Law of demand(managrial Economic Notes MBA, BBA)

Law of demand

There is an inverse relationship between quantity demanded and its price. The people know that when the price of a commodity goes up its demand comes down. When there is a decrease in price the demand for a commodity goes up. There is an inverse relationship between price and demand. (Exam Studies)The law refers to the direction in which quantity demanded changes due to price changes.

A consumer may demand one dozen oranges at $5 per dozen. He may demand two dozen when the price is $4 per dozen. A person generally buys more at a lower price. He buys less at a higher price. It is not the case with one person but all people liken to buy more due to fall in price and vice versa. This is true for all commodities and under all conditions. The economists call it the law of demand. In simple words, the law of demand states that other things being equal more will be demanded at a lower price and lower will be demanded at a higher price.

Definition of law of demand

1.     Alfred Marshal:- “the amount demanded increases with a fall in price, diminishes with a price rise”.

2.     C.E. Ferguson “according to the law of demand, the quantity demanded varies inversely with price”. 

3.     Paul A. Samuelson's “law of demand states that people will buy more at a lower price and buy less at higher prices, other things remaining the same”.

Assumptions of the law of demand

1.     There is no substitute for the commodity.

2.     The climate and weather conditions are the same

3.     There is no change in customs.

4.     There is no change in the income of consumers.

5.     There is no change in the price of the product.

6.     There is no change in the quality of the product.

7.     The prices of related commodities remain the same.

8.     There is no change in the taste and preference of consumers.

9.     The size of the population remains the same.

10. The tax rates and other fiscal measures remain the same.

Explanation of the law

The relationship between the price of a commodity and its demand depends upon many factors. The most important factor is the nature of the commodity. The demand schedule shows the response of quantity demanded to change in the price of that commodity. This is the table that shows prices per unit of commodity and the amount demanded per period. The demand of one person is called individual demand. The demand of many persons is known as market demand. The experts are concerned with the market demand schedule. The market demand schedule means 'quantities of the given commodity which all consumers want to buy at all possible prices at a given moment of time'. The demand schedules of all individuals can be added up to find out the market demand schedule.

Demand schedule

Price in dollars.	Demand in Kg.
5	10
4	20
3	30
2	40

The table shows the demand of all the consumers in a market. When the price decreases there is an increase in demand for goods and vice versa. When the price is rupees 5 demands is 10 kilograms. When the price is rupees 4 demands is 20 kilograms. Thus the table shows the total amount demanded by all consumers at various price levels.

Diagram

There is the same price in the market. All consumers purchase commodities according to their needs. The market demand curve is the total amount demanded by all consumers at different prices. The market demand curve slopes from left down to right.

Why demand curve downward

Why Demand Curve Downward /Falls

Marginal utility decreases:

When a consumer buys more units of a commodity, the marginal utility of such a commodity continues to decline. The consumer can buy more units of the commodity when its price falls and vice versa. The demand curve falls because demand is more at a lower price.

Price effect:

When there is an increase in price of the commodity, the consumers reduce the consumption of such commodity. The result is that there 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 consumers rises due to falling prices. The consumer can buy more quantities of the same commodity. When there is a price increase, the real income of consumers falls. This is the income effect that the consumer can spend increased income on other commodities. The demand curve slopes downward due to a positive income effect.

Same price of substitutes

When the price of a commodity falls, the prices of substitutes remain the same, consumers can buy more of the commodity and vice versa. The demand curve slopes downward due to the substitution effect.

The demand of poor people

The income of people is not the same, The rich people have money to buy the same commodity at high prices. A large majority of people are poor, They buy more when prices fall and vice versa. The demand curve slopes due to poor people.

Different uses of goods

There are different uses of many goods. When prices of such goods increase these goods are put into uses that are more important and their demand falls. The demand curve slopes downward due to such goods.

Exceptions to the law

Inferior goods

The law of demand does not apply in the case of inferior goods. When the price of inferior commodity decreases and its demand also decreases and the amount so saved is spent on the superior commodity. Wheat and rice are superior food grains while maize is inferior food grain.

Demonstration effect

The law of demand does not apply in the case of diamonds and jewelry. There is more demand when prices are high. There is less demand due to low prices. The rich people like to demonstrate such items that only they have such commodities.

Ignorance of consumers 

The consumer usually judges the quality of a commodity from its price. A low-priced commodity is considered inferior and less quantity is purchased. A high-priced commodity is treated as superior and more quantity is purchased. The law of demand does not apply in this case.

Less supply

The law of demand does not work when there is less supply of the commodity. People buy more for stock purposes even at a high price. They think that commodities will become short.

Depression

The law of demand does not work during periods of depression. The prices of commodities are low but there is an increase in demand. it is due to the low purchasing power of people.

Speculation

The law does not apply in the case of speculation. The speculators start buying shares just to raise the price. Then they start selling large quantities of shares to avoid losses.

Out of fashion  

The law of demand is not applicable in the case of goods out of fashion. The decrease in prices cannot raise the demand for such goods. The quantity purchased is less even though there is a fall in prices.

Importance of the law

Price determination

A monopolist can determine the price of a commodity-based on such law. He can know the effect on demand due to an increase or decrease in price. The demand schedule can help him to determine the most suitable price level.

Tax on commodities

The law of demand is important for tax authorities. The effect of tax on different commodities is checked. The commodity must be taxed if its demand is relatively inelastic. A commodity cannot be taxed if its sales fall to a great extent.

Agricultural prices 

The law of demand is useful to determine agricultural prices. When there are good crops, the prices come down due to changes in demand. In the case of bad crops, the prices go up if demand remains the same. The poverty of farmers can be determined.

Planning

An individual demand schedule is used in planning for individual goods and industries. There is a need to know the effect of change in price on the demand of commodities at national and world levels. The nature of the demand schedule helps to know such an effect. 

(Exam Studies)