What Is the Law of Demand | Definition & Meaning

The law of demand is one of the core notions in economics and price setting. It influences every type of economy and is tied to the law of supply. Together they illustrate how markets operate and how prices are determined in daily commodity trading. These laws hold true not only in commodity markets but also in stock and cryptocurrency markets. In this article, we will discuss the law of demand, provide the definition of the law of demand, and highlight its effects in the cryptocurrency market.

1. What Is the Law of Demand?
2. Demand vs. Quantity Demanded
3. Factors That Affect Demand
4. The Law of Supply
5. Cryptocurrency Supply & Demand
6. Final Thoughts

What Is the Law of Demand?

The law of demand states that the quantity of purchased goods changes inversely to the price. In other words, if the price for a good increases, consumers will demand a lower quantity of it. According to the law of diminishing marginal utility, consumers tend to buy what they need most before anything else. If they have sufficient money, they can buy additional units of goods they have already purchased. However, these additional units do not satisfy an urgent need, because they're not as essential. If the price for a commodity is unattractive, people may decide not to buy another unit of it. Instead, they'll likely buy a different commodity, something more urgently needed.

It's worth noting that although demand changes in response to price fluctuations, it's incorrect to say that prices themselves alter the level of demand. Demand results from decisions made by consumers. Specific circumstances in which consumers find themselves affect the demand curve. These circumstances include income, preferences, and awareness of the goods on the market, among others. Price is not the sole and direct driver of demand.

The law of demand unveils the model of how most people spend money when they cannot afford everything they want. Limited means are the reason why people would rather buy the first unit of a needed commodity than an extra unit of something they already possess.

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Let's consider an example. If a three-person family doesn't have a TV, they will likely buy one. This purchase satisfies the need for a TV for the entire family. They can place the TV in the living room and watch it together, or each family member can watch it alone if the others don't mind. They could buy a second TV for the kitchen, allowing them to watch it while cooking. Additionally, the second TV allows family members to watch different channels simultaneously. However, if all three family members or their guests want to watch different channels simultaneously, two TVs will not suffice. Buying a third TV can solve this problem.

As you may have noticed, any TV beyond the first one is not satisfying an urgent need. Moreover, the third TV is less important than the second one. The situation where the family needs one TV is typical. The need for a second TV arises less frequently. The situation where the three-person family urgently needs three TVs will be extremely rare.

Let's assume that all the TVs in our example are identical. Imagine how this might work in your own home: the first TV you buy holds significant value, but as you add more, each additional TV is a little less important. You'd probably be less willing to pay a high price for the third or fourth TV.

Demand vs. Quantity Demanded

There might be confusion about the similarity between the terms 'demand' and 'quantity demanded'. It's important to distinguish between the two. Demand describes how the quantity of goods consumers want changes as price changes. As prices grow, demand generally decreases. The demand curve reflects how consumers' desires and needs change based on their means.

Quantity demanded refers to the relationship between price changes and the quantity consumers are willing to buy. Unlike demand, quantity demanded doesn't reflect changes in consumers' preferences. Thus, the main conclusion we can draw from this is that price fluctuations affect the quantity demanded but do not change the demand itself.

Factors That Affect Demand

Now that we understand that prices don't directly impact demand, let's examine the factors that do affect demand. One of the most significant factors is changes in income. In most cases, an increase in income raises the demand for material goods; the more money people have to spend, the more needs they can afford to meet.

Another factor is the competition between substitute products. Each brand decreases the demand for its close substitutes. The introduction of new products by several brands on the market can decrease the demand for a product from a brand that previously held a monopoly in that segment. This is because these new brands may attract a portion of the buyers.

Certain goods are complementary in nature, and the growing demand for one triggers an increase in demand for the other, as they are often used together. For instance, smartphones and phone cases.

There are countless other factors that can significantly impact the demand for certain economic goods. Changes in political, environmental, social, and economic conditions can either boost or diminish demand. Over time, people's evaluation of a product's quality can change, which will be reflected in its demand.

The Law of Supply

Before discussing demand and supply in cryptocurrencies, we should define supply. Supply refers to the total amount of a specific good or asset available to consumers. Supply and demand are variable and mutually influence price.

Image source: The Economic Times

In the introduction to this article, we mentioned the law of supply. This law is straightforward: when demand exceeds supply, the price will likely increase. If the supply grows but demand remains the same, the price will fall.

Cryptocurrency Supply & Demand

Bitcoin and some other cryptocurrencies occupy a niche similar to gold — an asset that combines the qualities of a currency and a commodity. It can serve as a store of value or a means of exchange, and at the same time, Bitcoin is a scarce and deflationary asset, meaning its supply decreases over time rather than increasing, which can lead to an increase in value.

Bitcoin has a limited total supply of 21 million units. However, not all newer cryptocurrencies adhere to similar restrictions. Many don't have a hard cap and can be emitted indefinitely (e.g., Ether and Dogecoin). The teams behind some cryptocurrencies, like Binance Coin, periodically 'burn' or intentionally remove portions of their supply from circulation to control the inflation rate and keep the price high.

Given that Bitcoin and other cryptocurrencies are subject to intensive speculation, one of the largest factors driving their prices is traders' activity. The more people want to buy an asset, the higher the probability that its price will rise. If most people want to sell the asset, the asset's price will likely fall.

It's important to note that trading isn't the only driver of cryptocurrency prices. All the factors influencing fiat currency and stock prices are also relevant for cryptocurrencies, although the effects can differ. Political and social unrest, pandemics, scandals, and other factors shape the current state of cryptocurrency prices.

Certain factors that impact cryptocurrency prices are unique to the crypto market. The price gravity of Bitcoin is one of them. When the BTC price makes strong moves up or down, the rest of the crypto market tends to mirror these fluctuations. Traders anticipate the BTC price to rise every four years due to the BTC block reward halving. The halving is programmed to occur once every four years. After each halving, the miners will receive only half of the mining rewards for the same amount of work they did before the halving. To keep their business profitable, they will sell what they mine at higher prices. Coupled with the fact that the amount of bitcoins in the market will grow 50% slower, it creates a situation where new bitcoins become scarcer and more expensive. The same happens to other cryptocurrencies that can be mined and have a programmed halving (for instance, Litecoin).

Endorsements by celebrities or experts is another factor typical for the crypto market. When an influential individual speaks favorably about a specific crypto asset, its price tends to increase. As celebrities' opinions hold sway over thousands or even millions of people, any positive mention of a particular cryptocurrency can be interpreted as investment advice by a large number of individuals. Consequently, many people start buying this asset, and its price rises as a result.

One of the most notable examples is the meteoric rise of Dogecoin, triggered by tweets from Elon Musk. John McAfee also significantly influenced the prices of many cryptocurrencies. His favorable tweets about these currencies spurred his followers to purchase them. Later, he admitted that he had been paid to endorse these assets. That’s why XGo advises verifying all information for accuracy when dealing with financial matters.

Major brands that begin accepting payments in specific crypto assets impact these assets' prices in a similar way to endorsements by experts and celebrities.

Another factor exclusive to the crypto market is the prevalence of pump and dump groups. These social media groups are created by individuals seeking quick profits. They gather people and encourage them to start buying a cheap and little-known crypto asset simultaneously at a specified moment. This sudden spike in demand leads to a rapid increase in the asset's price. Then, at the specified moment, the group members start selling this asset. The price falls, while the group members enjoy some profit. By some estimates, the number of such schemes amounts to tens of thousands. You might have noticed that the mechanism behind pump and dump schemes is predicated on the laws of supply and demand.

Final Thoughts

The laws of supply and demand are so fundamental that they can be used to explain economic processes from past centuries to today's cryptocurrency markets. Each period or market segment may have its specific characteristics, but they don't negate the validity of these basic principles.