Law of demand

In economics, the law of demand is an economic law that states that consumers buy more of a good when its price decreases and less when its price increases (ceteris paribus). The greater the amount to be sold, the smaller the price at which it is offered must be, in order for it to find purchasers. Law of demand states that the amount demanded of a commodity and its price are inversely related, other things remaining constant. That is, if the income of the consumer, prices of the related goods, and tastes and preferences of the consumer remain unchanged, the consumers demand for the good will move opposite to the movement in the price of the good.

[edit] Mathematical expression

The negative relation (i.e., higher price attracts lower demand & lower prices encourages high quantity to be bought by the consumers) is based on logic and experience. Mathematically, the inverse relation may be stated with causal relation as: Qx = f(Px) Where, Qx is the quantity demanded of x goods f is the function of independent variables contained within the parenthesis, and Px is the price of x goods. Hence, in the above model, the function (f) is a varying one i.e., the law of demand postulates Px as the causal factor (independent variable) and Qx is the dependent variable. The two variables move in the opposite direction. When Px falls Qx rises and the reverse. In regard to the question "by how much will quantity demanded rise?", the law is silent. For example, when Px for a one-way rail ticket on the Acela Express from Boston's South Station to New York City's Penn Station falls from $111 to $105, ridership may rise from 1625 daily riders to 1825 daily riders or even to just 1626 daily riders. Thus the law of demand merely states the direction in which quantity demanded changes for a given change in price. Moreover, what the law states is hypothetical and not actual.

[edit] Assumptions
Every law will have limitation or exceptions. While expressing the law of demand, the assumptions that other conditions of demand were unchanged. If remain constant, the inverse relation may not hold well. In other words, it is assumed that the income and tastes of consumers and the prices of other commodities are constant. This law operates when the commoditys price changes and all other prices and conditions do not change. The main assumptions are Habits, tastes and fashions remain constant. Money, income of the consumer does not change. Prices of other goods remain constant. The commodity in question has no substitute or is not competed by other. The commodity is a normal good and has no prestige or status value. People do not expect changes in the prices.

[edit] Exceptions to the law of demand

Generally, the amount demanded of good increases with a decrease in price of the good and vice versa. In some cases, however, this may not be true. Such situations are explained below.

[edit] Giffen goods

As noted earlier, if there is an inferior good of which the positive income effect is greater than the negative substitution effect, the law of demand would not hold. For example, when the price of potatoes (which is the staple food of some poor families) decreases significantly, then a particular household may like to buy superior goods out of the savings which they can have now due to superior goods like cereals, fruits etc., not only from these savings but also by reducing the consumption of potatoes. Thus, a decrease in price of potatoes results in decrease in consumption of potatoes. Such basic good items (like bajra, barley, grain etc.) consumed in bulk by the poor families, generally fall in the category of Giffen goods. It should be noted that not all inferior goods are giffen goods, but all giffen goods are inferior goods.

[edit] Commodities which are used as status symbols

Some expensive commodities like diamonds, air conditioned cars, etc., are used as status symbols to display

ones wealth. The more expensive these commodities become, the higher their value as a status symbol and hence, the greater the demand for them. The amount demanded of these commodities increase with an increase in their price and decrease with a decrease in their price. Also known as a Veblen good.

[edit] Expectation of change in the price of commodity

If a household expects the price of a commodity to increase, it may start purchasing greater amount of the commodity even at the presently increased price. Similarly, if the household expects the price of the commodity to decrease, it may postpone its purchases. Thus, law of demand is violated in such cases. In the above circumstances, the demand curve does not slope down from left to right instead it presents a backward sloping from top right to down left. This curve is known as exceptional demand curve. Technically, this is not a violation of the law of demand, as it violates the ceteris paribus condition.

[edit] Law of demand and changes in demand

The law of demand states that, other things remaining same, the quantity demanded of a good increases when its price falls and vice-versa. Note that demand for goods changes as a consequence of changes in income, tastes etc. Hence, the demand may sometime expand or contract and increase or decrease. In this context, let us make a distinction between two different types of changes that affect quantity demanded, viz., expansion and contraction; and increase and decrease. While stating the law of demand i.e., while treating price as the causative factor, the relevant terms are Expansion and Contraction in demand. When demand is changing due to a price change alone, we should not say increase or decrease but expansion or contraction. If one of the non-price determinants of demand, such as the prices of other goods, income, etc. change & thereby demand changes, the relevant terms are increase and decrease in demand. The expansion and contraction in demand are shown in the diagram. You may observe that expansion and contraction are shown on a single DD curve. The changes (movements) take place along the given curve k.

[edit] Limitation
Change in taste or fashion. Change in income Change in other prices. Discovery of substitution. Anticipatory change in prices. Rare or distinction goods.[1] There are certain goods which do not follow this law. These include Veblen goods and Giffen goods. Demand curve is slope downward because of inverse relationship between price and quantity. The demand curve slopes downwards due to the following reasons (1) Substitution effect: When the price of a commodity falls, it becomes relatively cheaper than other substitute commodities. This induces the consumer to substitute the commodity whose price has fallen for other commodities, which have now become relatively expensive. As a result of this substitution effect, the quantity demanded of the commodity, whose price has fallen, rises. (2) Income effect: When the price of a commodity falls, the consumer can buy more quantity of the commodity with his given income, as a result of a fall in the price of the commodity, consumer's real income or purchasing power increases. This increase induces the consumer to buy more of that commodity. This is called income effect. (3) Number of consumers: When price of a commodity is relatively high, only few consumers can afford to buy it, And when its price falls, more numbers of consumers would start buying it because some of those who previously could not afford to buy may now afford to buy it, Thus, when the price of a commodity falls, the number of its consumers increases and this also tends to raise the market demand for the commodity. (4) various uses of a commodity (5) law of diminishing marginal utility It is assumed that if all thinngs remain constant once the price of a good decreases you buy more hence the reason for the negative slope dowards of the demand curve