Economics: Law of Demand and Derivation

Law of Demand

The "Law of Demand" is one of the most important applied theories used in macroeconomics. It is pronounced by a Neo-Classical Economist, Alfred Marshall in his book "Principle of Economics". The "Law of Demand" is based on the functional relationship between price and quantity demand. There is an inverse relationship between price and quantity demand.

Alfred Marshall defines it as "Other things remaining the same, the amount demanded increases with a fall in price and diminishes with a rise in price."

Prof. Ferguson says, "According to the law of demand, the quantity demand varies inversely with price."

According to the Marshall, "Higher the price, lower the demand and lower the price, higher the demand."

It means the demanded quantity increases with the fall in price and diminishes with the rise in price. Thus, there is an inverse relation between price and demand for a commodity. This law can be expressed in demand function as D = f (P). Where,

D = Demand for a commodity

f = function

P = Price of the commodity

This law is based on the following assumptions:

• No change in income of consumer
• No change in taste and preference of the consumer
• No change in fashion and technology
• No change in price of substitution and complementary goods
• No change in population size

 

We can clarify the law of demand more clearly with the help of following demand schedule and curve:

Price (Rs)	Quantity Demand (Kg)
50	100
40	200
30	300
20	400
10	500

 

The above demand schedule shows that when the price increases, demand decreases but when the price of the commodity decreases, the demand for the commodity increases. When the price of the commodity is Rs.50, the demand quantity is 10kg and when the price decreases to 40, 30, 20 and 10, the demand quantity also increases to 200, 300, 400 and 500 respectively. Therefore, when the price falls, demand for the commodity increases and vice versa.

 

The demand curve is the graphical representation of price and demand for a commodity. In the above diagram, the X-axis represents quantity demanded and the Y-axis represents the price of a commodity. When the price of the commodity is Rs.10, then the demand is 500kg and when the price rises to Rs.20, the demand falls that is 400kg. Similarly, when the price increases from Rs.20, Rs.30, Rs.40 and Rs.50, the quantity demanded falls from 400, 300, 200 to 100kg. This shows the inverse relationship between price and demand. Thus, the demand curve DD is downward sloping curve.

EXCEPTION OR LIMITATIONS OF THE LAW OF DEMAND

• Price or Shortage Expectation

When the consumer feels that a certain commodity is going to be a shortage in near future or price is going to rise, they demand more goods and servicesat present price at a high amount for the future references.

• Goods for Basic Needs

Law of demand is not applicable in a case of basic or necessary goods. The demand for necessary goods such as salt, medicine, etc. remains unchanged at all level of price i.e. whether the price rises or falls, it does not bring any changes in demand.

• Change in Population

The next exception of the Law of Demand is a change in population. As there is an increase in population, it increases quantity demanded at the higher price. Likewise, as there is drastic fall in population due to any natural disaster or war, quantity demand falls even though there may be fall in price.

• Cultural and Religious Factors

If the goods are related to the cultural and religious factors, then the Law of Demand does not hold true.

• Giffen Goods

Those inferior goods whose quantity demanded increases with a rise in price and decreases with the fall in price are called giffen goods. It is also against the law of demand.

• Ignorance

If the consumers are ignorant about the market price, then they can purchase more units of goods at the higher price. Under such condition, the law of demand does not hold true.

DERIVATION OF INDIVIDUAL DEMAND CURVE

The quantity demanded by an individual consumer from the market at a given price at a particular time period is called individual demand. A schedule prepared on the basis of different units demanded by a consumer at a various price in a fixed time period is known as individual demand schedule. Individual demand curve can be derived with the help of the following schedule:

Price in Rs	Quantity purchased (units)
2	100
4	80
6	60
8	40
10	20

 

The above table shows the quantity demand of a commodity by a single consumer at various prices. When the price increases from Rs.2 to Rs.4, the demand decreases from 100 units to 80 units. Similarly, the price increases further to Rs.6, Rs.8 and Rs.10, the quantity demand decreases from 60 to 40 to 20 units respectively. This shows the inverse relation between price and quantity demand of a commodity.

 

The above figure, the individual demand curve shows the quantity demanded and prices of a commodity of a single consumer is shown on X-axis and Y-axis respectively. When the price is Rs.2 the consumer demanded 100 units of a commodity. And when the price rises to 4, 6, 8 and 10, the demand goes on decreasing to 80, 60, 40 and 20. Thus, the individual demand schedule shows the opposite relationship between price and demand.

DERIVATION OF MARKET DEMAND CURVE

Market demand is the sum of demand schedule of all individuals at a particular time. Market demand schedule shows the various quantities of a product that all individuals are willing to pay and able to purchase from the market at various prices during a given period of time. Market demand schedule is prepared after deriving the total demand at different prices. The following table shows the market demand schedule:

Price (in Rs)	Individual demands (Kg)		Total market demand (Kg)
	A	B
10	0	2	2
8	1	4	5
6	2	6	8
4	4	8	12
2	6	10	16

 

From the above table, we can assume the quantity demanded by various consumers at a various price. At Rs.10 per kg, the demand of A and B is 0kg and 2 kg. So, the total demand is 2kg. When the price decreases to Rs.8, the demand of consumers increases to 1kg and 4 kg. Total demand is 5kg. Finally, when the price falls to Rs.2 per kg, the quantity demanded rise up to 6kg and 10kg (total 16kg) by both consumer. This shows the market demand increases as the price of the commodity decreases.

When this schedule is converted into a figure it is called market demand curve.

 

In the above figure, the X-axis represents the quantity demanded and the Y-axis shows the price of a commodity. DD_A and DD_B are the individual demand curve for the consumer A and B. The market demand curve DD_M is derived by the horizontal addition of individual demand DD_A and DD_B. In market demand curve DD_M, when the price is Rs.10 per kg aggregate demand is 2kg. Similarly, when the price is Rs 2 per kg, aggregate demand is 16kg.