LAW OF DEMAND

Introduction
The law of demand expresses a relationship between the quantity
demanded and its price. It may be defined in Marshall’s words as “the
amount demanded increases with a fall in price, and diminishes with a
rise in price”. Thus, it expresses an inverse relation between price and
demand. The law refers to the direction in which quantity demanded changes
with a change in price. It is represented by the slope of the demand curve
which is normally negative. The inverse price- demand relationship is based
on other things remaining equal. This points towards certain important
assumptions on which this law is based. This law of demand expresses the
functional relationship between price and quantity demanded. The law of
demand or functional relationship between price and quantity demanded of a
commodity is one of the best known and most important laws of economic
theory.

Meaning of Law of Demand

According to the law of demand, other things being equal, if the price of
a commodity falls, the quantity demoded of it will rise, and if the price of the
commodity rises, its quantity demanded will decline.

Thus, according to the law of demand, there is inverse relationship

between price and quantity demanded, other things remaining the same
(“ceteris paribus”). These other things which are assumed to be constant are
the tastes and preferences of the consumer, the income of the consumer, and
the prices of related goods. If these other factors which determine demand
also undergo a change at the same time, then the inverse price-demand
relationship may not hold good Thus, the constancy of these other things
which is generally stated as ceteris paribus is an important qualification of
the law of demand.

Definitions of Law of Demand

❖ According to Prof. Samuelson "The law of demand states that people

will buy more at lower prices and buy less at higher prices, ceteris
paribus".
❖ According to Fergusion “The quantity demanded varies inversely with
price”
Assumptions of the Law of Demand

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

b) The income of the consumer remains constant

c) There is no change in customs

d) The commodity to be used should not confer distinction on the

consumer

e) There should not be any substitutes of the commodity

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

g) There should not be any possibility of change in the price of the product
being used

h) There should not be any change in the quality of the product and

i) The habits of the consumers should remain unchanged. Given these

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

Demand Schedule and Demand Curve

Given these assumptions, the law of demand is explained in terms of Table

3 and Figure 7.

i) Tabular Presentation

The above table shows that when the price of say, orange, is Rs. 5 per
unit, 100 units are demanded. If the price falls to Rs.4, the demand increases
to 200 units. Similarly, when the price declines to Re.1, the demand increases
to 600 units. On the contrary, as the price increases from Re. 1, the demand
continues to decline from 600 units.

ii) Diagrammatic Representation

In the figure, point P of the demand curve DD1 shows demand for 100
units at the Rs. 5. As the price falls to Rs. 4, Rs. 3, Rs. 2 and Re. 1, the
demand rises to 200, 300, 400 and 600 units respectively. This is clear from
points Q, R, S, and T. Thus, the demand curve DD1 shows increase in demand
of orange when its price falls. This indicates the inverse relation between price
and demand.

Reasons for the Law of Demand: why does demand curve slope
downward?

We have explained above that when price falls the quantity demanded
of a commodity rises and vice versa, other things remaining the same. It is
due to this law of demand that demand curve slopes downward to the right.
Now, the important question is why the demand curve slopes downward, or
in other words, why the law of demand which describes inverse price-demand
relationship is valid.

➢ Law of Diminishing Marginal Utility: the law was formulated by Alfred

Marshall and he states that as the consumer has more and more of a
good its marginal utility to him goes on declining. A consumer is not
interested in buying more units of the same commodity at the same
price. Instead, he is ready to pay a price equal to his marginal utility
and marginal utility goes on diminishing. In other words, he is willing
to pay a lesser price for more units of a good. This implies that demand
curve is downward sloping.
 ➢ Substitution Effect: when the price of a good rises, consumer feels
that relative prices of other goods have reduced, so the consumer
prefers to buy less quantity of the good whose price has risen.
➢ Income Effect: Increase in income means increase in the purchasing
power of the consumer. With fall in the price of a good, consumer’s real
income or purchasing power rises and he demands more units of the
good. Thus, when price falls, demand rises.
➢ New Consumers Creating Demand: as price of a commodity falls, new
consumer class appears, who can now afford the commodity. Thus, the
total demand for the commodity increases, i.e. with fall in price,
quantity demanded rises.
➢ Several Uses: Some commodities can be put to several uses which
leads to downward slope of the demand curve. When the prices of such
commodities go up, they will be used for important purposes, so their
demand will be limited. On other hand, when the price falls, the
commodity in question will extend its demand.
➢ Psychological Effects: When the price of a commodity falls, people
favour to buy more, which is natural and psychological. Therefore, the
demand increases with the fall in prices.

Exceptions to the Law of Demand

In certain cases, the demand curve slopes up from left to right, i.e., it
has a positive slope. Under certain circumstances, consumers buy more when
the price of a commodity rises, and less when price falls, as shown by the D
curve in Figure 8. Many causes are attributed to an upward sloping demand
curve.

i) Giffen Goods or Inferior Goods

One exception to the law of demand was pointed out by Sir Robert Giffen.
Sir Robert Giffen, a notable English Economist. who observed that when price
of bread increased, the low-paid British workers in the early 19th century
purchased more bread and not less of it and this is contrary to the law of
demand described above. These goods constitute very inferior goods which
are essential for a minimum living. The reason given for this is that these
British workers consumed a diet of mainly bread and when the price of bread
went up they were compelled to spend more on given quantity of bread.

Therefore, they could not afford to purchase as much meat as before. Thus,
they substituted even bread for meat in order to maintain their intake of food.
After the name of Robert Giffen, such goods in whose case there is a direct
price-demand relationship are called Giffen goods. It is important to note that
with the rise in the price of a Giffen good, its quantity demand increases and
with the fall in its price its quantity demanded decreases, the demand curve
will slope upward to the right and not downward.

ii) Goods having Prestige Value: Veblen Effect

Another exception to the law of demand is associated with the name of the
economist, Thorstein Veblen who propounded the doctrine of conspicuous
consumption. According to Veblen, some consumers measure the utility of a
commodity entirely by its price i.e., for them, the greater the price of a
commodity, the greater its utility.

For example, diamonds are considered as prestige good in the society and
for the upper strata of the society the higher the price of diamonds, the higher
the prestige value of them and therefore the greater utility or desirability of
them. In this case, some consumers will buy less of the diamonds at a lower
price because with the fall in price its prestige value goes down.

On the other hand, when price of diamonds goes up, their prestige value
goes up and therefore their utility or desirability increases. As a result at a
higher price the quantity demanded of diamonds by a consumer will rise. This
is called Veblen effect. Besides diamonds, other goods such as mink coats,
luxury cars have prestige value and Veblen effect works in their case too.

iii) War
If shortage is feared in anticipation of war, people may start buying for
building stocks or for hoarding even when the price rises.

iv) Depression
During a depression, the prices of commodities are very low and the
demand for them is also less. This is because of the lack of purchasing power
with consumers.
 v) Ignorance Effect
Consumers buy more at a higher price under the influence of the “igno-
rance effect”, where a commodity may be mistaken for some other commodity,
due to deceptive packing, label, etc.

vi) Speculation
Marshall mentions speculation as one of the important exceptions to
the downward sloping demand curve. According to him, the law of demand
does not apply to the demand in a campaign between groups of speculators.
When a group unloads a great quantity of a thing on to the market, the price
falls and the other group begins buying it. When it has raised the price of the
thing, it arranges to sell a great deal quietly. Thus, when price rises, demand
also increases.

vii) Necessities of Life

Normally, the law of demand does not apply on necessities of life such
as food, cloth etc. Even the price of these goods increases, the consumer does
not reduce their demand. Rather, he purchases them even the prices of these
goods increase often by reducing the demand for comfortable goods. This is
also a reason that the demand curve slopes upwards to the right.

Importance of the Law of Demand

The law of demand has great theoretical and practical importance in

economics are:

❖ Price Determination: The law of demand is useful to the monopolist to

fix the price of their product.
❖ Importance for the Consumer: The law tells that the fall in price, the
consumer will buy more and vice versa. Thus, the consumer maximises
his satisfaction.
❖ Importance to Finance Minister: While imposing the tax, he keeps in
mind the law of demand. He comes to know through law, the effect of
tax on amount demanded of various commodities. Moreover, he will
impose more taxes on commodities which have relatively inelastic
demand.
❖ Importance for Planning: The Planning Commission while framing the
plan keeps in mind not only the demand schedule but also the effect of
price on a commodity.
❖ Importance for Producers: The law provides guidelines to the producers
regarding the production of those goods whose prices have reduced. The
law is for the welfare of the producers to concentrate on the production
of those goods whose price have been reduced.