Law of Demand

Key Highlights

• The Law of Demand states that as the price of a good or service increases, its demand decreases. It highlights an inverse relationship between price and quantity demanded, based on consumer behavior.
• The law assumes consumers prefer lower prices, preferences remain stable, substitutes are available, and consumers have perfect information.
• Some goods, like Giffen goods (where demand increases as price rises),
  Veblen goods (luxury items where higher prices increase desirability), essential goods, speculative demand, and products perceived as higher quality at a higher price, may not follow the law.

What is Law of Demand?

The Law of Demand states that, as the price of a good or service increases, its demand decreases. This law is based on consumer behavior whereby people prefer to purchase more of a good when its price is lower and less when its price is higher. In other words, the Law of Demand states that there is an inverse relationship between price and the quantity demanded.

Assumptions of law of demand

The law of demand states that, all other things being equal, the quantity demanded of a good and services is inversely related to its price. This is one of the most foundational principles in economics, based on a few key assumptions:

1. Consumer Preference for Lower Prices: When the price of a certain commodity is low, consumers tend to buy more, and when a cheaper alternative is available, they would always go for it.

2. Stable Consumer Preferences: This assumes that tastes and incomes do not change over time. This means that usually, changes in demand are due to a change in price and not because of changes in tastes and income.

3. Availability of Substitutes: It assumes that most products have good substitutes. If a product has few or no substitutes, people may still buy the product in case the price rises.

4. Perfect Information: It is also assumed that consumers have full information regarding the availability of commodities and the prices prevailing so that their choices are better informed.

Exception of law of demand

The law of demand states that, all else being equal, when the price of a good or service decreases, the quantity demanded increases, and vice versa. There are some exceptions:

1. Giffen Goods: These are inferior goods whose demand increases with a rise in the price. This is attributed to the income effect over the substitution effect. If the price of bread becomes high, poor consumers end up buying more bread instead of switching to alternatives that are relatively pricier.

2. Veblen Goods: These are goods which have a higher price; due to the status symbol attached, they become desirable at that price. So with the increase in the price of a Veblen good, demand could rise too as people want to show off their wealth.

3. Essential Goods: There may be certain essentials like drugs or foodstuff, which could experience a stable demand regardless of price since customers require them, regardless of the price charged.

4. Speculative Demand: At times, demand may go up if consumers expect that prices are going to rise in the future. Example, if people expect that the price of a stock is going to rise, they may buy more now even if the price is high.

5. Quality Perception: If consumers believe that a higher price goes with better quality, then they may demand more of a product as its price increases.

Implications of the Law of Demand

The Law of Demand has various implications on businesses, producers, and consumers.

For Businesses: Companies should be aware of how changes in prices can affect the consumer's demand and ability to sell their products.

For Consumers: This law allows them to make smart purchasing decisions since they can consider both the quality and prices when deciding on what goods or services they ought to buy.

For Producers: This law can be used by producers to maximize their profits by setting prices at an optimum level which balances satisfying customer demand while still providing sufficient profits.