In this Article we are Going to Discuss about Law of Demand Meaning, Assumptions, Reasons, Determinants of Demand. Micro Economics Notes B.Com 1st Sem || Micro Economics Notes B.Com 5th Sem
Table of Contents
Law of Demand Meaning
The law of demand expresses the functional relationship between price and quantity demanded. It is the most important laws of economic theory which states that, other things being equal, if price of a commodity falls, the quantity demanded of it will rise, and if 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. However, it should be remembered that the law is only an indicative and not a quantitative statement. This means that it is not necessary that such variation in demand be proportionate to the change in price.
Among the many causal factors affecting demand, price is the most significant and the price- quantity relationship called as the Law of Demand is stated by Alfred 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”.
In simple words other things being equal, quantity demanded will be more at a lower price than at higher price. The law assumes that income, taste, fashion, prices of related goods, etc. remain the same in a given period.
Law of demand Assumptions
The statement of the law of demand, demonstrates that that this law operates only when all other things remain constant. These are then the assumptions of the law of demand. We can state the assumptions of the law of demand as follows:
1. Income level should remain constant: The law of demand operates only when the income level of the buyer remains constant. If the income rises while the price of the commodity does not fall, it is quite likely that the demand may increase.
2. Prices of other goods should remain constant: Changes in the prices of other goods often affect the demand for a particular commodity. Therefore, for the law of demand to operate it is imperative that prices of other goods do not change.
3. Tastes of the buyer should not alter: It often happens that when tastes or fashions change people revise their preferences. As a consequence, the demand for the commodity which goes down the preference scale of the consumers declines even though its price does not change.
4. No new substitutes for the commodity: If some new substitutes for a commodity appear in the market, its demand generally declines. This is quite natural, because with the availability of new substitutes some buyers will be attracted towards new products and the demand for the older product will fall even though price remains unchanged. Hence, the law of demand operates only when the market for a commodity is not threatened by new substitutes.
5. Advertising expenditure should remain the same If the advertising expenditure of a firm increases, the consumers may be tempted to buy more of its product. Therefore, the advertising expenditure on the good under consideration is taken to be constant.
6. Price rise in future should not be expected: If the buyers of a commodity expect that its price will rise in future they raise its demand in response to an initial price rise which violates the law of demand. Therefore, it is necessary that there must not be any expectations of price rise in the future.
Reasons for the Law of Demand: Why Does Demand Curve generally slopes downward?
According to the law of demand, the demand of a commodity rises when price falls and vice versa, other things remaining the same. The main five reasons for the law of demand are listed below:
1. Law of Diminishing Marginal Utility:
Law of diminishing marginal utility states that as we consume more and more units of a commodity, the utility derived from each successive unit goes on decreasing. The consumer will be ready to pay more for those units which provide him more utility and less for those which provide him less utility. It implies that he will purchase more only when the price of the commodity falls. .
2. Income Effect:
When price of a commodity falls, purchasing power or real income of the consumer increases which enables him to purchase more quantity of the commodity with the same money income. Let us take an example. Suppose we buy 5 kgs wheat when price of wheat is Rs. 20 per kg. If price of ice creams falls to Rs. 10, then with the same money income we can buy 10 kgs wheat now.
3. Substitution Effect:
When price of a commodity falls, it becomes comparatively cheaper as compared to its substitutes. This will lead to rise in demand for the given commodity. For example, if VIVO and OPPO both are sold at Rs. 10,000 each and price of OPPO falls. Now OPPO has become relatively cheaper and will be substituted for VIVO. It will lead to rise in demand for OPPO.
4. Change in Number of Buyers:
When price of a commodity falls, some old buyers may demand more of the commodity at the reduced price and some new buyers may also start buying this commodity who were not in a position to buy it earlier due to higher price. This will lead to increase in number of buyers when price of the commodity falls. As a result demand for the commodity rises when its price falls.
5. Diverse Uses of a Commodity:
Some commodities have diverse uses, like milk. It can be used for drinking, for sweet preparation, for ice cream preparation etc. If price of milk rises, its use may be restricted to important purpose only. This will lead to reduction in demand for other less important uses. When price of milk falls, it can be put to other uses also leading to rise in demand for it.
Law of Demand Exceptions
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 of the law. Some of these important exceptions are as under.
1. Giffen goods: Giffen goods, as pointed by Sir Robert Giffen, are those goods in which there is a direct relationship between price and demand. Giffen goods are special type of inferior goods in which negative income effect is stronger than negative substitution effect. Giffen goods do not follow law of demand as their demand rises when their price rises. Examples of Giffen goods are jowar and bajra etc. in case of giffen goods the demand curve will slope upward to the right not downward.
2. Conspicuous Consumption: Conspicuous Consumption refers to the consumption of those commodities which are bought as a matter of prestige, e.g. diamonds, gold jewellary etc. The higher the price, the higher will be the demand for these goods. When price of such goods falls, these goods are no longer looked at as status symbol goods and, therefore, their demand falls.
3. Conspicuous necessities: Certain things become the necessities of modern life. So we have to purchase them despite their high price. The demand for T.V. sets, automobiles and refrigerators etc. has not gone down in spite of the increase in their price. So they are purchased despite their rising price.
4. Ignorance: A consumer’s ignorance is another factor that at times induces him to purchase more of the commodity at a higher price. This is especially so when the consumer is haunted by the phobia that a high-priced commodity is better in quality than a low-priced one.
5. Emergencies: When the buyers expect a scarcity of a particular good in near future, they start buying more and more of that good even if their prices are rising. For example, during war, famines etc. people tend to buy more of some goods even at higher prices due to fear of their scarcity in near future.
6. Future changes in prices: When the prices of household products are expected to rise in future, households tend to purchase large quantities of the commodity. When prices are expected to fall further, they wait to buy goods in future at still lower prices.
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.
Factors Determining Demand/Determinants of Demand
Demand Schedule and Law of Demand state the relationship between price and quantity demanded by assuming other things remaining the same. When there is a change in these other things, the whole demand schedule or demand curve undergoes a change. The following are the factors which determine demand for goods are listed below:
1. Price of a commodity: Price of the commodity is the most important factor that determines demand. An increase in price of a commodity leads to a reduction in demand and a decrease in price leads to an increase in demand.
2. Price of related goods: Demand for a commodity depends on Price of related goods also. Related goods include both substitutes and complementary goods.
a) Substitutes are those goods which can be used one another or the goods with same use are substitutes. e.g.:- tea and coffee. When price of tea falls demand for coffee also falls. Because when price of tea falls people buy more tea and less coffee.
b) Complementary goods are those goods which can be used only jointly. e.g.: – car, petrol or pen, ink. When price of a commodity raises demand for its complementary goods falls. If x and y are complementary goods we cannot use x without y. When price of x raises demand for x falls and y cannot be used without x and demand for y also falls.
3. Income of the consumer: Income of the consumer and demand for a commodity are positively related. For normal goods when income increases demand also increases and vice versa. But for inferior goods there is a negative relationship between income and demand. So when income increases, demand decreases.
4. Taste and Preferences of consumers: Taste and Preferences of consumers also brings out changes in demand for a commodity. Tendency to imitate other fashions, advertisements etc. affect demand for a commodity. It changes from person to person, place to place and time to time.
5. Rate of Interest: Higher will be demanded at lower rates of interest and lower will be demanded at higher rate of interest.
6. Money supply: Demand is positively related to money supply. If the supply of money increases people will have more purchasing power and hence the demand will increase and vice versa.
7. Business condition: Demand will be high during boom period and low during depression.
8. Distribution of income: Distribution income in the society also affects the demand of commodity. If there is equal distribution of income demand for necessary goods and comforts will be greater.
9. Government policy: Government policy also affects the demand of commodities.
10. Consumers’ expectations: Consumers’ expectation about a further rise or fall in future price will affect the demand of a commodity. If consumers expect a rise in the price of a commodity in the near future, they may purchase large quantity even though there is some rise in the price. When the price of a commodity decreases, people expect a further fall in price and postpone their purchase.