Rationale of Law of Demand

Rationale of Law of Demand

The law of demand states that other things remaining constant if the price of a product declines then the demand for such product increases whereas if the price of a product rise then the demand for such product declines. Therefore, we can say that an inverse relationship exists between the price of the given commodity and the quantity demanded of such commodity, ceteris paribus.  

Why does a demand curve slopes downward?

Usually the demand curve is downward sloping. This implies that the quantity demanded is more at lower prices and vice versa.  Now let’s see the reasons of downward sloping demand curve.

  • Law of diminishing marginal utility: The law states that as a consumer consumes successive units of a given commodity at a given time, the utility derive out of each additional unit diminishes. In other words, consumer is willing to pay less for the additional unit consumed as each additional unit consumed gives lower satisfaction. Consumer is at equilibrium where marginal utility of a commodity is equal to its price( Mux = Px).When the price falls the equilibrium is disturbed and in order  to regain equilibrium, demand rises with the fall in price, this leads to further reduction in marginal utility which then falls and becomes equal to the price.
  • Substitution effect: The change in quantity demanded of a commodity due to change in its price, keeping prices of substitutes constant is termed as substitution affect. As the price of the commodity falls it becomes cheaper and more attracted as comparison to its substitutes, therefore consumer demands more of a cheaper commodity in place of the other one. Hence, demand rises when price falls. For example decrease in the price of tea will result in the decrease in demand of coffee as the price of the coffee is unchanged and the consumer can buy the substitute of coffee i.e. tea at a lower price.
  • Income Effect: The change in quantity demanded for a commodity due to change in its price, keeping money income constant is called income effect. As the price of a commodity falls, real income of consumer increases and they are able to purchase more hence demand rises with the fall in price. For example if a consumer can buy 10 pens @$15 each by paying $150. Now if the price of pen falls to @$10/- each, then the consumer can buy 15 pens with the same amount which thereby increases the purchasing power of the consumer.

(Substitution effect + Income effect = Price effect)

  • Additional consumers: When the price of the commodity falls, new consumer who could not afford to buy the given commodity starts demanding it. New buyers push up the demand of the commodity along with the old ones. Hence demand of the commodity rises with the fall in its price.
  • Different uses: If the commodity has different uses and its price falls then the commodity can be used for varied purposes and as a result the demand of the commodity rises whereas if the price of the commodity increases then such commodity will be used for limited purpose. Therefore, different uses of the commodity are also a reason for the downward sloping demand curve.

Final Thought:

Law of demand states that more of the quantity of any given product will be demanded when there is a decrease in the price of the commodity and vice versa. The reasons of downward sloping demand curve includes law of diminishing marginal utility, income effect, and consumer effect, various uses of commodity and Arrival of new consumers.

Related Articles:

  1. What is Demand?
  2. Law of Demand
  3. Determinants of Demand

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