Demand-side Economics

Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services.

Understanding demand side economics

Demand side economics was developed by British economist John Maynard Keynes who described the theory in his 1936 book The General Theory of Employment, Interest and Money. For this reason, the theory is also known as Keynesian economics.

Keynes posited that economic growth was driven by effective demand, or the demand for products and services.

He also believed that consumer spending led to business expansion and in turn, to more employment opportunities.

More employment then creates a multiplier effect that further increases demand and thus economic growth

This idea contradicts those espoused by classic and supply-side economists who argue that demand is driven by the production and supply of goods and services.

Demand side economics and the Great Depression

Keynes refined his theory in response to the Great Depression in the 1930s. Classical economists of the time believed that economic balance would ultimately be restored via market supply and demand forces.

However, this did not prove to be the case.

In the aftermath of the stock market crash, the market failed to return to equilibrium and many remained unemployed.

Classical economic theory could not explain this outcome, but Keynes was quick to point out that demand – not supply – was the driver of economic growth. Workers were unemployed and factories sat idle because there was no demand for products.

Keynes then noted that government intervention was necessary to promote growth and restore market equilibrium.

In the process, he established a new school of thought in economics that focused on demand and lives on in various forms today.

Government intervention using demand side economics

Governments can intervene by:

  • Lowering interest rates – this makes it easier for consumers to pay off debt and increases discretionary income/spending.
  • Public works and infrastructure projects – these are popular options because they tend to deliver superior ROI over time. 
  • Tax cuts – where lower to middle-class individuals receive tax cuts in preference to wealthier taxpayers. For example, the Earned Income Tax Credit (EITC) was a critical part of the Obama administration’s response to the 2008 GFC.

These measures push more money into the market and increase the buying capacity of consumers.

In response, factories and other producers are encouraged to create more goods which increases employment.

Lowering interest rates is particularly effective because it determines liquidity preference, or the desire for consumers to spend or save money.

Demand-side economics favors monetary expansion which causes interest rates to decrease, which makes it more attractive for individuals and businesses to borrow money and stimulate the economy further.

Key takeaways:

  • Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services. The theory was developed by British economist John Maynard Keynes in the 1930s.
  • Keynes refined his theory in response to the Great Depression in the 1930s as classical economists failed to explain why the market and employment levels did not rebound after the 1929 crash.
  • Governments can intervene using demand side economics by funding infrastructure projects, implementing low and middle-class tax cuts, and lowering interest rates.

Connected Business Concepts

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Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall business model.

Pricing Strategies

A pricing strategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long term financial sustainability to build a solid business model.

Dynamic Pricing


Price Sensitivity

Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Ceiling

A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Price Elasticity

Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

Economies of Scale

In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

Negative Network Effects

In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

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