Looking at standard texts on economics, demand refers to the willingness and ability of consumers to buy a given amount of a good or a service at a particular price. The quantity demanded depends on several factors, the most important being the product’s price.
However, when we look at the demand side of an asset, we have to realize that the demand curve isn’t always a linear curve. Often, we actually try to get an idea of the elasticity of demand. In economics, price elasticity is a measure used to show how the quantity demanded changes in response to a change in price. When we want to value an asset, we should try to find out how badly the market needs or wants that asset.
There are several ways in which the demanded quantity for an asset can change. As mentioned previously, the most obvious one is price. There are, however, also other factors that have an influence on demand but we will not go into all of them. For the purpose of this course, we will again divide these factors into bottom-up factors and top-down factors.
Bottom-up factors have more to do with the product or the asset itself. Examples of this are the quality of the product and the availability and price of certain substitutes and complements for the product. Another important factor for the elasticity of demand has to do with the extent to which a good is viewed as necessary or optional. The more the good is seen as being necessary, the less elastic its demand is likely to be. The more optional a product is, the more elastic its demand is likely to be.
An example of a commodity that people historically couldn’t live without is salt. Salt was used for both consumption and commercial. For example, meat preservation. Since people always had a demand for salt, relatively independent of the price of salt, we say that salt has a very ‘inelastic’ demand curve. It doesn’t matter too much what the supply or price of salt is, the demand will stay relatively constant, driving the price up.
The next category are the top-down factors, these are often (socio-economic) trends within societies that can greatly affect (short term) demand for assets. These include things such as a change in income levels or a change in the tastes and preferences of consumers.
A great example of this is the influence of the Atkins diet on the demand for meat and carbohydrates. Due to the low-carb and high-protein Atkins diet, the demand for meat went through the roof and the demand for carbohydrates totally collapsed. However, when Mr. Atkins died at the age of 73, the people threw away the diet the next day. The next business day, meat prices locked limit down while the prices for oranges locked limit up. This is a great example of how the movement of a large group of people in one particular direction can greatly influence the supply-demand dynamics.
When considering this information on supply and demand, try to think about how this applies to the assets that you are interested in. In the case of cryptocurrencies, why do people want them? What makes bitcoin so interesting to people? Is it for example that it might protect their purchasing power due to the monetary policy of the central banks (a top-down factor)? At the same time, developers are constantly creating new coins. Are these new coins better alternatives to bitcoin (a bottom-up factor)? And why?
Think about these kinds of questions when thinking about any type of non-equity investment!