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What is the Law of Demand?

The law of demand can be stated as, all other things remaining constant, the quantity demanded of a commodity decreases when its price increases and increases when the price decreases. The law implies that demand and price are inversely related. Marshall states the law of demand as ‘the amount demanded increases with a fall in price and diminishes with a rise in price’. This law holds under the ceteris paribus assumption that all other things remain unchanged.

The “all other things” that need to be equal under ceteris paribus are the other determinants of demand. These are prices of related goods or services, income, tastes or preferences, and expectations. For aggregate demand, the number of buyers in the market is also a determinant.

The Demand Schedule

The demand schedule is a tabular presentation of different prices of a commodity and its corresponding quantities demanded per unit of time.

The Demand Curve

The demand curve is the graphical presentation of the demand schedule. It is obtained by plotting a demand schedule. Quantity demanded is plotted on the x-axis and prices are plotted on the y-axis. The demand curve is downward sloping showing an inverse relation between prices and quantity demanded.

Figure 1: Demand Schedule and Curve

Causes of Downward Sloping of Demand Curve

  • Law of diminishing marginal utility
  • Substitution effect
  • Income effect
  • New buyers
  • Old buyers
1. Law of diminishing marginal utility

The law of diminishing marginal utility states that with each increasing quantity of the commodity, its marginal utility declines. For example, when a person is very hungry the first chapatti that he eats will give him the most satisfaction. As he will consume more chapattis, his level of satisfaction will diminish.

Thus, when the quantity of goods is more, the marginal utility of the commodity is less. Thus, the consumer is not willing to pay more price for the commodity and he will be ready to buy more goods only at lesser prices. Hence, the demand curve slopes downwards from left to right.

2. Substitution effect

When the price of a good falls, it becomes relatively cheaper than the other goods. It induces the consumer to substitute the commodity whose price has fallen for other commodities which have now become relatively dearer. Let us understand this with an example. Tea and coffee are substitute goods. If the price of tea falls, consumers will substitute tea for coffee. This will decrease the demand for coffee and increase the demand for te. Thus, the demand curve of tea will slope downwards.

3. Income effect

The income effect refers to the change in the real income or the purchasing power of the consumers. When the price of a commodity falls the purchasing power of the consumer increases and he buys more goods. Similarly, when the price level rises, the purchasing power of the consumer decreases, and he buys less quantity of goods.

4. New and Old buyers

Due to the fall in the price of a commodity new buyers get attracted to it and buy it. Thus, this increases the demand for the commodity. Similarly, with the fall in prices, the old buyers tend to buy more goods than usual thereby increasing their demand. This causes the downward sloping of the demand curve.

Exceptions to the Law of Demand

Note that the law of demand holds true in most cases. The price keeps fluctuating until an equilibrium is created. However, there are some exceptions to the law of demand. These include the Giffen goods, Veblen goods, possible price changes, and essential goods. Let us discuss these exceptions in detail.

1. Giffen Goods

Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are goods that are inferior in comparison to luxury goods. However, the unique characteristic of Giffen goods is that as its price increases, the demand also increases. And this feature is what makes it an exception to the law of demand.

The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a staple diet of Irish people. During the potato famine, when the price of potatoes increased, people spent less on luxury foods such as meat and bought more potatoes to stick to their diet. So as the price of potatoes increased, so did the demand, which is a complete reversal of the law of demand.

2. Veblen Goods

The second exception to the law of demand is the concept of Veblen goods. Veblen Goods is a concept that is named after the economist Thorstein Veblen, who introduced the theory of “conspicuous consumption“. According to Veblen, there are certain goods that become more valuable as their price increases. If a product is expensive, then its value and utility are perceived to be more, and hence the demand for that product increases.

And this happens mostly with precious metals and stones such as gold and diamonds and luxury cars such as Rolls-Royce. As the price of these goods increases, their demand also increases because these products then become a status symbol.

3. The expectation of Price Change

In addition to Giffen and Veblen goods, another exception to the law of demand is the expectation of price change. There are times when the price of a product increases and market conditions are such that the product may get more expensive. In such cases, consumers may buy more of these products before the price increases any further. Consequently, when the price drops or may be expected to drop further, consumers might postpone the purchase to avail of the benefits of a lower price.

For instance, in recent times, the price of onions had increased to quite an extent. Consumers started buying and storing more onions fearing further price rise, which resulted in increased demand. There are also times when consumers may buy and store commodities due to a fear of shortage. Therefore, even if the price of a product increases, its associated demand may also increase as the product may be taken off the shelf or it might cease to exist in the market.

4. Necessary Goods and Services

Another exception to the law of demand is necessary or basic goods. People will continue to buy necessities such as medicines or basic staples such as sugar or salt even if the price increases. The prices of these products do not affect their associated demand.

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