Law of demand

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A graph, with quantity on the X-axis and price on the Y-axis. A red curve sloping downwards from left to right, labeled D, intersects a blue curve sloping upwards from left to right, labeled S. The D curve is shifting to the right.
A demand curve, shown in red and shifting to the right, demonstrating the inverse relationship between price and quantity demanded (the curve slopes downwards from left to right; higher prices reduce the quantity demanded).

In economics, the law states that, all else being equal, as the price of a product increases, quantity demanded falls; likewise, as the price of a product decreases, quantity demanded increases.

In other words, the law of demand states that the quantity demanded and the price of a commodity are inversely related, other things remaining constant. If the income of the consumer, prices of the related goods, and preferences of the consumer remain unchanged, then the change in quantity of good demanded by the consumer will be negatively correlated to the change in the price of the good.[1] There are, however, some possible exceptions to this rule (see Giffen goods and Veblen goods).

Mathematical expression[edit]

Mathematically, the inverse relationship may be expressed as a causal relation:

Q_x = f(P_x)
Where, Q_x is the quantity demanded of x goods
f is the function of independent variables contained within the parenthesis, and
P_x 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 P_x as the causal factor (independent variable) and Q_x as the dependent variable.

Graphical depiction[edit]

A demand curve is a graphical depiction that abides by the law of demand. It shows how the quantity demanded of some product during a specified period of time will change as the price of that product changes, holding all other determinants of the quantity demanded constant. Price is measured on the vertical axis and quantity demanded on the horizontal axis.

There are two important things to note about the demand curve:

  • It is downward sloping indicating that between the] price of a product and the quantity demanded a negative or inverse relationship exists. In other words, as the price declines the quantity demanded increases. This is indicated by a downward movement along the demand curve. An increase in price decreases the quantity demanded, and an upward movement along the demand curve occurs.
  • The movement along a given demand curve due to a change in price is referred to as "change in quantity demanded". As the price changes, the quantity demanded changes. The term "change in demand" refers to a shift of the demand curve because of factors other than price.

Assumptions[edit]

Every law will have limitations or exceptions. While expressing the law of demand, the assumption is that other factors of demand, except the price of a good, are unchanged. If they don't 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 related goods are constant. This law operates when the price of the good changes and all other non-price factors do not change.

The main assumptions are:

  • The function shows the relationship between Price and Quantity Demanded at a static time (t).
  • Habits, tastes and fashions remain same.
  • Income of the consumer does not change.
  • Prices of related goods remain constant.
  • Number of buyers remain constant.
  • The commodity is a normal good and has no prestige or status value.
  • People do not expect changes in the price.
  • Price is independent and quantity demanded is dependent.
  • income level should remain constant

Exceptions to the law of demand[edit]

Generally, the amount demanded of a 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 as in below.

Giffen goods[edit]

Initially discovered by [vasudeva], economists disagree on the existence of Giffen goods in the market. A Giffen good describes an inferior good that as the price increases, demand for the product increases. As an example, during the Irish Potato Famine of the 19th century, potatoes were considered one of Giffen good's. Potatoes were the largest staple in the Irish diet, so as the price rose it had a large impact on income. People responded by cutting out on luxury goods such as meat and vegetables, and instead bought more potatoes. Therefore, as the price of potatoes increased, so did the demand.[2] However, this change of demand did not mean movement along the demand curve, but rather a shift of the whole demand curve. What occurred was not an increase in demanded quantity due to increase in price (which would be a violation of law of demand), but rather, a change in the relationship between price and demanded quantity. Thus, the Giffen good confuses the change in demanded quantity with the change in the relationship between price and quantity. .

Veblen Goods[edit]

Some expensive commodities like diamonds, expensive cars, etc., are used as status symbols to display one’s 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.

Expectation of change in the price of commodity[edit]

If a household expects the price of a commodity to increase, it may start purchasing a 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, some argue that the law of demand is violated in such cases. In this case, the demand curve does not slope down from left to right; instead it presents a backward slope from the top right to down left. This curve is known as an exceptional demand curve. Technically, this is not a violation of the law of demand, as it violates the ceteris paribus condition.

The Law of Demand and Change in Demand[edit]

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, demand may 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 (which means movement along the curve of demand). When the 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 (which means shift of the demand curve to the right or to the left). 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 k.

Limitations[edit]

  • Change in taste or demand.
  • Change in income
  • Change in other prices.
  • Discovery of substitution.
  • Anticipatory change in prices.
  • Rare or distinction goods.[3]

There are certain goods which do not follow this law. These include Veblen goods and Giffen goods.

See also[edit]

References[edit]

  1. ^ http://www.investopedia.com/terms/l/lawofdemand.asp; Investopedia, Retrieved 9 September 2013
  2. ^ Mankiw, Gregory (2007). Principles of Economics. South-Western Cengage Learning. p. 470. ISBN 978-0-324-22472-6. 
  3. ^ Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey: Pearson Prentice Hall. p. 552. ISBN 0-13-063085-3.