The definition of a "new" car is one that has not yet had the title issued to a buyer. There is no real limit to how many miles it can have on it and still be considered "new" for the purposes of financing, registration, etc.
On the other hand, there are certainly practical considerations when the dealer tries to sell a car with miles on it as "new." If you have a choice of this car with 700 miles on it or the exact same car in a different color with only 12 miles on it, which one is worth more? The answer is that it depends on how much you want this particular car and how much you are willing to pay for it, even with the miles on it.
In terms of your purchase, it really does not matter whether it was a dealer "demo" (which usually means that one of the managers was driving it) versus a "tester" (which would usually refer to the only car of a certain model that is kept on the lot for test drives until more show up). The fact remains that it is not yet "used" in the sense that it was sold and titled.
Once a car is "used," the dealer can buy it back after the initial depreciation hit. That means that, depending on the vehicle, the car might have dropped $2,000 in value or $10,000 in value. The dealer pays less for it because it is worth siginifcantly less than a brand new one.
For the car you are looking at, the dealer still owns it at the original invoice price. It does not matter to him that there are miles on it. His cost for the vehicle has not changed (although a couple of manufacturers do give dealers allowances for demos). Therefore, he still wants to sell it at or above his net cost, which is going to be significantly higher than his cost would be if he had bought the car used.
The way that dealers usually make up for the miles on a "demo" car is that they sell it for less than one with no miles on it. In these times, however, almost every dealer is selling almost every car at a low price. It is likely that the dealer (or another one down the road) would give you the same deal on a car with no miles as he will with this one.
At this point, it's up to you if you want this particular car or one with fewer miles. If there is not another one like this one around, you have a choice to make. For most new cars, the dealer should be able to find you one with fewer miles and still give you a great deal. If the dealer refuses to look for another car with fewer miles, try a different dealer.