Law of demand

The law of demand expresses a relationship between the quantity demanded and its price. It depicts an inverse relationship between price and demand.

STATEMENT OF LAW

According to Marshall," The amount demanded increases with a fall in price, and diminishes with a rise in price."

Prof. Samuelson writes," Law of Demand states that people will buy more at lower prices and buy less at higher prices, other things remaining the same."

ASSUMPTIONS

The assumptions of the law are as under:-

1) There is no change in the tastes and preferences of the consumer.

2) The income of the consumer remains constant.

3) There is no change in customs.

4) There should not be any substitutes of the commodity.

5) There should not be any change in the prices of other products.

6) There should not be any change in the quality of the product.

7) The habits of the consumer should remain unchanged.

Given these assumptions, the law of demand operates. If there is change even in one of these conditions, it will stop operating.

EXPLANATION

Same explanation as in individual demand schedule and demand curve.

REASONS FOR THE LAW OF DEMAND/ CAUSES FOR DOWNWARD SLOPING OF DEMAND CURVE

Why does the law of demand apply? Why is the demand curve negatively sloped? There are some reasons given for the inverse relationship between price and amount demanded in case of ordinary commodities.

(1) PRICE EFFECT:- As we know price is inversely related to demand of a commodity. Thus, due to the price effect when consumers consume more or less of the commodity, the demand curve slopes downward.

(2) LAW OF DIMINISHING MU:- Diminishing MU for the consumer in case of the commodity is the fundamental cause of the law of demand. As the price of the commodity falls, consumer purchases more of the commodity so that his Marginal Utility from the commodity also falls to equal the reduced price. If the price rises, opposite happens.

(3) SUBSTITUTION EFFECT:- When the price of a commodity falls, it becomes cheaper as compared to the other commodities which the consumer is purchasing. As a result the consumer would like to substitute this cheaper commodity for other commodities whose prices remain the same. This is again a major cause for law of demand.

(4) INCOME EFFECT:- Another cause behind the law of demand is known as income effect. As the price of a commodity is reduced, the consumer has to spend less amount of money income for the same amount of the commodity. This may be taken to be a rise in his real income. Thus, when the price falls, amount demanded rises and vice-versa.

(5) DIFFERENT USES OF THE COMMODITY:- Commodities have many uses. If their price rises, they are used only for the more important purposes. As a result their demand will go down. On the contrary, when the price is reduced, the commodity will be put to many other uses and its demand will go up.

(6) DIFFERENT INCOME GROUPS:- The downward sloping demand curve depends upon the low income groups. Ordinary people buy more when price falls and vice-versa. The rich people do not have any affect of price.

EXCEPTIONS TO THE LAW OF DEMAND

 There are certain situations where the law of demand does not apply or becomes ineffective, i.e. with a fall in the price the demand falls and with the rise in price the demand rises are called as the exceptions to the law of demand.

1) Emergencies: During emergencies such as war, natural calamity- flood, drought, earthquake, etc., the law of demand becomes ineffective. In such situations, people often fear the shortage of the essentials and hence demand more goods and services even at higher prices.

2) Ignorance: Often people are misconceived as high-priced commodities are better than the low-priced commodities and rest their purchase decision on such a notion. They buy those commodities whose price are relatively higher than the substitutes.

3) Speculative Demand: In a speculative market (such as the stock market), a rise in the price of a commodity (such as, share) creates an impression among buyers that its price will rise further. So people start buying more of a share when its price rises.

4) Giffen Paradox:- If a commodity happens to be a neccesity of life like wheat and its price goes up, consumers are forced to curtail the consumption of more expensive foods like meat, fish and wheat being still the cheapest food they will consume more of it. In the case of an underdeveloped economy, with the fall in the price of an inferior commodity like maize, consumers will start consuming more of the superior commodity like wheat. As a result, the demand for maize will fall. This is what Marshall called the GIFFEN PARADOX which makes the demand curve to have a positive slope.

5) Demonstration Effect:- If consumers are affected by the principle of Conspicuous Consumption or Demonstration Effect, they will like to buy more of those commodities which confer distinction on the possessor, when their prices rise. On the other hand, with the fall in the prices of such articles, their demand falls, as is the case with diamonds.

IMPORTANCE OF THE LAW

(i) Determination of price. The study of law of demand is helpful for a trader to fix the price of a commodity. He knows how much demand will fall by increase in price to a particular level and how much it will rise by decrease in price of the commodity. The schedule of market demand can provide the information about total market demand at different prices. It helps the management in deciding whether how much increase or decrease in the price of commodity is desirable.

(ii) Importance to Finance Minister. The study of this law is of great advantage to the finance minister. If by raising the tax the price increases to such an extend than the demand is reduced considerably. And then it is of no use to raise the tax, because revenue will almost remain the same. The tax will be levied at a higher rate only on those goods whose demand is not likely to fall substantially with the increase in price.
 

(iii) Importance to the Farmers. Goods or bad crop affects the economic condition of the farmers. If a goods crop fails to increase the demand, the price of the crop will fall heavily. The farmer will have no advantage of the good crop and vice-versa.

Summing up we can say that the limitations or exceptions of the law of demand stated above do not falsify the general law. It must operate.