Law of Demand: Assumptions, Downward Slope, and Exceptional Demand Curve

Law of Demand

The Law of Demand asserts that, “All other factors remaining constant, the demand for a good increases when its price decreases, and decreases when its price increases.” This relationship can be represented by the following equation:

Dₓ = f(Pₓ, P₁, Y, T, E)

Where:

• Dₓ = Demand for commodity X
• Pₓ = Price of commodity X
• P₁ = Price of related goods
• Y = Consumer’s income
• T = Consumer’s tastes and preferences
• E = Consumer’s expectations regarding future price changes

This equation demonstrates that demand is influenced not only by the price of the good itself but also by the prices of related goods, the consumer’s income, preferences, and their expectations about future price fluctuations.

You may also read – What Is Demand? Determinants Of Demand

Definition

The law of demand states that other things being equal, the quantity demanded per unit of time will be greater, the lower the price and smaller the higher the price.-Professor Bilas

Assumptions of Law of Demand

The Law of Demand applies only under the condition of “other things being equal” or ceteris paribus. This means that all factors affecting demand, aside from the price of the commodity, are assumed to remain constant. These are known as the assumptions of the law.

The assumptions of the Law of Demand include all other determinants of the demand function, excluding the price (P). In other words, the following conditions must be met for the law to hold true:

1. No change in the prices of related goods.
2. No change in the consumer’s income.
3. No change in consumers’ tastes and preferences.
4. No expectation of a future change in the price of the commodity.

Suggested reading: Nature and Scope of Microeconomics

Why Does Demand Curve Slope Downwards?

From the above diagrams, it is evident that the demand curve slopes downward, meaning demand increases as the price falls and decreases as the price rises. Some reasons for this downward-sloping demand curve, illustrating the Law of Demand, include:

1. Law of Diminishing Marginal Utility

As you consume more of a product, the satisfaction or benefit you get from each additional unit decreases. For example, imagine you are buying slices of pizza. The first slice may give you a lot of satisfaction, but by the fourth or fifth slice, you’re likely to enjoy each one less. To encourage you to buy more slices, the price of each slice would need to decrease, hence the downward slope of the demand curve.

2. Income Effect

When the price of a product falls, it’s like the consumer has more income to spend. For example, if the price of a shirt drops from ₹500 to ₹400, the consumer can now afford to buy more shirts with the same amount of money. This increased purchasing power leads to higher demand at lower prices, contributing to the downward slope of the demand curve.

3. Substitution Effect

When the price of one good decreases, consumers tend to switch from higher-priced substitutes to the now cheaper product. For instance, if the price of tea decreases, some coffee drinkers might switch to tea because it is now more affordable, thus increasing the demand for tea. This effect causes the demand curve to slope downward as the price of the good decreases.

4. Size of Consumer Group

A decrease in price often makes the product affordable for more people, increasing the number of consumers. For example, if the price of smartphones drops, more people, especially students or lower-income groups, might be able to buy one. As a result, the demand increases, contributing to the downward slope of the demand curve.

5. Different Uses

Some products have multiple uses, and when their prices fall, consumers find more ways to use them. For instance, if the price of a versatile kitchen appliance like a blender decreases, people might buy it not just for making smoothies but also for making soups, sauces, or even grinding spices. This increased demand for the same product at lower prices further contributes to the downward-sloping demand curve.

Exceptional Demand Curve

There are some exceptions to the law of demand, meaning that the demand for certain goods increases when their price is high, and decreases when their price is low. The demand curve for these goods rises from bottom to top, as shown in Figure 4, with a positive slope. This positive slope occurs only for low-quality goods or Giffen goods. Sir Giffen first analyzed this, so it is also called the Giffen Paradox. The main exceptions to the law of demand that cause this abnormal demand curve include:

1. Articles of Distinction

This exception was first explained by Veblen. He argued that prestige goods see higher demand when their price is higher. For example, demand for jewels and precious carpets increases when their price is high because expensive items are seen as symbols of status. If the price of such goods decreases, the demand also decreases. Therefore, the law of demand does not apply to these goods.

2. Giffen Goods

Now, consider a staple food item, like rice or bread, in a region where it is the primary food source for many people. If the price of rice rises, you might expect demand to fall, but in some cases, the opposite happens. Due to a decrease in income or a higher price of other goods, people may buy more rice because it’s their most affordable option. This is known as a Giffen good, where the price rise causes an increase in demand for the good because consumers substitute other, more expensive foods with rice.

• Example: Imagine a low-income household where rice is a staple. If the price of rice increases, they might cut back on buying meat or other expensive foods, and as a result, they buy even more rice to fill the gap. This creates an upward-sloping demand curve for rice, showing an exceptional case.

3. Ignorance

Sometimes, due to ignorance or confusion, consumers perceive a low-priced product as less valuable and buy less of it. However, when the price increases, they consider it more valuable. Benham provided an example from World War I: A book with pictures was initially priced at ten and a half shillings, but its demand was low. After the war, the price was raised to three and a half pounds, and the demand increased because people believed it was more important due to its higher price.

4. Expectation of Future Price Changes

If consumers expect prices to rise in the future, they may buy more of a good even when its price is rising in the present. Conversely, if they expect prices to fall in the future, they may buy less of a good even when its current price is low. In such cases, the demand curve slopes upward.

5. Fear of Future Supply Shortages

When consumers believe a product’s supply will decrease in the future, they tend to buy more of it immediately, even if the price is rising. This behavior is common with non-essential goods like kerosene oil or sugar, where people may stockpile due to fear of scarcity. As a result, demand goes up despite higher prices, so the usual law of demand does not apply.

Suggested reading: Main Features of Indian Economy

Conclusion

In summary, while the law of demand states that the demand for a good typically falls as its price rises, several exceptions challenge this principle. Factors such as prestige goods, consumer ignorance, the nature of Giffen goods, expectations of future price changes, and fears of supply shortages lead to demand patterns that defy this standard rule. Understanding these exceptions helps explain why demand behavior sometimes deviates from expectations, offering valuable insights into consumer psychology and market dynamics. Recognizing these nuances is crucial for businesses and economists to make better-informed decisions and strategies in response to changing market conditions.

FAQ’s