what is demand theory 
demand theory is an economic principle relating to the relationship between the demand for consumer 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 understanding demand theorydemand 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 1 its utility to satisfy a want or need and 2 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 the law of demand and the demand curvethe law of demand introduces an inverse relationship between price and demand for a good or service it simply states that as the price of a commodity increases demand decreases provided other factors remain constant also as the price decreases demand increases this relationship can be illustrated graphically using a tool known as the demand curve the demand curve has a negative slope as it charts downward from left to right to reflect the inverse relationship between the price of an item and the quantity demanded over a period of time an expansion or contraction of demand occurs as a result of the income effect or substitution effect when the price of a commodity falls an individual can get the same level of satisfaction for less expenditure provided it s a normal good in this case the consumer can purchase more of the goods on a given budget this is the income effect the substitution effect is observed when consumers switch from more costly goods to substitutes that have fallen in price as more people buy the good with the lower price demand increases sometimes consumers buy more or less of a good or service due to factors other than price this is referred to as a change in demand a change in demand refers to a shift in the demand curve to the right or left following a change in consumers preferences taste income etc for example a consumer who receives an income raise at work will have more disposable income to spend on goods in the markets regardless of whether prices fall leading to a shift to the right of the demand curve the law of demand is violated when dealing with giffen or inferior goods giffen goods are inferior goods that people consume more of as prices rise and vice versa since a giffen good does not have easily available substitutes the income effect dominates the substitution effect supply and demandthe law of supply and demand is an economic theory that explains how supply and demand are related to each other and how that relationship affects the price of goods and services it s a fundamental economic principle that when supply exceeds demand for a good or service prices fall when demand exceeds supply prices tend to rise there is an inverse relationship between the supply and prices of goods and services when demand is unchanged if there is an increase in supply for goods and services while demand remains the same prices tend to fall to a lower equilibrium price and a higher equilibrium quantity of goods and services if there is a decrease in supply of goods and services while demand remains the same prices tend to rise to a higher equilibrium price and a lower quantity of goods and services the same inverse relationship holds for the demand of goods and services however when demand increases and supply remains the same the higher demand leads to a higher equilibrium price and vice versa supply and demand rise and fall until an equilibrium price is reached for example suppose a luxury car company sets the price of its new car model at 200 000 while the initial demand may be high due to the company hyping and creating buzz for the car most consumers are not willing to spend 200 000 for an auto as a result the sales of the new model quickly fall creating an oversupply and driving down demand for the car in response the company reduces the price of the car to 150 000 to balance the supply and the demand for the car to ultimately reach an equilibrium price who proposed the theory of supply and demand the theory of supply and demand is attributed to adam smith who observed that the costs of products rise and fall according to customer needs the theory was later expressed more formally by david ricardo in the principles of political economy and taxation 