The Law of Demand

The law of demand

The law of demand is one of the fundamental laws of economics. The law of demand states that the demand for a commodity increases when its price decreases and falls when its price rises, other things remaining constant. It explains the relationship between price and quantity demanded of a commodity. The law states that demand varies inversely with price, not necessarily proportionately.

According to Marshall, "The greater the amount to be sold, the smaller must be the price at which it is offered in order that it may find purchasers, or in other words, the amount demanded increases with a fall in price and diminishes with a rise in price".

This law is based on the law of diminishing marginal utility. The demand thus is a function of price and can be expressed as:

D = F(P)

D => Demand

F => Function

P => Price

Features of the Law of Demand

• There is an inverse relationship between price and quantity demanded
• Price is an independent variable and demand is a dependent variable.
• It is only a qualitative statement and does not indicate quantitative changes in price and demand.
• Generally, the demand curve slopes downwards from left to right.

Demand schedule

Demand schedule is a series of prices in descending (or) ascending order & the corresponding quantities which consumers would like to purchase per unit of time.

Demand-Curve

A demand curve is a locus of points showing various alternative price-quantity combinations. The graphical presentation of the demand schedule is known as the demand curve.

This curve represents the functional relationship between the quantity demanded and the price of a given commodity. The demand curve has a negative slope which goes downwards to the right. It clearly indicates that demand increases with the fall in price or vice-versa.

Why does a demand curve slope downwards?

A demand curve demonstrates the effect of a price change on the quantity demanded of a commodity. This is known as the price effect. The price effect is the sum total of Income effect and substitution effect.

Income effect: When the price of a commodity falls, other things remaining the same, the real income of the consumer increases. The increase in real income encourages the consumer to demand more of the goods. The increase in demand because of the increase in real income is known as the income effect.

Substitution effect: When the price of a commodity falls, prices of its substitutes remaining constant, then substitutes become relatively costlier. Since a utility-maximizing consumer substitutes cheaper goods for costlier ones, demand for the cheaper commodity increases. The increase in demand on account of this factor is known as the substitution effect.

Utility-Maximizing behavior: When a person buys a commodity, he exchanges his money income for the commodity in order to maximize his satisfaction. He continues to buy good and services so long as the marginal utility of his money is equal to the marginal utility of the commodity.

MUm = Pc = MUc

This is another reason why the demand for a commodity increases when its price decreases.

Assumptions of the law:

• No change in habits, customs, and income of consumers:
• No anticipation of price change in future
• No change in the price of related commodities
• No change in the size of the population
• No change in the taxation policy of the government
• No discovery substitutes.

Exceptions to the law of demand: 

When the demand curve slopes upwards from left to right, it is known as an exceptional demand curve. In other words. with a fall in price, demand also falls, and with a rise in price demand also rises.

Giffen Goods: Giffen goods are inferior goods, that are much cheaper than the superior substitutes. It is often consumed by the poor as an essential commodity. According to Sir Robert Giffen, "Demand is strengthened with a rise in price or weakened with a fall in price." He gave the example of poor people of Ireland who were using potatoes and meat as daily food articles. When the price of potatoes declined, customers instead of buying larger quantities of potatoes started buying more of meat [superior goods]. Thus, the demand for potatoes declined in spite of the fall in price.

Veblen's effect: American economist Thorstein Veblen contends that there are certain commodities that are purchased by rich people for their 'snob-appeal' or ostentation. Veblen's effect states that demand for prestigious goods, such as diamonds, precious stones, rare paintings, would go up with a rise in price and fall with a fall in price. Rich people buy such goods mainly because their prices are high and buy more of them when their prices move up.

The expectation of Price Change in Future: If people expect a continuous increase in price in the future, they buy more of it despite the increase in price with a view to avoiding a much higher price in the future.

Fear of shortage: When a serious shortage is anticipated, people get panic and buy more even though the price is rising.

          

Necessary Goods: People will buy basics need product such as medicines, sugar, or salt even irrespective of the increase in the price. The prices of these products do not affect their associated demand.

Emergency: In case of an emergency such as war, and natural calamity such as flood, drought, the law of demand will not be applicable.

Bandwagon Effect: When the consumer tries to purchase those commodities which are bought by his friends, relatives, or neighbors, irrespective of the price of the commodity, then the law of demand does not apply. For example, if the majority of group members have Mercedes then the consumer will also demand the Mercedes even if the prices are high.

Change in fashion, tastes and preferences: In the case of the change in fashion trends, tastes, and preferences of the consumers, the law of demand will not applicable.

Shift in Demand-Curve

If demand changes, not because of price changes but because of other factors or forces, then, in that case, there would be either increase or decrease in demand. If demand increases, there would be a forward shift in the demand curve to the right, and if demand decreases, then there would be a backward shift in the demand curve.

Demand increases due to a shift in the demand curve on account of some other factors, such as an increase in consumer's income, an increase in the price of substitutes, an increase in population, etc.. This kind of increase in demand results in an increase in revenue. However, in case the demand curve is made to shift through advertisement or other sales promotion devices, the additional demand isn't free of cost.

Increase & Decrease VS Extension & Contraction of Demand

An increase & decrease in demand is associated with non-price quantity relationships of demand while extension & contraction of demand are associated with the price-quantity relationship of demand.

Dr. Swati Gupta

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