Law of Demand: Explained

You can make even a parrot into a learned political economist – all he must learn are the two words “supply” and “demand.”

-Thomas Carlyle.

Demand is a desire to have or to own a certain product or service. However, wanting a product must coincide with the ability and willingness to pay for it.

In general, we see demand as a measure in terms of the sales volume in a particular industry. However, the important measure is how much will be bought at a higher and lower price?

For example, different iPhone models are set at a different selling price. And their demand is quite different in different years.

• iPhone (4GB): $499
• iPhone 3G (8GB): $599
• iPhone 3GS (16GB): $599
• iPhone 4 (16GB): $599
• iPhone 4S (16GB): $649
• iPhone 5 (16GB): $649
• iPhone 5s (16GB): $649
• iPhone 6 (16GB): $649
• iPhone 6 Plus (16GB): $749
• iPhone 6s (16GB): $649
• iPhone 6s Plus (16GB): $749
• iPhone 7 (32GB): $649
• iPhone 7 Plus (32GB): $769
• iPhone 8 (64GB): $699
• iPhone 8 Plus (64GB): $799
• iPhone X (64GB): $999

Demand for products and services drives revenue and ultimately profit for businesses. Investors should glue their eyes into this very measure which is the heart of any businesses. Here is an example of it reported on CNN.

A year ago, Apple told suppliers to prepare for shipments of 100 million iPhone 8, iPhone 8 Plus and iPhone X devices. This year, Apple is taking a “cautious approach,” telling suppliers to prepare for 80 million iPhones, Nikkei reported.

– CNN

Law of Demand

In theory, the Law of Demand is the change in quantity demanded. The relatively high prices of products and services are associated with relatively low quantities demanded. Similarly, low prices are associated with high quantities demanded.

It is extremely difficult to anticipate to demand of any products or services. For example, one can not accurately predict how much iPhone will be demanded next year. However, one can estimate whether the demand will be higher or lower in a long term.

Change in Quantity demanded is based on:

• Income Effect
• Substitution Effect

So, watching/understanding these metrics will help in evaluating the future of the demand. Income effect is highly important to premium products like iPhone. If people have higher income and higher disposable income, certainly one can expect more demand for iPhone. Also, if there are any substitutes in the market, then the demand will soften.

Change in Demand is based on:

• Consumer Income
• Consumer Tastes
• Price of Related Products

These variables should give an estimates of how a demand of products or services will fluctuate.

Diminishing Marginal Utility

It’s the extra usefulness or satisfaction a person gets from acquiring one more unit of a product. In the case of the iPhone, users are not expected to buy more than one phone, so the marginal utility is near zero. The higher the marginal utility, the greater the chance the consumers are expected to buy it.

Demand Elasticity

It indicates the extent to which changes in price cause changes in the quantity demanded. This is another important concept to understand to fully understand the Law of Demand.

Determinants of Demand Elasticity

1. Can the Purchase Be Delayed?
2. Are Adequate Substitutes Available?
3. Does the Purchase use a Large portion of Income?

iPhone, I believe, is a unique product. It does not follow the law of demand elasticity. Certainly, the purchase of a new iPhone can be delayed. However, the demand surges once the new version of the iPhone comes out in the market. It is not because there is a pure demand in the market. This is something emotional and psychological phenomenon.

The iPhone purchase can be delayed, there are few substitutes available and the purchase use a large portion of income, and still, it is considered Inelastic. The more expensive model of the iPhone sells even better.

Apple company enjoys a share of mind that its consumers believe that its products are of supreme class. They have so much desire to buy a new model of iPhone that sometimes their ability to purchase is compromised. People have a psychological desire to be in the elite class by wearing branded clothes, riding an expensive car and carrying fancy gadgets. Apple products, with its sleek design and seamless software, are considered fancy gadgets. Nevertheless, Apple creates a virtual demand in its consumer’s mind. This is a phenomenon practice, which is directly reflected in its revenue.

Demand analysis is one of the important analysis while analyzing businesses. A very few investors do follow it religiously. And the ones who do are the greatest of all. We intend to change this practice in the greater public.