Before we proceed, we should have concept of "Demand".
Demand: Demand is willingness of people (public) of buying a commodity at a given market price in a specific time period.
Law of Demand is known as Demand Analysis for Quantitative Demand Analysis. This work has been developed by Marshall and therefore the Demand Curve derived from this law is known as Marshallian Demand Curve.
The Law of Demand identifies inverse relationship between Demand for the product and price of the product. It is observed that in the market when price of the product is increasing, demand for the product is getting downward trend and vice versa. This is rational behavior of the consumer in the market.
Demand Function is reflecting the inverse relationship between demand for the product and price of the product in the market.
D = f (P)
where,
D = Demand for the product
P = Price of the product
The Law of Demand is dependent on the following factors:
1. Principal of Diminishing Marginal Utility -
This factor is accepted as the basis of Law of Demand. In this factor we observe that when a consumer is consuming continuously different units of a particular product in a given time, given income, given tests and preferences, given prices of the substitute products, it is observed that in this situation Total Utility for the Consumer increases but at a diminishing rate and therefore marginal utility parameter is diminishing. As Demand parameter is based on Marginal Utility Parameter, and as Marginal Utility Parameter is getting a downward trend and therefore Demand Parameter is also getting a downward trend. Thus it is observed that Marginal Utility is the main determinant of demand Parameter.
2. Income Effect -
Income Effect is an important determinant of demand parameter. It is observed that the real income parameter is ultimately determining the nature of demand in the market,where,
Real Income = (Money Income) / (Consumer Price)
It is observed that when real income of the consumer is increasing, the ability to pay of the consumer is increasing and therefore the demand for the product is increasing. Similarly if the real income parameter is declining the ability to pay of the consumer is getting downward trend and therefore demand parameter in this situation gets a downward trend. This behavior is reflected in the income equation, i.e.,
D = f (y)
where,
D = Demand for the product
y = Real Income of the consumer
Thus we observe that real income parameter is another important determinant of the demand parameter.
3. Substitution Effect -
This is important factor of Law of Demand particularly in changed economic scenario for which different substitute products are operating in the market. According to this factor, upon a significant increase in the price of a product the demand of its substitute products increases. For example, if there are two products X and Y in the market, which are known as Substitute Products, and the price of product X has increased significantly while the price of product Y remains more or less constant, in this situation we get that demand for product Y increases. The manager understands that the demand for his/her product is directly dependent on the price of each substitute product. In Indian economy since 1991, new economy policy has been accepted, based on the parameters Liberalization, Privatization and Globalization, in this changed economic scenario there are lots of substitute products which are being produced by the New Domestic Firms including New Foreign Firms. In this situation the substitution effect is playing dominant role in the determination of demand parameter.
4. Price Effect -
This factor is the combination of income effect and the substitution effect. Price effect is itself known as Law of Demand as in the price effect we observe inverse relationship in demand for the product and price of the product. It is seen that when price of the product is increasing demand parameter is getting a downward trend and similarly when price of the product is decreasing demand parameter is getting an upward trend.
Exceptions of Law of Demand
There are certain cases where we do not get the inverse relationship between demand for the product and price of the product. These cases are known as Exceptional Cases of Law of Demand. These are as follows:
1. In case of the consumers with very high level of income, the law of demand does not hold good. These customers are primarily interested in the purchase of luxurious items which are known as Status Symbol Product in the economy. In this case it is observed that when price of these products is increasing, these consumers demand more of this product as at that time the product is reflecting higher status in the economy. Similarly when price of these products is falling, these consumers are not interested to purchase these products because at this time the product is indicating low status in the economy. Therefore we observe that in this situation there is a positive relationship between Demand for the product and Price of the product.
2. Giffen has pointed out that law of demand does not hold good in case of the behavior of the consumers who are having very low level of income. In this situation, it is observed that these consumers are primarily associated with the purchase of basic essentials. If price of basic essentials is going up these consumers withdraw their income from the consumption of comfort and spend the entire income for the purchase of basic essentials only not only for the present consumption but also for future consumption. Therefore at this time we observe a positive relationship between Demand for the product and Price of the product.
3. The law of demand does not hold good in case of behavior of the consumers who perform consumption activities on the basis of speculation. In this situation, it is observed that if price of the product is increasing slightly, the consumers speculate that the price of product will increase significant in the near future and therefore it will be better as present to purchase more of the product not only for present consumption but also for future consumption. Therefore in this situation we get a positive relationship between Demand for the product and Price of the product. This behavior is generally observed in stock market.
4. The law of demand does not hold good if there is any departure from the condition of the principle of diminishing marginal utility which is known as the basis of the law of demand.
Therefore it is observed that there will be an inverse relationship between demand for the product and price of the product other things remaining constant, i.e., Income parameter, Test and Preferences parameter, Price of the substitute product parameter.