Law of Demand

80-20 Rule

What is the law of demand?

The law of demand is one of the most basic concepts of economics. It works with the law of supply to explain how market economies allocate resources and determine the prices of goods and services that we observe in daily transactions. The law of demand stipulates that the quantity purchased varies inversely with the price. In other words, the higher the price, the lower the quantity demanded. This occurs due to diminishing marginal utility. That is, consumers use the first units of an economic good they buy to meet their most urgent needs first, and use each additional unit of the good to successively serve lower value purposes.

Key points to remember

  • The law of demand is a fundamental principle of economics which states that at a higher price, consumers will demand less of the good.
  • The demand stems from the law of diminishing marginal utility, the fact that consumers use economic goods first to meet their most urgent needs.
  • A market demand curve expresses the sum of the quantities demanded at each price for all consumers in the market.
  • Price changes can be reflected in movements along a demand curve, but do not per se increase or decrease demand.
  • The form and extent of demand changes in response to changes in consumer preferences, income or related economic goods, NOT price changes.

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Law of demand

Understanding the law of demand

Economics involves the study of how people use limited means to meet unlimited needs. The law of demand focuses on these unlimited needs. Naturally, people prioritize the most urgent wants and needs over the least urgent ones, in their economic behavior, and this affects how people choose from the limited means available to them. For any economic good, the first unit of that good that a consumer gets hold of will tend to be used to satisfy the most urgent need of the consumer that this good can satisfy.

For example, consider a shipwrecked man on a desert island who obtains a pack of six bottles of fresh water washed ashore. The first bottle will be used to satisfy the most urgent need felt by the shipwrecked person, most likely drinking water to avoid dying of thirst. The second bottle can be used for bathing to avoid illness, an urgent but less immediate need. The third bottle could be used for a less urgent need, such as boiling fish for a hot meal, and up to the last bottle, which the castaway uses for a relatively low priority like watering a small plant in pot to keep him company. Island.

In our example, because each additional bottle of water is used for a need or a need successively less valued by our castaway, we can say that the castaway values ​​each additional bottle less than the previous one. Likewise, when consumers buy goods on the market, each additional unit of a given good or service they buy will be used at a lower value than the previous one, so we can say that they value each unit additional less and less. Because they value less for each additional unit of property, they are willing to pay less for it. Thus, the more units a good consumer purchases, the less he is willing to pay in terms of price.

By adding together all the units of a good that consumers are ready to buy at a given price, we can describe a market demand curve, always in a downward slope, like the one illustrated in the graph below. Each point on the curve (A, B, C) reflects the quantity demanded (Q) at a given price (P). At point A, for example, the quantity demanded is low (Q1) and the price is high (P1). At higher prices, consumers demand less of the good and at lower prices, they demand more.

Image of Julie Bang © Investopedia 2019

Demand vs quantity demanded

In economic thought, it is important to understand the difference between the phenomenon of demand and the quantity demanded. In the graph, the term “demand” refers to the green line drawn through A, B and C. It expresses the relationship between the urgency of consumer needs and the number of units of the economic good in question. A change in demand means a change in position or shape of this curve; it reflects a change in the underlying structure of consumers’ wants and needs compared to the means available to satisfy them. In contrast, the term “quantity requested” refers to a point along the horizontal axis. Changes in the quantity demanded strictly reflect price changes, without implying a change in the pattern of consumer preferences. Changes in the quantity demanded simply mean a movement along the demand curve itself due to a change in price. These two ideas are often confused, but this is a common mistake; the rise (or fall) in prices does not decrease (or increase) demand, they change the quantity demanded.

Factors affecting demand

So what is the change request? The shape and position of the demand curve can be affected by several factors. Rising incomes tend to increase the demand for normal economic goods, as people are willing to spend more. The availability of close substitutes that compete with a given economic good will tend to reduce demand for that good, as they can satisfy the same types of wants and needs of consumers. Conversely, the availability of closely complementary products will tend to increase demand for an economic good, since the use of two products together may be even more valuable to consumers than using them separately, such as peanut butter and jelly. Other factors such as future expectations, changes in basic environmental conditions, or changes in the actual or perceived quality of a good can change the demand curve, as they change the pattern of consumer preferences for how the asset can be used and how urgent it is. necessary.

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