Law of Demand

The law of demand states that the quantity demanded of a good shows an
inverse relationship with the price of a good when other factors are held
constant (cetris peribus). It means that as the price increases, demand decreases.

It is used together with the law of supply to determine the efficient allocation of
resources in an economy and find the optimal price and quantity of goods.

Figure 1. Demand Curve Approximation

Graphical Representation of the Law of Demand

The law of demand is usually represented as a graph. The graphical

representation of the law of demand is a curve that establishes the relationship
between the quantity demanded and the price of a good.

The demand curve is drawn against the quantity demanded on the x-axis and the
price on the y-axis. The definition of the law of demand indicates that the
demand curve is downward sloping.

It is important to distinguish the difference between the demand and the

quantity demanded. The quantity demanded is the number of goods that
the consumers are willing to buy at a given price point. On the other hand, the
demand represents all the available relationships between the good’s prices and
the quantity demanded.

A demand schedule is crucial for constructing a demand curve. A demand

schedule lists prices and corresponding quantities based on law of demand. To
understand the concept of demand schedule better, let us look at the following
table.

Price (in Rs) Quantity Demanded

5 1

4 2

3 3

2 4

1 5

Table 1 exhibits hypothetical demand schedule of an individual. In table 1, we

find that there is an inverse relationship between price and quantity demanded
because demand schedule follows law of demand.

As stated earlier, we can construct a demand curve based on a demand schedule.

Due to the conventional practice established by Alfred Marshall, horizontal axis
measures quantity and vertical axis measures price always while deriving
demand curve.

Table 1 shows that when the price is 5, the quantity demanded is 1 unit.
Similarly, when the price is 4, the quantity demanded is 2 units and so on. As
we see, there is a corresponding quantity for each price. By joining all the points
established by plotting all prices and their corresponding quantities on a graph,
we can obtain a demand curve. Hence, demand curve exhibits the relationship
between two variables, namely price and quantity. We can also see that the
demand curve is downward sloping from left to right.

Determinants of Demand

Some of the important determinants of demand are as follows,

1] Price of the Product

People use price as a parameter to make decisions if all other factors remain
constant or equal. According to the law of demand, this implies an increase in
demand follows a reduction in price and a decrease in demand follows an increase
in the price of similar goods.

The demand curve and the demand schedule help determine the demand quantity
at a price level. An elastic demand implies a robust change quantity accompanied
by a change in price. Similarly, an inelastic demand implies that volume does not
change much even when there is a change in price.

2] Income of the Consumers

Rising incomes lead to a rise in the number of goods demanded by consumers.

Similarly, a drop in income is accompanied by reduced consumption levels. This
relationship between income and demand is not linear in nature. Marginal utility
determines the proportion of change in the demand levels.

3] Prices of related goods or services

• Complementary products – An increase in the price of one product

will cause a decrease in the quantity demanded of a complementary
product. Example: Rise in the price of bread will reduce the demand
for butter. This arises because the products are complementary in
nature.

• Substitute Product – An increase in the price of one product will cause

an increase in the demand for a substitute product. Example: Rise in
price of tea will increase the demand for coffee and decrease the
demand for tea.
4] Consumer Expectations

Expectations of a higher income or expecting an increase in prices of goods will

lead to an increase the quantity demanded. Similarly, expectations of a reduced
income or a lowering in prices of goods will decrease the quantity demanded.

5] Number of Buyers in the Market

The number of buyers has a major effect on the total or net demand. As the
number increases, the demand rises. Furthermore, this is true irrespective of
changes in the price of commodities.

Why Demand Curve Slopes Downward?

There may be various reasons for the falling nature or downward sloping of
demand curve. Some of them are as follows:

• Law of diminishing the marginal utility

• Substitution effect
• Income effect
• New buyers
• Old buyers

1. Law of diminishing the marginal utility

The law of diminishing marginal utility states that with each increasing quantity of
the commodity, its marginal utility declines.

For example, when a person is very hungry the first chapatti that he eats will give
him the most satisfaction. As he will consume more chapattis, his level of
satisfaction will diminish.

Thus, when the quantity of goods is more, the marginal utility of the commodity is
less. Thus, the consumer is not willing to pay more price for the commodity and
its demand will decline.

Also, when the price of the commodity is low, its demand increases.

Hence, the demand curve slopes downwards from left to right.

2. Substitution effect

Let us understand this with an example. Tea and coffee are substitute goods. If the
price of tea rises, consumers will shift to coffee.

This will decrease the demand for tea and increase the demand for coffee. Thus,
the demand curve of tea will slope downwards.

3. Income effect

Income effect refers to the change in the real income or the purchasing power of
the consumers. When the price level falls the purchasing power of the consumer’s
increases and they buy more goods.

Similarly, when the price level rises, the purchasing power of the consumer’s
decreases and they buy less quantity of goods.

4. New buyers

Due to the fall in the prices of a commodity new buyers get attracted towards it
and buy it. Thus, this increases the demand for the commodity.

5. Old buyers

When the prices of the goods fall the old buyers tend to buy more goods than
usual thereby increasing its demand. This causes the downward sloping of
demand curve.

Movement and Shift in the Demand Curve

Movement of the Demand Curve

When there is a change in the quantity demanded of a particular commodity,

because of a change in price, with other factors remaining constant, there is a
movement of the quantity demanded along the same curve.

The important aspect to remember is that other factors like the consumer’s income
and tastes along with the prices of other goods, etc. remain constant and only the
price of the commodity changes.

In such a scenario, the change in price affects the quantity demanded but the
demand follows the same curve as before the price changes. This is Movement of
the Demand Curve. The movement can occur either in an upward or
downward direction along the demand curve.We know that if all other factors
remain constant, then an increase in the price of a commodity decreases its
demand. Also, a decrease in the price increases the demand.

In Fig. 1 above, we can see that when the price of a commodity is OP, its demand
is OM (provided other factors are constant). Now, let’s look at the effect of an
increase and decrease in price on the demand:

• When the price increases from OP to OP”, the quantity demanded

falls to OL. Also, the demand curve moves UPWARD.
• When the price decreases from OP to OP’, the quantity demanded
rises to ON. Also, the demand curve moves DOWNWARD.
Therefore, we can see that a change in price, with other factors remaining constant
moves the demand curve either up or down.

The shift of the Demand Curve

When there is a change in the quantity demanded of a particular commodity, at

each possible price, due to a change in one or more other factors, the demand
curve shifts. The important aspect to remember is that other factors like the
consumer’s income and tastes along with the prices of other goods, etc., which
were expected to remain constant, changed.

In such a scenario, the change in price, along with a change in one/more other
factors, affects the quantity demanded. Therefore, the demand follows a different
curve for every price change.
This is the Shift of the Demand Curve. The demand curve can shift either to the
left or the right, depending on the factors affecting it.

Let’s look at an example which captures the effect of a change in consumer’s

income on the quantity demanded.

Price (Rs.) Quantity demanded when the Quantity demanded when the
average household income is average household income is
Rs. 4000 Rs. 5000

5 10 (A) 15 (A1)

4 15 (B) 20 (B1)

3 20 (C) 25 (C1)

2 35 (D) 40 (D1)

1 60 (E) 65 (E1)

The demanded quantities are plotted as demand curves DD and D’D’ as shown
below:

From Fig. 2 above, we can clearly see that if the income changes, then a change in
price shifts the demand curve. In this case, the shift is to the right which indicates
that there is an increase in the desire to purchase the commodity at all prices.
Hence, we can conclude that with an increase in income the demand curve shifts
to the right. On the other hand, if the income falls, then the demand curve will
shift to the left decreasing the desire to purchase the commodity.

Exceptions to the Law of Demand

Note that the law of demand holds true in most cases. The price keeps fluctuating
until an equilibrium is created. However, there are some exceptions to the law of
demand. These include the Giffen goods, Veblen goods, possible price changes,
and essential goods. Let us discuss these exceptions in detail.

Giffen Goods

Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods
are goods that are inferior in comparison to luxury goods. However, the unique
characteristic of Giffen goods is that as its price increases, the demand also
increases. And this feature is what makes it an exception to the law of demand.

The Irish Potato Famine is a classic example of the Giffen goods concept. Potato
is a staple in the Irish diet. During the potato famine, when the price of potatoes
increased, people spent less on luxury foods such as meat and bought more
potatoes to stick to their diet. So as the price of potatoes increased, so did the
demand, which is a complete reversal of the law of demand.

Veblen Goods

The second exception to the law of demand is the concept of Veblen goods.
Veblen Goods is a concept that is named after the economist Thorstein Veblen,
who introduced the theory of “conspicuous consumption“. According to Veblen,
there are certain goods that become more valuable as their price increases. If a
product is expensive, then its value and utility are perceived to be more, and hence
the demand for that product increases.

And this happens mostly with precious metals and stones such as gold and
diamonds and luxury cars such as Rolls-Royce. As the price of these goods
increases, their demand also increases because these products then become a
status symbol.

The expectation of Price Change

In addition to Giffen and Veblen goods, another exception to the law of demand is
the expectation of price change. There are times when the price of a product
increases and market conditions are such that the product may get more
expensive. In such cases, consumers may buy more of these products before the
price increases any further. Consequently, when the price drops or may be
expected to drop further, consumers might postpone the purchase to avail the
benefits of a lower price.

For instance, in recent times, the price of onions had increased to quite an extent.
Consumers started buying and storing more onions fearing further price rise,
which resulted in increased demand.

There are also times when consumers may buy and store commodities due to a
fear of shortage. Therefore, even if the price of a product increases, its associated
demand may also increase as the product may be taken off the shelf or it might
cease to exist in the market.

Necessary Goods and Services

Another exception to the law of demand is necessary or basic goods. People will
continue to buy necessities such as medicines or basic staples such as sugar or salt
even if the price increases. The prices of these products do not affect their
associated demand.

Change in Income

Sometimes the demand for a product may change according to the change in
income. If a household’s income increases, they may purchase more products
irrespective of the increase in their price, thereby increasing the demand for the
product. Similarly, they might postpone buying a product even if its price reduces
if their income has reduced. Hence, change in a consumer’s income pattern may
also be an exception to the law of demand.