Law of Demand - all else constant, as price falls, the quantity demanded rises. Similarly, as price increases, the corresponding quantity demanded falls. This relationship leads to the downward sloping demand curve.
Rationale:
1.) Common sense and simple observation seems to substantiate this assertion
2.) Consumption is subject to diminishing marginal utility - consuming successive units of a particular product yields less and less extra satisfaction. For example; after the first hamburger getting a second hamburger is less appealing because the person is not as hungry.
3.) The income effect - a decline in the price increases the purchasing power of a buyer's money, enabling him or her to buy more of the product than before.
3.) The income effect - a decline in the price increases the purchasing power of a buyer's money, enabling him or her to buy more of the product than before.
4.) The substitution effect - at a lower price, buyers have the incentive to substitute the cheaper good for similar goods which are now relatively more expensive. For example, at a lower price, beef is relatively more attractive and is substituted for pork, mutton, chicken, etc.
Exceptions to law of demand
1. Giffen goods
2.
Veblen goods
Veblen goods
3.
Speculation
Speculation
4.
Life saving drugs
Life saving drugs
5.
Ignorance buying
Ignorance buying
6. Fear of scarcity
7. Necessaries
Giffen goods: these are those inferior goods on which the consumer spends a large part of his income and the demand for which falls with a fall in their price. The demand curve for these has a positive slope. the consumers of such goods are mostly the poor. a rise in their price drains their resources and the poor have to shift their consumption from the more expensive goods to the giffen goods, while a fall in the price would spare the household some money for more expensive goods. which still remain cheaper. These goods have no closely related substitutes; hence income effect is higher than substitution effect.
Articles of snob appeal: Goods which serve ' status symbol ' do not follow the law of demand. These are goods of ' conspicuous consumption '.they gives their possessor utility in the sense of their ownership. Rich buy diamond as their possession is prestigious. When their price rises the prestige value goes up.
-Expectations regarding future prices: If the price of a commodity is rising and is expected to rise in future the demand for the commodity will increase.
Emergency: At times of war, famine etc. consumers have an abnormal behavior. If they expect shortage in goods they would buy and hoard goods even at higher prices. In depression they will buy less at even low prices.
-Quality-price relationship: some people assume that expensive goods are of a higher quality then the low priced goods. In this case more goods are demanded at higher prices.
Articles of snob appeal: Goods which serve ' status symbol ' do not follow the law of demand. These are goods of ' conspicuous consumption '.they gives their possessor utility in the sense of their ownership. Rich buy diamond as their possession is prestigious. When their price rises the prestige value goes up.
-Expectations regarding future prices: If the price of a commodity is rising and is expected to rise in future the demand for the commodity will increase.
Emergency: At times of war, famine etc. consumers have an abnormal behavior. If they expect shortage in goods they would buy and hoard goods even at higher prices. In depression they will buy less at even low prices.
-Quality-price relationship: some people assume that expensive goods are of a higher quality then the low priced goods. In this case more goods are demanded at higher prices.
The degree to which a demand or supply curve reacts to a change in price is the curve's elasticity. Elasticity varies among products because some products may be more essential to the consumer. Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases. Conversely, a price increase of a good or service that is considered less of a necessity will deter more consumers because the opportunity cost of buying the product will become too high.
A good or service is considered to be highly elastic if a slight change in price leads to a sharp change in the quantity demanded or supplied. Usually these kinds of products are readily available in the market and a person may not necessarily need them in his or her daily life. On the other hand, an inelastic good or service is one in which changes in price witness only modest changes in the quantity demanded or supplied, if any at all. These goods tend to be things that are more of a necessity to the consumer in his or her daily life.
To determine the elasticity of the supply or demand curves, we can use this simple equation:
To determine the elasticity of the supply or demand curves, we can use this simple equation:
Elasticity = (% change in quantity / % change in price) |
If elasticity is greater than or equal to one, the curve is considered to be elastic. If it is less than one, the curve is said to be inelastic.
Types of PED:
1. Perfectly elastic demand: (Ep=
) It shows a small change in proce needs to add infinity changes in demand. The shape of the cure is horizontal
) It shows a small change in proce needs to add infinity changes in demand. The shape of the cure is horizontalFactors Affecting Demand Elasticity
There are three main factors that influence a demand's price elasticity:
1. The availability of substitutes - This is probably the most important factor influencing the elasticity of a good or service. In general, the more substitutes, the more elastic the demand will be. For example, if the price of a cup of coffee went up by $0.25, consumers could replace their morning caffeine with a cup of tea. This means that coffee is an elastic good because a raise in price will cause a large decrease in demand as consumers start buying more tea instead of coffee.
However, if the price of caffeine were to go up as a whole, we would probably see little change in the consumption of coffee or tea because there are few substitutes for caffeine. Most people are not willing to give up their morning cup of caffeine no matter what the price. We would say, therefore, that caffeine is an inelastic product because of its lack of substitutes. Thus, while a product within an industry is elastic due to the availability of substitutes, the industry itself tends to be inelastic. Usually, unique goods such as diamonds are inelastic because they have few if any substitutes.
2. Amount of income available to spend on the good - This factor affecting demand elasticity refers to the total a person can spend on a particular good or service. Thus, if the price of a can of Coke goes up from $0.50 to $1 and income stays the same, the income that is available to spend on coke, which is $2, is now enough for only two rather than four cans of Coke. In other words, the consumer is forced to reduce his or her demand of Coke. Thus if there is an increase in price and no change in the amount of income available to spend on the good, there will be an elastic reaction in demand; demand will be sensitive to a change in price if there is no change in income.
3. Time - The third influential factor is time. If the price of cigarettes goes up $2 per pack, a smoker with very few available substitutes will most likely continue buying his or her daily cigarettes. This means that tobacco is inelastic because the change in price will not have a significant influence on the quantity demanded. However, if that smoker finds that he or she cannot afford to spend the extra $2 per day and begins to kick the habit over a period of time, the price elasticity of cigarettes for that consumer becomes elastic in the long run.
However, if the price of caffeine were to go up as a whole, we would probably see little change in the consumption of coffee or tea because there are few substitutes for caffeine. Most people are not willing to give up their morning cup of caffeine no matter what the price. We would say, therefore, that caffeine is an inelastic product because of its lack of substitutes. Thus, while a product within an industry is elastic due to the availability of substitutes, the industry itself tends to be inelastic. Usually, unique goods such as diamonds are inelastic because they have few if any substitutes.
2. Amount of income available to spend on the good - This factor affecting demand elasticity refers to the total a person can spend on a particular good or service. Thus, if the price of a can of Coke goes up from $0.50 to $1 and income stays the same, the income that is available to spend on coke, which is $2, is now enough for only two rather than four cans of Coke. In other words, the consumer is forced to reduce his or her demand of Coke. Thus if there is an increase in price and no change in the amount of income available to spend on the good, there will be an elastic reaction in demand; demand will be sensitive to a change in price if there is no change in income.
3. Time - The third influential factor is time. If the price of cigarettes goes up $2 per pack, a smoker with very few available substitutes will most likely continue buying his or her daily cigarettes. This means that tobacco is inelastic because the change in price will not have a significant influence on the quantity demanded. However, if that smoker finds that he or she cannot afford to spend the extra $2 per day and begins to kick the habit over a period of time, the price elasticity of cigarettes for that consumer becomes elastic in the long run.
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