Law of Demand: Introduction, Definition, Explanation and Exception

The law of demand explains the functional relationship between the quantity demanded and price.

This article will help you to understand the following things:- 1. Introduction to the Law of Demand 2. Definition of the Law of Demand 3. Explanation 4. Assumptions 5. Exceptions 6. Causes of Operation 7. Why the Demand Increases When the Price Falls and Conversely?

Introduction to the Law of Demand:

The law of demand explains the functional relationship between the quantity demanded and price.

Prof. Alfred Marshall—used the inductive method of study in economics. On the basis of the market analysis he framed this law.

According to this law, there exists a negative relationship between the price and quantity demanded. It speaks of the direction of change in the amount demanded and not of its magnitude. The law does not state how much the quantity demanded would have been if the price of the commodity were to change.

Prof. Alfred Marshall has defined it as “If other things remain the same, the amount demanded increases with a fall in and diminishes with a rise in price.”

In this definition, the phrase, “other things remaining the same” is very important qualifying phrase of law. It is because the demand is not only a function of price alone. Demand depends upon many things like population, income, taste, habit and distribution of income in the society etc.

Apart from these there are certain psychological factors which affect the demand. Therefore, in the study of Law of Demand, we should keep all these factors as constant.

Definition of the Law of Demand:

The Law of Demand has been defined by various economists differently. The essence of all the definitions is same—price and quantity demanded are inversely related.

Some of the definitions are as follows:

1. According to Marshall – “The greater the amount to be sold the smaller must be the price at which it is offered in order that it may find purchasers; or in other words, the amount demanded increases with a fall in price and diminishes with a rise in price.”

2. As Lipsey has said – “A fall in the price of a commodity causes the household to buy more of that commodity and less of the other commodities which complete with it, while rise in prices causes the household to buy less of this commodity and more of competing commodities.”

3. According to Thomas – “At any given time the demand for a commodity or service at the prevailing price is greater than it would be at a higher price and less than it would be at a lower price”.

4. According to Samuelson – “When the price of a commodity is raised (at the same time that all other things are held constant) less of it is demanded or…………. if a greater quantity of a commodity is put on the market, then, other things being equal, it can be sold at a lower price.”

All the above definitions exhibit one thing that there exists a negative association between prices and quantities demanded. More will be purchased at lower prices and less at higher prices. The qualifying clause, “other things remaining the same” or “Ceteris Paribus” implies the assumptions underlying this law.

Explanation of the Law of Demand:

It is the view of economists that the Law of Demand is based on Diminishing Marginal Utility. This law simply states that as the price of a commodity increases demand reduces and vice-versa. Consumer wants to pay the price of a commodity up to the extent of marginal utility. Therefore, an increase in the quantity of a commodity, its utility diminishes, slowly and consumer likes to pay less price of that commodity.

In other-words, it can be said that if the price of a commodity reduces additional unit of goods can be purchased. Eminent economist like Prof. Marshall has compared this law with a game of “See-Saw” in which he has stated that when one end of a plank of wood goes up the other end goes down which can be seen from the diagram given below:

This Law of Demand can be expressed more clearly by an example, Suppose, the price of the mango is Re. 1 per mango, its demand is 12 mangoes. When the price is Rs. 2 then 10; Rs. 3 then 8; Rs. 4 then six and Rs. 5 then on 4 mangoes. From the following table demand of mangoes can be studied clearly when there is increase and decrease in price.

Diagrammatic Representation of the Law of Demand:

The Law of Demand can be expressed by the following diagram:

In this diagram OX-axis indicate quantity of mango and OY-axis price. D-D 1 line in Demand Curve. From this diagram it is clear that “Demand curve slopes downward towards the right.”

Explanation of the Law of Demand by Prof. Hicks:

Prof. Hicks has discussed the Law of Demand on the basis of two effects.

The two effects are as follows:

1. Income Effect.

2. Substitution Effect.

1. Income Effect:

Prof. Hicks has said that—”When there is decrease in the price of the goods, the income of the consumer increases and if the price increases the consumer’s income decreases. Because of the variation in price the effect which falls on income that effect Hicks has called “Income effect of price change”.

For example:

Suppose the price of mango is Rs. 20 per kg and the consumer purchase 5 kg of mangoes. Then he will pay Rs. 100/- as price. If the price of mango reduces to Rs. 16/-, then the price will be Rs. 16 x 5 = 80/-. Consumer will have a saving of Rs. 20/= (Rs 100 – Rs 80). This income is like his ‘Real Income’. He may purchase more mango with that money which he has saved i.e., from Rs. 20/= Just opposite to it, if the price of mango increases further, his real income will decrease and then he will purchase less of mango.

2. Substitution Effect:

If the price of all other goods remain the same and the price of one goods is reduced then in comparison to other goods it will look cheaper. When the price reduces people start substituting their goods with other goods whose price is high. To this change Prof. Hicks has given the name of “Substitution Effect of Price Change”.

For example:

If the price of tea is reduced and the price of coffee remains as usual, then some people will substitute tea in place of coffee. In this way the demand of tea will increase. Combined result of both the effects i.e., (income effect and substitution effect) is that when the price of a commodity decreases its demand increases and vice-versa.

Assumptions or Limitations of the Law of Demand:

Prof. Albert Mayers has given the following main assumptions of the Law of Demand:

1. There should not be any Change in the Income of the Consumer:

It means, throughout the operation of the law, the consumer’s income should remain the same. If the level of a buyer’s income changes, he may buy more, even at a high price invalidating the Law of Demand.

2. There should be no Change in the Tastes, Habits and Fashion of the Consumers:

There should be no change in the tastes, habits and fashion of the consumers. It means the consumer’s tastes, habits and preferences should remain constant. If the commodity concerned goes out of fashion, buyers may not buy more of it even at a substantial price reduction.

3. No Change in the Prices of Related Goods:

The prices of other related commodities should be constant. It means prices of other goods like substitutes and complementariness remain unchanged. If the prices of other related goods change, the consumer’s preferences would change which may invalidate the Law of Demand.

4. Population should be Constant:

The population of the country should be constant. This necessitates that the size of population as well as its age. Structure and sex ratio should remain the same throughout the operation of the law. Otherwise if population changes, there will be additional buyers in the market, so the total market demand may not contract with a rise in price.

5. Should not Anticipate any Price Change in the Future:

The law requires that the given price change for the commodity is a normal one and has no speculative consideration. That is to say, the buyers do not expect any shortages in the supply of the commodity in the market and consequent future changes in the prices. The given price change is assumed to be final at a time.

6. The Distribution of Wealth should not Change:

There should not be in the distribution of income and wealth of the community. There should not be re-distribution of income either, so that the levels of income of the consumers remain the same.

7. The Season and Climate Should not Change:

It means that there should be no change in weather conditions. It should be assumed that climate and weather conditions are unchanged in affecting the demand for certain goods like woollen clothes, umbrellas etc.

8. No Change in Government Policy:

The level of taxation and fiscal policy of the government should remain the same throughout the operation of the law. Otherwise, the changes in income-tax for instance, may cause changes in consumer’s income or commodity taxes like sales tax or excise duties may lead to distortions in consumer’s preferences. Therefore, the validity of the Law of Demand or the inference about inverse relationships between price and demand depends on the existence of these conditions or assumptions.

Exceptions to the Law of Demand or Exceptional Demand Curve:

As we have seen that it is almost a Universal Phenomenon of the Law of Demand that when the price falls, the demand expands and it contracts when the price rises. But sometimes, it may be observed that with a fall in price, demand also falls and with a rise in a price, demand also rises.

This is a situation which is apparently contrary to the Law of Demand. Cases in which this tendency is observed are referred to an exception to the general Law of Demand. The demand curve for such cases will be typically unusual. It will be an upward sloping demand curve as shown below.

It is described as an exceptional demand curve:

DD is an upward-sloping demand curve. It shows that demand rises with increase in price.

In the figure drawn above DD is the demand curve which slopes upward from left to right. It appears that when OP₁ is the price, QR₁ is the demand and when prices rise to OP₂, demand also expands to OR₂.Thus, the upward sloping demand curve expresses a direct functional relationship between price and demand.

Such upward-sloping demand curves are unusual and quite contradictory to the Law of Demand as they represent the phenomenon that “more will be demanded at a higher price and “vice-versa.” ” The upward-sloping demand curve thus refers to the exceptions to the Law of Demand.

There are a few such exceptional cases which have been discussed as under:

As we have seen earlier, that there are certain situations where the price increases and the demand also increases; price falls and the quantity demanded decreases. This exception to the Law of Demand was propounded by an American Economist Prof. T. B. Veblen. According to him some consumers measure the utility derived from the commodity entirely on the basis of its price. More the price of a commodity more will be utility derived from it. He named this concept as “Conspicuous Consumption.”

A similar exception was made by British Economist Sir Robert Giffin—According to him, “When the price of bread increased the low paid workers purchased more bread and with the fall in price the demand for bread declined.” Apart from this there are certain other exceptions, some of them are associated with increase in price increases the demand and others with the fall in price the demand decreases.

Following are certain situations when the price of the commodity increases the demand also increases. These situations are:

1. Future Expectation in Prices:

When we expect that the price of any commodity will increase in the near future with the prices that are rising now. In that case we shall buy more at increasing prices. If we anticipate that the price will fall in the near future even with the fall in price at present we shall buy less. This is contrary to the Law of Demand.

2. Conspicuous Consumption:

This exception is associated with the name of Prof. Veblen—There are certain items like diamonds and other commodities which are purchased by the rich and wealthy upper class people of the society When their prices are very high and high and beyond the reach of the common man, the rich buy more and when its prices comes down they buy less of that. Hence, these status symbol commodities are exceptions to the Law of Demand.

3. Giffen Goods:

Sir Robert Giffen has observed that there is a strange relationship between price and quantity demanded and thus, consumers buy less of a commodity at a lower price and more of a commodity at higher price. He has cited the example of low paid British wage earners. During the early period of nineteenth century, a rise in the price of bread caused the wage earners to buy the same amount of bread as before. This tendency is generally known as “Giffen Paradox.”

4. ‘U’ Sector Goods or ‘Utility Sector’ Goods:

It is a recent concept which exhibits that there are certain commodities which are necessities on the one hand and luxuries on the other. They are considered ‘utility sector goods’ e.g., Television, Scooter, Refrigerators etc. Despite of the increase in prices the demand is also increasing day by day.

5. Fashion Goods:

The goods which are in fashion now a day’s even if their prices increase the demand also increases. If they will go out of the fashion, even if the price go down the demand does not increase.

6. Consumer’s Ignorance:

Consumer’s ignorance also affects the quantity demanded. He purchases more of the commodity at a higher price. This is especially so when the consumer is haunted by the phobia that a higher priced commodity is better in quality and low priced commodity is inferior.

7. In case of an Emergency:

The law of demand does not apply in case of an emergency. This may be caused by war, famine political or social Upheaval. During these periods consumers behave in an abnormal way. They accentuate scarcities and induce further price rises by making more purchases even at higher prices. This can also be caused by emergency of wants also.

8. Consumer’s Psychological Bias or Illusion:

When the consumer is wrongly biased against the quality of a commodity with the price change, he may contract his demand with a fall in price. Some sophisticated consumers do not buy when there is a stock clearance sale at reduced prices, thinking that the goods are of bad quality.

In the exceptions written above there are certain facts which need consideration and discussion. The demand for luxurious commodities has been considered from social point of view and not from economic consideration. The demand of Giffen goods should be considered from existence point of view.

Bread is bare necessary for existence. The wage earners purchase the same or more amount of bread despite the price rise as they are habituated to consume bread only and no other eatables. During emergency the human beings work irrationally which violates the economic principle. Thus, we find that there are hardly any exceptions to the Law of Demand. This shows the universality of the Law of Demand.

In this connection Prof. Hicks has said:

“The simple law of demand, the downward slope of the demand curve, turns out to be almost in falliable in its working exceptions to it are rare and unimportant.”

Causes of the Operation of the Law of Demand:

The demand curve slopes downward to the right in accordance with the law of demand. When the price falls, the new consumers enter the market and the old consumers buy more than before. Since the particular commodity has become cheaper, it will be purchased by some people in preference to other commodities.

There are five main reasons why the demand curve slopes downwards to the right:

1. Negative Correlation between Price and Quantity Demanded:

The Law of Demand expresses a negative association between prices and quantities demanded. More will be bought at lower prices and vice versa. This state of affairs makes the demand curve to slope downward towards the right.

2. Based upon Diminishing Marginal Utility:

The Law of Demand is based upon the Law of Diminishing Marginal Utility. According to this law, with the successive increase in the units of consumption of a commodity, every additional unit gives lesser satisfaction. The consumer always tries to balance the utility derived from the consumption with the price of commodity. In order to increase consumption he pays lower prices for the commodity. Hence the demand curve slopes downward from left to right.

3. Emergence of Potential Buyers:

Potential buyers are those buyers who are ready to buy the commodity, process means to buy it, but cannot buy because of high prices. As soon as the price falls, they put forward their demand. Hence at low price demand increases and the demand curve slopes downward to the right.

4. Income and Substitution Effect:

Prof. R.G.D. Allen and Prof. J.R. Hicks in the analysis of indifference curves have tried to make this fact clear that due to fall in prices not only the real income of the consumer increases but also there is redistribution in budget allocation which causes substitution of one commodity for another.

If the price of a commodity falls the consumer can afford to buy more, his real income increases. It is called ‘Income Effect’. On the other hand, when the commodity becomes dearer he tries to substitute that commodity with other commodities. This is called ‘Substitution Effect’. Because of these effects the demand curve slopes downward to the right.

5. Commodity of Several Uses:

A commodity of tends to be put to more uses or less important uses when its price is lowered. On the other-hand, increase in price will compel the consumers to withdraw that from unimportant uses. Hence, the slope of demand curve is downward to the right. The above explanations make it clear that we buy more at lower prices and less at higher prices.

Why the Demand Increases When the Price Falls and Conversely?

Prof. Benham has written in his book regarding this problem in the following manner:

Having a limited amount of money at our disposal every consumer wants to get the maximum satisfaction there-from. He quotes price with utility derived. This arrangement will continue and hence according to the law of equi-marginal utility he will make purchases.

With the fall in price, divergence has been created between the marginal utility and price and this must be rectified. This can be done by buying more of a commodity when its price falls and thus bringing its marginal utility to the level of the price. That is why, people buy more when the prices fall. We buy less, when the price rise because:

(i) We substitute other cheaper things for it; and

(ii) Our real income falls and hence we economise our expenses and cut down some consumption.

Thus, the Law of Diminishing Marginal Utility forms the basis of the Law of Demand.