Law of Demand

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. According to the law of demand, other things being equal, if the price of a commodity falls, the quantity demand 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. 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.

Demand Curve and the Law of Demand:

The law of demand can be illustrated through a demand schedule and a demand curve. A demand schedule of an individual consumer is presented in Table 6.1. It will be seen from this demand schedule that when the price of a commodity is Rs. 12 per unit, the consumer purchases 10 units of the commodity. When the price of the commodity falls to Rs. 10, he purchases 20 units of the commodity.

Similarly, when the price further falls, quantity demanded by him goes on rising until at price Rs.2, the quantity demanded by him rises to 60 units. We can convert this demand schedule into a demand curve by graphically plotting the various price-quantity combinations, and this has been done in Fig. 6.1 where along the X-axis, quantity demanded is measured and along the Y-axis price of the commodity is measured.

By plotting 10 units of the commodity against price 12, we get a point in Fig. 6. 1 Likewise, by plotting 20 units of the commodity demanded against price 10 we get another point in Fig. 6.1. Similarly, other points are plotted representing other combinations of price and quantity demanded of the commodity and are shown in Fig. 6.1. By joining these various points, we get a curve DD, which is known as the demand curve. Thus, this demand curve is a graphic representation of quantities of a good which are demanded by the consumer at various possible prices in a given period of time.

It should be noted that a demand schedule or a demand curve does not tell us what the price is; it only tells us how much quantity of the good would be pur­chased by the consumer at a various possible prices. Further, it will be seen from both the demand schedule and the demand curve that as the price of a commodity falls, more quantity of it is purchased or demanded.

Since more is demanded at a lower price and less is demanded at a higher price, the demand curve slopes downward to the right. Thus, the downward-sloping demand curve is in accordance with the law of demand which, as stated above, describes inverse price-demand relationship.

It is important to note here that behind this demand curve or price-demand relationship always lie the tastes and preferences of the consumer, his income, the prices of substitutes and complementary goods, all of which are assumed to be constant in drawing a demand
curve.

If any change occurs in any of these other factors, the whole demand schedule or demand curve will change and new demand schedule or a demand curve will have to be drawn. Further, in drawing a demand curve, we assume that the buyer or consumer does not exercise any influence over the price of a commodity, that is, he takes the price of the commodity as given and constant for him.

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.

It may however be mentioned here that there are two factors due to which quantity demanded increases when price falls:

(1) Income effect,

(2) Substitution effect.

(1) Income Effect:

When the price of a commodity falls the consumer can buy more quantity of the commodity with his given income. Or, if he chooses to buy the same amount of quantity as before, some money will be left with him because he has to spend less on the commodity due to its lower price.

In other words, as a result of fall in the price of a commodity, consumer’s real income or purchasing power increases. This increase in real income induces the consumer to buy more of that commodity. This is called income effect of the change in price of the commodity. This is one reason why a consumer buys more of a commodity when its price falls.

(2) Substitution Effect:

The other important reason why the quantity demanded of a commodity rises as its price falls is the substitution effect. When price of a commodity falls, it becomes relatively cheaper than other commodities. This induces the consumer to substitute the commodity whose price has fallen for other commodities which have now become relatively dearer. As a result of this substitution effect, the quantity demanded of the commodity, whose price has fallen, rises.

This substitution effect is more important than the income effect. Marshall explained the downward-sloping demand curve with the aid of this substitution effect alone, since he ignored the income effect of the price change. But in some cases even the income effect of the price change is very significant and cannot be ignored. Hicks and Allen who put forward an alternative theory of demand called as indifference curve analysis of consumer’s behaviour explain this downward-sloping demand curve with the help of both income and substitution effects.

Exceptions to the Law of Demand:

Law of demand is generally believed to be valid in most of the situations. However, some exceptions to the law of demand have been pointed out.

Goods having Prestige Value: Veblen Effect:

One 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.

Giffen Goods:

Another exception to the law of demand was pointed out by Sir Robert Giffen 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. 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.