Demand and Law of Demand

What is Demand?
Demand for a commodity refers to the quantity of the commodity that people are willing to purchase at a specific price per unit of time, other factors (such as price of related goods, income, tastes and preferences, advertising, etc) being constant. Demand includes the desire to buy the commodity accompanied by the willingness to buy it and sufficient purchasing power to purchase it. For instance-Everyone might have willingness to buy “Mercedes-S class” but only a few have the ability to pay for it. Thus, everyone cannot be said to have a demand for the car “Mercedes-s Class”.

Demand may arise from individuals, household and market. When goods are demanded by individuals (for instance-clothes, shoes), it is called as individual demand. Goods demanded by household constitute household demand (for instance-demand for house, washing machine). Demand for a commodity by all individuals/households in the market in total constitute market demand.

Demand is an economic principle referring to a consumer's desire to purchase goods and services and willingness to pay a price for a specific good or service. Holding all other factors constant, an increase in the price of a good or service will decrease the quantity demanded, and vice versa. Market demand is the total quantity demanded across all consumers in a market for a given good. Aggregate demand is the total demand for all goods and services in an economy.

Determinants of Demand

There are five determinants of demand. The most important is the price of the good or service itself. The second is the price of related products, whether they are substitutes or complementary. Circumstances drive the next three determinants. The first is consumer incomes or how much money they have to spend. The second is buyers' tastes or preferences in what they want to purchase. If they prefer electric vehicles to save on gasoline, then demand for Humvees will drop. The third is their expectations about whether the price will go up. If they are concerned about future inflation they will stock up now, thus driving current demand.

What drives demand? In economics, there are five determinants of individual demand and a sixth for aggregate demand.

The five determinants of demand are:

1. The price of the good or service.
2. Income of buyers.
3. Prices of related goods or services. These are either complementary, those purchased along with a particular good or service, or substitutes, those purchased instead of a certain good or service. 
4. Tastes or preferences of consumers.
5. Expectations. These are usually about whether the price will go up.

Demand function is a mathematical function showing relationship between the quantity demanded of a commodity and the factors influencing demand.

Dx = f (Px, Py, T, Y, A, Pp, Ep, U)

In the above equation,

Dx = Quantity demanded of a commodity

Px = Price of the commodity

Py = Price of related goods

T = Tastes and preferences of consumer

Y = Income level

A = Advertising and promotional activities

Pp = Population (Size of the market)

Ep = Consumer’s expectations about future prices

U = Specific factors affecting demand for a commodity such as seasonal changes, taxation policy, availability of credit facilities, etc.

Law of Demand:
The law of demand is one of the most fundamental concepts in 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 everyday transactions. The law of demand states that quantity purchased varies inversely with price. In other words, the higher the price, the lower the quantity demanded. This occurs because of diminishing marginal utility. That is, consumers use the first units of an economic good they purchase to serve their most urgent needs first, and use each additional unit of the good to serve successively lower valued ends.

The law of demand states that other factors being constant (cetris peribus), price and quantity demand of any good and service are inversely related to each other. When the price of a product increases, the demand for the same product will fall.

Law of demand explains consumer choice behavior when the price changes. In the market, assuming other factors affecting demand being constant, when the price of a good rises, it leads to a fall in the demand of that good. This is the natural consumer choice behavior. This happens because a consumer hesitates to spend more for the good with the fear of going out of cash.
Demand schedule is a tabular representation of the quantity demanded of a commodity at various prices. 

Demand curve is a diagrammatic representation of demand schedule. It is a graphical representation of price- quantity relationship. Individual demand curve shows the highest price which an individual is willing to pay for different quantities of the commodity. While, each point on the market demand curve depicts the maximum quantity of the commodity which all consumers taken together would be willing to buy at each level of price, under given demand conditions.

Demand curve has a negative slope, i.e, it slopes downwards from left to right depicting that with increase in price, quantity demanded falls and vice versa. The reasons for a downward sloping demand curve can be explained as follows-

1. Income effect- With the fall in price of a commodity, the purchasing power of consumer increases. Thus, he can buy same quantity of commodity with less money or he can purchase greater quantities of same commodity with same money. Similarly, if the price of a commodity rises, it is equivalent to decrease in income of the consumer as now he has to spend more for buying the same quantity as before. This change in purchasing power due to price change is known as income effect.
2. Substitution effect- When price of a commodity falls, it becomes relatively cheaper compared to other commodities whose price have not changed. Thus, the consumer tend to consume more of the commodity whose price has fallen, i.e, they tend to substitute that commodity for other commodities which have not become relatively dear.
3. Law of diminishing marginal utility- It is the basic cause of the law of demand. The law of diminishing marginal utility states that as an individual consumes more and more units of a commodity, the utility derived from it goes on decreasing. So as to get maximum satisfaction, an individual purchases in such a manner that the marginal utility of the commodity is equal to the price of the commodity. When the price of commodity falls, a rational consumer purchases more so as to equate the marginal utility and the price level. Thus, if a consumer wants to purchase larger quantities, then the price must be lowered. This is what the law of demand also states.

Exceptions to Law of Demand

The instances where law of demand is not applicable are as follows-

1. There are certain goods which are purchased mainly for their snob appeal, such as, diamonds, air conditioners, luxury cars, antique paintings, etc. These goods are used as status symbols to display one’s wealth. The more expensive these goods become, more valuable will be they as status symbols and more will be there demand. Thus, such goods are purchased more at higher price and are purchased less at lower prices. Such goods are called as conspicuous goods.
2. The law of demand is also not applicable in case of giffen goods. Giffen goods are those inferior goods, whose income effect is stronger than substitution effect. These are consumed by poor households as a necessity. For instance, potatoes, animal fat oil, low quality rice, etc. An increase in price of such good increases its demand and a decrease in price of such good decreases its demand.
3. The law of demand does not apply in case of expectations of change in price of the commodity, i.e, in case of speculation. Consumers tend to purchase less or tend to postpone the purchase if they expect a fall in price of commodity in future. Similarly, they tend to purchase more at high price expecting the prices to increase in future.