Understanding Demand
If you enjoy eating apples and each apple cost $10 then you are likely to be very conservative with your apple consumption. But if the price of an apple drops to 10 cents then you will likely hoard apples. This is the key to understanding Demand. As prices drop, demand will increase. As prices rise, demand will decrease.
However, it’s imperative to realize that the demand for a product or service is never fixed. Considering all other factors remain constant, the price of a product will drive demand inversely – i.e an increase in price will drive demand down; and a decrease in price will drive demand up. Understanding demand is really important for businesses and entrepreneurs to operate efficiently.
Shortage & Surplus
Businesses spend a considerable amount of resources to determine the demand for a product or service. If a business underestimates the demand, then they will supply less. As a result there will be more demand than items available. This is called a shortage. Consumers needs will be left unmet and suppliers would be leaving money on the table. This economically an inefficient outcome.
Underestimate —> Shortage (money left on the table)
Overestimate —> Oversupply (not enough buyers - losses)
On the other hand, if a business overestimates the demand, then they will supply too much of the product – a oversupply. In this case, there won’t be enough consumers to buy all of the supply which will result in losses. In either case — overestimation or underestimation — a business will be losing money. This is why understanding demand is imperative.
It’s crucial to note that there’s a key difference between “shortage” and “scarcity”. Scarcity refers to the quantity available relative to the population. An increased scarcity of an item means that there are fewer items relative to the population. Scarcity of an item is not impacted by its price, but by the limited number available – a natural limitation. Shortage of an item is a phenomenon of price.
Previous: Fundamentals Of Economics
Next: Supply
Resources Referenced
Basic Economics - Thomas Sowel
Naked Economics - Charles Wheelan
Khan Academy - Economics & Finance