The law of demand explains consumer decision-making in response to price changes. When a product’s price increases, there is less demand for it in the market, assuming other factors that affect demand remain constant. This occurs due to consumers’ reluctance to spend more money because they are concerned about running out of money. But how does this affect other aspects of commerce and business? In this article, we are explaining the law of demand and how it works.
What is the Law of Demand?
The law of demand is based on economics as a discipline. When all other parameters are fixed, an inverse relationship exists between the prices of the goods or services and the required quantity. In other words, as a product’s price increases, demand for it will reduce, and vice versa; when its price goes down, demand will rise.
According to the law of demand, the quantity bought varies inversely with the price. In other words, the quantity demanded decreases as the price increases. This often occurs because of declining marginal utility.
This means that consumers utilize the initial units of an economic good they buy to fulfill their most pressing requirements first, and then they use each additional unit to fulfill progressively lower-valued goals.
Understanding of the Law of Demand
Economics studies how people use scarce resources to satiate endless demands. These limitless wants are the focus of the law of demand. In their economic behaviour, people naturally prioritize more urgent wants and requirements above less urgent ones. This habit also extends to how people choose among the limited means. For any economic good, a consumer will typically use the first unit they can get their hands on to take care of the most pressing need they have that the good can meet.
Facts about the Law of Demand
#1. One-Side
The Law of Demand is biased since it primarily discusses how price changes affect changes in the amount wanted of a good, not how changes in quantity demanded of a good affect changes in its price.
#2. Relative Inverse
According to the Law of Demand, the price and quantity of a good are inversely related to one another. In other words, if a commodity’s price increases, the demand will decrease; if its price decreases, the quantity demanded will increase.
#3. Quantitative rather than qualitative
Only a qualitative statement, not a quantitative one, is made by the Law of Demand. In other words, it does not reflect the degree of change but rather the direction of change in the quantity requested.
#4. There Is No Proportional Relation
The Law of Demand does not indicate a proportional relationship between a commodity’s price and demand change. It implies that if a commodity’s price decreases by 10%, the increase in demand could be 20%, 30%, or any other percentage.
Examples of the Demand Law
The real-world application of the law of demand may be seen in how demand varies for a particular thing when a product’s price changes
#1. Price Declines, Demand Rises
Apples are normally sold at a grocery shop for $1 each. They plan to hold a sale and reduce the cost of apples to fifty cents for one day. According to the law of demand, those who wouldn’t typically purchase apples at the higher price would do so if the price was lower.
#2. Price Increases, Demand Declines
A vehicle dealership decides to increase the price of trucks to increase sales profits. According to the law of supply and demand, fewer people will purchase trucks at this new, higher price point.
#3. Price Constant, Demand Constant
A coffee business tried a variety of price points for its coffee and discovered that it makes the most money by selling a cup for $1 apiece, with demand staying high at that price. Both the cost and the demand for their coffee cup are unchanged.
Exceptions to the Demand Law
#1. Giffen Products
Giffen Goods are a specific category of subpar goods on which customers spend a significant portion of their income. The demand for these products rises as the price rises and reduces as the price declines. Giffen’s Paradox, first noticed by Sir Robert Giffen, is a well-known name for this occurrence. For instance, wheat is a typical product, whereas rice is a subpar food. As a result, if rice prices decrease, consumers will start purchasing more wheat instead of rice.
#2. Fear of Shortage
If customers believe that a commodity will become scarce soon, they will begin purchasing more of it now, even if the price is higher, out of concern for its future scarcity and price increase. For instance, during the early stages of COVID, consumers increased their demand for basic commodities like wheat and pulses, even at higher prices, out of concern for impending shortages and general uncertainty.
#3. Status Symbol or Goods of Ostentation
Goods that individuals employ as status symbols are another exception to the law of demand. For instance, people purchase items like ancient paintings to uphold their status symbol. Only because they are expensive do they seek antique paintings. In other words, if the cost of ancient paintings drops, people will stop viewing them as status symbols, lowering their demand.
Even when expensive, they are more in demand. Customers will purchase a particular mobile phone model, for instance, if it is fashionable, even if the cost increases.
#5. Ignorance
Customers are occasionally uninformed about the going rate for a product on the market. In such situations, they purchase more of a good or service, albeit at a higher cost.
#6. Life’s Basic Needs
Regardless of price changes, goods essential to human survival are in greater demand. For instance, even if their prices rise, demand for essential items like wheat, beans, and medications will rise.
#7. Weather Change
Despite price rises, demand for some commodities fluctuates when the weather changes. For instance, even though their price increases during the rainy season, raincoat demand rises.
What is an Easy Way to Explain the Law of Demand?
Given a finite supply, the law of demand states that if more people want to buy something, the price will rise; conversely, the higher the price of a good, the lesser the amount customers buy.
What Makes the Law of Demand Crucial?
Together with the law of supply, the law of demand enables us to comprehend why prices are established at the levels they are and to spot chances to purchase or sell products, commodities, or securities that appear to be overvalued (or to sell those that are believed to be underpriced). For instance, a company might increase output in reaction to price increases brought on by increased demand.
Can the Demand Legislation be Disregarded?
Yes. A rise in demand occasionally unexpectedly affects pricing inconsistent with the rule of demand. For instance, because they are viewed as status symbols, so-called Veblen products are items whose demand rises as their price does. Like Veblen products, demand for Giffen goods—not luxury items—increases when prices rise and decreases when prices decline. Giffen products can include things like wheat, rice, and bread. These are typically popular necessities and essentials that are hard to replace at comparable prices. As a result, even when the price of toilet paper rises, people may begin to stockpile it.
Pros and Cons of the Law of Demand
The rule of demand and supply is one of the key theories that underpin the analysis and calculation of micro and macroeconomic variables, but there are a few advantages and restrictions to it that will become obvious from the following discussion.
Pros
The law of demand offers opportunity to traders, consumers, and other linked parties, among other advantages. Here are a few of the benefits:
- It assists the party selling various things in setting the prices of their sold goods. It will inform them of the effects on the quantity their clients demand if they increase or lower demand pricing.
- The study of the law of demand in economics is particularly important to the finance minister of every nation since changes in tax rates affect the prices of various goods, which in turn affects consumer demand for those goods.
Cons
The following are some of the several restrictions and downsides of the law of demand in economics:
- They don’t apply in every circumstance. In situations like war, depression, the Giffen paradox, speculation, the ignorance effect, and the need for basic requirements. For instance, if a war is anticipated, people would begin purchasing the supplies they need and storing them for use when the war breaks out, even if the cost of those items keeps rising. As a result, this is an exception to the law of demand since, even though the prices of the items would rise, they would still need them during a time of war.
- There are demand law presumptions. The law of demand will not apply in certain circumstances if assumptions are false.
Causes of the Law of Demand
Because of the following factors, a buyer purchases more of a product when its price is lower than its higher price:
#1. The Law of Diminishing Marginal Utility
Asserts that when more and more units of a good are used, the consumer’s utility from each additional unit keeps dropping. It implies that a commodity’s utility determines its demand. As a result, if a product gives a customer greater satisfaction, the consumer will be willing to pay more for it, but not at the same price for additional units. Therefore, the consumer will only purchase more of the good when its price decreases.
#2. Substitution Effect
Substitution replaces one commodity with another when the former becomes comparably less expensive. In other words, when a commodity’s price decreases—let’s say the price of coffee—it becomes relatively cheaper than its equivalent—let’s say the price of tea—assuming that the price of the alternative (tea) does not change as a result of rising demand for the provided commodity (coffee).
#3. Income Effect
The demand for a certain commodity is impacted when the consumer’s real income changes due to a change in the commodity’s price. The term “Income Effect” refers to this impact on demand. In other words, a decrease in the price of a specific commodity raises the consumer’s purchasing power, which in turn enhances their capacity to purchase more of it. As an illustration, Sayeba has Rs 100 in her pocket and uses it to purchase 10 ice creams at Rs 10. Now, if the cost of the ice cream drops to Rs 5 a serving, her purchasing power will improve, and she will be able to purchase 20 servings with her pocket money.
#4. More Customers
When a commodity’s price drops, some new customers who were previously unable to acquire it because of its high cost can now do so. Along with attracting new clients, the commodity’s current and past clients will demand more due to the price decrease. For instance, if pizza prices drop from Rs 200 to Rs 150, many new customers who couldn’t previously afford it can now buy it due to the price reduction. Additionally, since existing customers can now order more pizza, its overall demand will rise.
#5: Various Uses
A few uses for certain commodities are more significant than others, with some more varied uses. When the price of such goods rises, customers only use them for the most crucial uses, boosting the demand for those uses while decreasing the demand for the less crucial ones. Consumers will utilize the commodity for any purpose, whether important or not if the good’s price drops. For instance, milk is used for various things, including creating cheese, butter, desserts, and beverages. Customers will limit their usage of ghee to the crucial function of drinking if the price rises.
What is an example of the Law of Supply and Demand?
A product with a high demand and a limited supply will likely cost more money. The availability of a product and its overall demand are the two factors that determine its price. For instance, if demand for tennis balls suddenly increases, the supply may become constrained, and the price may rise.
Conclusion
The law of demand asserts that all other demand-affecting variables remain constant, and there is an inverse relationship between a commodity’s price and the quantity sought. It means that when an item’s price decreases, demand for the good increases, and demand decreases when a good’s price increases.
- HOW TO FACTORY RESET A MacBook 2023: EASY Guide
- CUSTOMER 360: What Is It, Why It Matters & All to Know
- HOW TO OPTIMIZE PC FOR GAMING: Complete Guide
- TOP KINAXIS COMPETITORS AND ALTERNATIVES 2023
- CLOUD BURSTING: What Is It and Why Is It Important?
References
