What is a demand letter?

A demand letter is simply a request. It has no legal bearing. If the demand letter is ignored, a lawsuit could be filed. The lawsuit would have legal bearing if successful. 

A demand letter is just a simple written statement that you want somebody to pay $X, or you will sue. It gives the other side a choice, it might start a negotiation. Almost always, you have to send a demand letter before you can start a lawsuit.

A demand letter is *much* cheaper than a lawsuit. You can write one yourself (not recommended, unless maybe you're planning a small claims case). Most lawyers will do one for a few hundred dollars, or even less.

Be *very* careful not to put anything slanderous in the letter, just cold hard objective relevant provable facts. You might think that the other guy is a liar and a thief, but your suing him for damaging your bicycle, not for lying about it.

The only way to sue someone is via lawsuit.  The demand letter is a step in that process, showing you have made efforts to collect prior to litigation.

No.  A demand letter is you telling them that they need to pay you or you are going to sue.  In most states you have to send one before you can file.

A demand letter, is just what it states, it is demanding an action and often don't to make sure the person recieving it knows exactly what is expected BEFORE court/legal action