Demand refers to both the willingness and the ability of customers to pay a given price to buy a good or service.

Effective demand

This is sometimes referred to as effective demand to distinguish genuine demand from want or a desire to buy something.

For example, a million households might wish that they owned a luxury yacht, but there might only be actual attempts to buy 100 luxury yachts at a given price. Economic demand needs to be effective.

Law of demand

When the price of a good rises, the quantity demanded will fall. This relationship is known as the law of demand.

There are two reasons for this law:

The income effect

People will feel poorer following a rise in the price of a good. They will not be able to afford to buy so much of the good with their money. The purchasing power of their income (their real income) has fallen. This is called the income effect of a price rise.

The substitution effect

Following a rise in price, a good will now cost more than alternative or ‘substitute’ goods, and people will switch to these. This is called the substitution effect of a price rise.