Elements and Analysis of Law of Demand

Before discussing the law of demand, we need to understand demand in economics. When we find people protesting against price hike or shortage of wheat, the newspapers report them demanding for wheat on low prices. However, in economic terms, demand is different from what a layman or a journalist like to define it.

Melvin and Boyes like to define demand as the quantity of well defined good or service that people are willing and able to buy during a particular period. Accordingly, demand is comprised of following three elements:

  • Desire or effective want for some product
  • Ability to pay the price for the product
  • Willingness to purchase and own the product

Understandably, elimination of a single element, the desire for a product does not qualify to be a demand. You can desire strongly for a Rolls-Royce motor, but you can’t term it a demand if you don’t have money to purchase it. Even if you have money but willing to own a Mitsubishi Pajero, your desire for Rolls-Royce can’t be termed a demand.

This demand can’t be same at all times and all prices. So, demand is for the quantity which can be purchased at per unit price in per unit of time.

Levels of Demand

There are three levels of demand; individual, market and aggregate.

The individual demand is a demand made by individuals like you and me. It is influenced by income, preferences and taste of the consumers. The price vis-à-vis its substitutes and complements also affects the demand. The future expectations or fears of consumer regarding price and advertisements also influence individual demand for a product.

The market demand is a demand made by a market. It is governed by number of consumers, distribution of wealth and common habits and preferences of the market (targeted income group). The demographic structure and product price vis-à-vis substitutes and complements also influence the market demand.

The aggregate demand is not related to managerial economics. However, it is defined as: “The total amount of goods and services demanded in the economy at a given overall price level and in a given time period.”  It is influenced by changes in fiscal and monetary policies of a country, changes in income and inflation of the country, changes in household income and international economic factors.

Elements of Law of Demand

There are two main elements of the law of demand:

a)   The demand for a product rises with fall in price and decreases with increase in price. This change in demand is inverse to the change in price.

b)   It can only happen with the condition of ‘ceteribus paribus’ (Latin for ‘assumption that all else is held constant).

The second condition makes this model conditionally practicable as it is impossible to keep everything else (influencing factors) constant. Whenever you study rise and fall in demand for a product, you will find one or more of the following factors changing frequently:

  • Income of the consumers
  • Wealth distribution
  • Preferences of the consumers
  • Fashion
  • Price of the related products
  • Future expectations of prices
  • Demographic structures and population growth
  • Government policies

Whatever limitations may be the whole managerial economics structure follows the law of supply and demand.

Is 'Law of Demand' a Law?

This question can be raised for all social laws. For example, it is socially desired that the parents should look after their kids. But can we term it a law?

When you violate a man-made coded law (like theft or fraud), there are corporal or financial punishments. Similarly, when you violate a natural law without the aid of technology (like jumping from a plane without a parachute), there are punishments.

Is there any punishment for violation of the law of demand?

Suppose you take Coca-Cola as a soft drink. Due to some reason, the Coca-Cola decides to increase the prices. As per the law of demand, the demand for Pepsi-Cola shall rise. Will you continue to purchase Coca-Cola at a high price or shift towards Pepsi-Cola?

The economists presume that the consumers are rational people while deciding on spending. If you continue to purchase Coca-Cola at higher rates, you shall suffer a financial loss. Similarly, if Coca-Cola continues with higher prices, it shall eventually lose the market.

Under the circumstances, a violation of the law of demand has its financial implications and punishments. In fact, the economic laws are defined by observing human behavior in certain conditions. When a majority of the people follow a set pattern, we are inclined to build an economic model.

However, there are certain situations in which law of demand does not work. For example, it does not explain prices of the durable goods when second hand and new products of the same category are available simultaneously in the market. Furthermore, the law of demand does not work in following situations:

1-   Giffen Goods (basic staple food)

2-   Veblen Goods (Snob goods)

3-   Speculative Market Goods

4-   Psychologically Bias Relating Goods (Many people evaluate the quality of a product by its price)

5-   Demand for scarcity or fear of scarcity

6-   Necessities (like basic staple food)