The Law of Demand: Definition, Curve, and Exceptions
Law of Demand
Definition: The law of demand states that, assuming other factors remain constant (ceteris paribus), the price and quantity demanded of any good or service are inversely related. When the price of a product increases, the demand for that product will fall.
Description: The law of demand explains consumer choice behavior when the price changes. In the market, assuming other factors affecting demand remain constant, when the price of a good rises, it leads to a fall in the demand for that good. This is natural consumer choice behavior. This happens because consumers hesitate to spend more for a good for fear of depleting their available funds.
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The above diagram shows the demand curve, which is downward sloping. Clearly, when the price of the commodity increases from price P3 to P2, then its quantity demanded comes down from Q3 to Q2 and so on, and vice versa.
Why the Demand Curve Falls
Marginal Utility Decreases
When a consumer buys more units of a commodity, the marginal utility of that commodity continues to decline. The consumer is more likely to buy more units of a commodity when its price falls and vice versa. The demand curve falls because demand is higher at a lower price.
Price Effect
When the price of a commodity increases, consumers reduce their consumption of that commodity. The result is a decrease in demand for that commodity. Consumers consume more or less of a commodity due to the price effect. The demand curve slopes downward.
Income Effect
The real income of the consumer rises due to the fall in prices. The consumer can buy a larger quantity of the same commodity. When there is an increase in price, the real income of the consumer falls. This is the income effect: that the consumer can spend increased income on other commodities. The demand curve slopes downward due to the positive income effect.
Substitution Effect
When the price of a commodity falls, with the prices of substitutes remaining the same, the consumer can buy more of the commodity and vice versa. The demand curve slopes downward due to the substitution effect.
Exceptions to the Law of Demand
The law of demand does not apply in every case and situation. The circumstances when the law of demand becomes ineffective are known as exceptions to the law. Some of these important exceptions are as follows:
1. Giffen Goods
Some special varieties of inferior goods are termed Giffen goods. Cheaper varieties in this category, like bajra and cheaper vegetables like potatoes, come under this category. Sir Robert Giffen of Ireland first observed that people used to spend more of their income on inferior goods like potatoes and less of their income on meat. Potatoes constituted their staple food. When the price of potatoes increased, after purchasing potatoes, they did not have as much surplus to buy meat. So the rise in the price of potatoes compelled people to buy more potatoes and thus raised the demand for potatoes. This is against the law of demand. This is also known as the Giffen paradox.
2. Conspicuous Consumption
This exception to the law of demand is associated with the doctrine propounded by Thorsten Veblen. A few goods, like diamonds, are purchased by the rich and wealthy sections of society. The prices of these goods are so high that they are beyond the reach of the common person. The higher the price of diamonds, the higher the prestige value. So when the price of these goods falls, consumers think that the prestige value of these goods has come down. So the quantity demanded of these goods falls with the fall in their price. So the law of demand does not hold good here.
3. Necessities of Life
Another exception occurs with commodities that become necessities of life due to their constant use. For example, commodities like rice, wheat, salt, and medicines are purchased even if their prices increase.
4. Ignorance
Consumer ignorance is another factor that at times induces them to purchase more of the commodity at a higher price. This is especially so when the consumer is influenced by the idea that a high-priced commodity is better in quality than a low-priced one.
5. Emergencies
Emergencies like war, famine, etc., negate the operation of the law of demand. At such times, households behave in an abnormal way. Households accentuate scarcities and induce further price rises by making increased purchases even at higher prices during such periods. During depressions, on the other hand, no fall in price is a sufficient inducement for consumers to demand more.
6. Future Changes in Prices
Households also act as speculators. When prices are rising, households tend to purchase large quantities of the commodity out of the apprehension that prices may still go up. When prices are expected to fall further, they wait to buy goods in the future at still lower prices. So quantity demanded falls when prices are falling.
7. Change in Fashion
A change in fashion and tastes affects the market for a commodity. When a broad-toe shoe replaces a narrow-toe, no amount of reduction in the price of the latter is sufficient to clear the stocks. The broad-toe, on the other hand, will have more customers even though its price may be going up. The law of demand becomes ineffective.