
The law of demand states that — all other things equal—the quantity of demand falls when prices rise. However, external factors can play a role in economic demand. These factors are known as determinants of economic demand. Comprehending how these determinants play a role in economic demand can help you as an employee or a job seeker to help you forecast sales projections and other vital factors that affect revenue.
Expectations play a massive role in economic demand. To illustrate this point, take a look at housing prices. Consumers will buy a home and continue to buy it at the current price (even if it’s rising daily) if they expect the price to rise in the future. In their minds, they’re getting more value for their home by buying it at the current price and letting it grow in value. The same can be said for falling prices, but conversely. If the prices of homes are falling, consumers are less likely to buy, as they believe the price will continue to fall.
Tastes and fad
Consumers are a finicky bunch. Over time, their tastes, preferences, emotions and desires change. If the change is in favor of a new product, the demand increases. When preferences go against a certain product, the demand decreases. Because of these changes in tastes, companies are always seeking ways to increase their brand favorability through marketing and advertising. Examples include companies with logo changes or a new slogan to connect with their target market.
With all other factors equal, price is the foremost determinant of whether consumers purchase a product, i.e. economic demand. While outliers exist that will pay premium prices based on the quality of a good, price still remains the most vital aspect of demand. Therefore, the company that you work is always trying to set a price point to maximize profitability without damaging economic demand.
Prices of related services or goods
When the price of goods increases, the demand for it falls. However, this price increase can affect complementary goods as well. For example, if you bought a Dell computer and Apple comes out with another computer that renders your model obsolete, your demand and the demand of others will fall. The same idea often happens in the automotive industry. When gas prices rise, the demand for economical cars increases, while the demand for gas guzzlers falls.
If income goes up, consumers have more spending power. In most instances, they will buy more products. The same is true if their income decreases. Consumers will have less buying power, and demand will decrease. Marginal utility is also a concept that you should factor into the link between demand and income. This idea states that consumers won’t buy a proportionate amount of a product compared to their increase in income. For example, a consumer that suddenly has more income may buy more steak. However, they don’t need 50 steaks all at once when one or two will meet their cravings. This is how you can think about marginal utility and a superb way to explain it to colleagues or clients.
The demand for inferior goods often goes hand-in-hand with income. When income goes up, the demand for non-name-brand products falls as consumers put a higher perceived value on name brands. When income falls, the demand for inferior goods rises as consumers find a product to meet their needs rather than buying a product on brand recognizance alone.
Number of buyers in the market
The number of buyers in a particular market can also drive demand. When more buyers are in the market for a good or service, the demand goes up. This principle is also known as aggregate demand.
If the price of a product goes up, it can force consumers to buy substitute products. For example, an increase in the price of a John Deere tractor may increase. This can lower the demand for John Deere, but increase the demand for a Case International tractor with similar amenities at a lower price. However, this may not affect all customers, especially those with strong brand loyalty.
As an employee, you have little control over the determinants of demand. However, knowing what causes demand to fluctuate can help you see the bigger picture within your company or the overall market.
Different types of economic demand
Companies and corporations put plenty of their budget into understanding the demand for their products. This enables them to push their product to consumers or other businesses without losing money due to overproduction or other factors. As an employee, understanding what type of demand your company falls under is a good business practice. Here’s a glance at the different types of economic demand.
Market and individual demand
Individual demand is the economic demand for a product at a certain price by one consumer. Customer tastes, perceived quality and brand loyalty all affect individual demand. Market demand, also known as aggregate demand, is the total economic demand of all individual demand in a particular market.
Company and industry demand
The demand for products at a certain price over a period of time from a single entity is known as company demand. Industry demand is the total aggregate demand for products in an industry. Company demand is often expressed as a percentage of industry demand in order to measure market share. For example, the demand for Pepsi products is the company demand, but it only makes up a percentage of the total industry demand for beverages.
Short-term and long-term demand
As the name implies, short-term demand for a product is the economic demand over a shorter duration of time. Short-term demand is elastic, meaning that it reflects price changes, fads and necessity more drastically than longer-term demand. For example, winter clothing is only worn during the colder months, making the demand short-term in comparison to clothes that are worn year-round. Price makes short-term demand fluctuate drastically. Long-term demand refers to consumers’ demand for products over a lengthier stretch of time. This demand doesn’t change nearly as much with respect to price. Instead, long-term demand changes based on promotion and advertising by a company, the availability of substitutes and competition.
Market and market segment demand
Market demand is the aggregate demand of all consumers who purchase the same type of product. Market segment demand, on the other hand, refers to a particular subset of market demand, namely age, race, gender and a variety of other demographic factors.
Perishable and durable goods demand
Durable goods are any products that can be used more than once in their life cycle. Perishable goods are items that only have a single use. While both types of goods satisfy the demands of consumers, durable items have more perceived value over the long-term. In addition, durable goods also need replacement over time (cars, shoes, clothing), so a market demand still exists for them after an initial purchase.
Derived and autonomous demand
Autonomous demand, also known as direct demand, is when the demand for a product is independent of all other goods in the market. Derived demand is an economic demand that directly correlates with the demand for another product. For example, if the demand for tires goes up, the demand for rubber will increase proportionately.
Income is a determinant of economic demand, so it’s easy to understand why it has it’s its own type of demand. Income demand is the willingness of a consumer to buy a certain product at a given income level and price. If income goes down, demand goes down. If income goes up, demand goes up.
Price demand refers to the quantity of a certain good that a consumer will buy at a certain price. Unlike income demand, price demand has an inverse relationship between price and overall demand. As the price goes up, demand falls and vice-versa.
This type of economic demand centers on the number of substitutes and related products in a particular market. When the price of a certain product goes up, cross demand dictates that its substitute will see an increase in demand. An example of cross demand is if the price of cow’s milk skyrockets, the demand for almond milk, soy milk and other milk substitutes will increase.
Types of demand vary by industry and company, but a vested knowledge and interest in the types of economic demand will help you understand the mission and goals of your department, company or potential employer. However, You don’t have to become an expert on all types of demands. Instead, focus your energy and study on those that impact your industry.
Some companies only have to deal with a single type of demand, while others fall under two or more. Once you’ve identified the types of economic demand of your company or prospective employer, you can better comprehend the role of your job and how to increase your effectiveness and efficiency at your position.
Relationship between supply and demand
The theoretics and principles behind economic demand are complex, but even a slight knowledge of how economic demand works can broaden your horizons and enhance your value to a company. Using this understanding of economic demand, you can impress in your next interview or take your role at your current position to the next level.
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