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What is Demand Theory?

By Alexis W.
Updated May 17, 2024
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Demand theory is an economic theory which is part of economists' understanding of the supply and demand curve. The supply and demand curve is often used as a fundamental argument for capitalism. According to demand theory and the concept of supply and demand, society will set the perfect price point for any item over time.

For every product that exists on earth, there is some level of demand. Demand simply refers to the desire of a consumer to buy an item. The given demand is represented often in terms of currency. For example, if an item costs a very low amount, many people may want the product, even if they do not truly need it or have a use for it. On the other hand, if an item is extremely expensive, then only those who truly want the item will be willing to pay for it.

As a result, the demand for a product is directly affected by how much it costs. There is an optimum level of demand that should be reached, under demand theory. That level of demand occurs when the price of a product is set so that only those who actually need the item will buy it. This maximizes efficiency.

Supply can also affect demand. As such, demand theory is intertwined with supply theory. The more of a product that is made — or the larger the supply — the more competition there will be for customers among the producers and sellers of that given product.

When the supply becomes too high, it exceeds the demand for the item. As a result, the manufacturers of that given product will need to lower the price of the item to increase the demand. When the price is lowered, more people will want the item. For example, assume an ice cream sundae cost $100 US dollars (USD); the demand would be very low. If a manufacturer then lowered the price to $1 USD, the demand would be very high. In fact, people who didn't even really want an ice cream would be likely to buy simply because the cost to them was so low.

Over time, eventually the supply and demand curves will meet at the optimal point. Under demand theory, this means that an industry will determine the exact price point at which charging too much would decrease the demand and cost them money, while charging less would result in a loss of income, even with the additional demand. This is fundamental to the idea of a capitalist society, which believes that the market will set the appropriate price without intervention.

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