ECONOMIC ANALYSIS

Module 2. Theory of demand

Lesson 6
LAW OF DEMAND

6.1 Introduction

In ordinary terms, demand means desire or want for something. Economic meaning of demand is much broad. It refers to the quantum of goods consumers are willing to purchase at a given price over a given period of time. Demand is the desire or want for any particular item backed up by ability to pay & willingness to pay. Thus a poor man’s desire to purchase a luxury car will not constitute demand due to lack of purchasing power. At the same time if a rich man desire to own a luxury car but if he not willing to spare the money then also it will not constitute demand. Demand is always quoted with price & time e.g. Demand for whole milk for middle income household is 1 liter per day at price of Rs. 28 per liter. Thus demand may be defined as ‘The demand for a product is the amount of it which will be bought per unit of time at a particular price.

6.2 Law of Demand

“The demand for a commodity increases with reduction in its price and decreases with increase in its price, other things remaining same.”

Explanation of the law of Demand: Following table depicts the hypothetical demand schedule for a whole milk.

Table 6.1 Hypothetical demand schedule for whole milk

By plotting the data of table we get a demand curve as shown in Fig. 6.1

6.2.1 Assumption of the law of demand

The following are the assumption of the law of demand

1. Consumers income remain same: During the time period of the law, it is necessary that there is no change in consumer income. If it increases he/she may be inclined to buy more even at higher price.

2. Consumer Preferences remains same: Consumers taste, choice, habits, should not change otherwise it may happen that if any product goes down the consumer preference scale than if might be purchased in less quantity even at same price.

3. No variation in fashion: If the product/item goes out of fashion, consumers might not purchase it even at reduced price.

4. Price of related goods should not change: If the price of substitute & complementary goods of a commodity decreases, consumers will be switching over to its purchases.

5. Price rise or shortage is not expected in future: If such a change is expected than consumers raise the demand in response to initial price rise. Such tendencies of consumers invalidate the law.

6. No change in demographics: During the operation period of the law, the number of persons, their age profile, sex ratio etc should not change.

7. No new varieties: Consumer should not get new type of goods due to innovations; otherwise it may change the choice of consumers.

8. No change in government rules: Government frames many rules for business houses including different types of direct & indirect taxes. Any change in such rules will effect the purchases by consumers.

Thus the law of demand is valid based on may such fixed preconditions. Any change is going to invalidate the law.

6.2.2 Exceptions to the law of demand

The consumer behavior of demanding more at a higher price and vice versa is just the opposite to the law of demand, such a behavior is exhibited by consumers for following goods/ conditions.

1. Giffin goods: Giffin goods are inferior goods e.g. cheap vegetables & food products. It is observed that when price of such giffin goods decreases, quite often less quatity is demanded than before due to negative income effect & increasing preferences for a better product with increase in their real income.

2. Snob appeal articles: Certain goods are attached with status symbol e.g. Luxury cars, diamonds etc. They are very costly & give psychological satisfaction. Thus some of the rich people prefer to buy such snob appeal articles in higher quantum with their increase in price.

3. Forecasting: If people believe that price of certain goods is going to increase in future, they may try to purchase them in present times even at higher price. Such a phenomena is observed in stock Market.

Wrong beliefs: If consumer has certain wrong belief that quality of product always decreases with fall in price, then they avoid purchases in such circumstances. Owing to such belief some consumers do not buy in stock clearance sale.