The law of demand is a fundamental principle in economics that states that, all other factors being equal, the quantity of a good or service that consumers are willing and able to purchase decreases as the price increases. This relationship between price and quantity demanded is typically represented by a downward-sloping demand curve, which shows the quantity of a good or service that consumers are willing to purchase at different price points.
The law of demand is based on the concept of marginal utility, which refers to the additional satisfaction or benefit that a consumer derives from consuming an additional unit of a good or service. As consumers purchase more of a good or service, the marginal utility of each additional unit decreases, leading to a decrease in demand.
There are several factors that can affect the law of demand, including the income and wealth of consumers, the prices of related goods or services, and consumer tastes and preferences. For example, if a consumer’s income increases, they may be willing to purchase more of a good or service, leading to an increase in demand. Conversely, if the price of a related good or service increases, it may cause consumers to substitute away from the original good or service, leading to a decrease in demand.
The law of demand is an important concept in economics, as it helps to explain how prices and quantities of goods and services are determined in a market. It is also a key factor in the development of economic policy, as it can be used to understand how changes in prices or other economic conditions may affect consumer behavior and the overall economy. The following are illustrative examples of the law of demand.
Prices Rise, Demand Falls
A global shortage of pineapples causes prices to rise from $304 a ton to $404 a ton. Demand drops from 1 million pineapples a month to 600,000 pineapples a month as consumers can easily find substitute products such as other fruits.
Prices Fall, Demand Rises
Solar panel manufacturers regularly reduce the cost per watt for solar panels, sparking increased demand on a global basis. Between 1975 and 2018, price per watt dropped from around $64 to around $1 in many markets. This caused solar panel demand to surge from being a niche product to a common sight on rooftops in many nations.
Demand Rises, Prices Rise
Demand for real estate in a particular region increases due to foreign investors looking for a safe place to invest their wealth. This causes increased competition for each property on the market and prices rise.
Demand Falls, Prices Fall
A trendy technology company with a high stock valuation reports that grow is slowing while spending is surging. Demand for the stock instantly collapses and little demand materializes until the price has fallen more than 50%.
It is customary for bottled water in a particular nation to cost $1.50 or less. The nation increases its value added taxes and some sellers try to pass this cost to customers with a price of $1.60. Sellers who increase the price find that demand drops 70% as people are accustomed to the $1.50 price. With time, most sellers revert back to the old price.
The law of demand has many exceptions. For example, a speculative bubble in stocks might produce situations where price increases stimulate more demand due to a fear of missing out amongst investors.