Law of Demand

The law of demand states that the demand is inversely related to price other things remaining constant (ceteris paribus). It means if price raises demand contracts or decreases and if price diminishes demand expands or increases. The law of demand operates only if factors determining demand other than prices are constant. It means prices of complementary goods, substitutes, income, taste of consumer, population, advertisement etc should be constant.

Law of demand can be explained with the help of demand schedule and demand curve as following

Price( in Rs) Demand(per week)
10 400
15 300
20 200

Let the initial price Rs 10 per kg and demand be 400 kg per week. If the prices raise to Rs 15 the consumer s reduce their demand. In above table demand is at 300 kg/week when price is Rs 15. If the price further raises to Rs 20 the demand further decreases to 200kg/week. It shows that demand changes inversely to the change in price when other things remain constant. If we represent the table in figure then we obtain a downwardly sloped demand curve as shown below

 

 

law of demand

In the above figure the demand curve is downwardly sloped. It shows that demand decreases with rise in price and increases with fall in price.

Assumptions

        1. Price of related goods is constant
        2. Income and taste of consumers are constant
        3. Size of population is constant
        4. There is no change in taxes and advertisement, money supply and government expenditure.

 

Limitation/ exception of law of demand

  1. Goods of prestige: Demand for goods of prestige like gold, demand may not decrease even there is rise in price. They are purchased and consumed because of their heavy prices.
  2. Goods of hobbies: The law of demand does not hold in case of goods of hobbies like collection, ticket collection, and collection of historical and archaeological materials and so on. The things are collected even paying more and more amount
  3. Goods of addiction: in case of goods and addiction like alcohol, tobacco, drugs etc the demand does not decrease even there is increase in price. Instead of operation of law of demand consumers purchase more units even if there is rise in price.
  4. Giffen goods: Demand for giffen goods increase even there is rise in price and vice versa. The law of demand isn’t applicable to them. The goods which are both basic and inferior are geffen goods.
  5. Goods of tradition: The goods consumed according to tradition, culture and religion have demand usually not inversely related to price. For example, during dashain the Nepalese people purchase more goods to celebrate the festival even if prices are increased.
  6. Future expected price: If the consumers expect fall in price in near future, they do not purchase more right now even if there is fall in price currently and vice versa.
  7. Future availability: If the consumers have fear of shortage of commodity in near future, they purchase more and keep the stock even if price has been higher. But if they expect greater availability of goods in the near future, they purchase less quantity even price has been decreased.
  8. Change in taste and preference: If the consumers have the fear of the goods out of fashion in near future, they demand less even if prices are decreased.
  9. Irrationality: Law of demand does not operate in case of irrational consumers. The unscrupulous consumers spend the money not according to satisfaction from the goods.

 

Why does demand law operate?

Why does demand curve slopes downward?

Why does demand vary inversely with price?

  1. Diminishing marginal utility: According to Gossen, of a consumer goes on consuming more units of same commodity without time gap, marginal utility diminishes. It means 2nd unit gives less utility or satisfaction than 1st unit, 3rd gives less than 2nd and so on. Therefore, the consumer demands more only if prices are reduced.
  2. Real income effect: if price falls real income increases even if the money is constant. Therefore, consumers demand more. If the price rises, real income falls even if money income is constant. Therefore, consumers demand less.
  3. Substitution effect: if a commodity becomes cheaper the commodity is substituted for other substituting goods. If the commodity becomes expensive, it is substituted by other substitutes.
  4. No. of uses: If the price falls, the commodity is used for least important purposes too. That’s why demand increases. If price rises, the commodity is used only for important purposes. That’s why demand decreases.
  5. No. of consumers: If price falls, the consumers who were unable to purchase the commodity because of high price, will also be able to consume the commodity. That’s why demand increases and vice versa.
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