Learn about one of the most fundamental laws in economics and how it is ingrained in your thinking and actions. Hear about some examples that reinforce this powerful law and a few rare exceptions.
Law of Demand
There is no escaping it. One of the most fundamental building blocks of economics is the law of demand. Every time you pull out your pocketbook to purchase something, the law of demand is at work. The better you understand the law of demand, the better you will understand why you pay different prices for different goods. If you want to run your own business someday, work in the marketing department, or simply want to sell your house, your success will start with your understanding of this concept.
Demand is the relationship between the quantity of a good or service consumers will purchase and the price charged for that good. The law of demand states that the quantity demanded for a good rises as the price falls, with all other things staying the same. The ‘all other things staying the same’ part is really important.
There are other things that can affect demand besides price. They are prices of related goods or services, income, tastes or preferences, and expectations. For example, if you really like Apple products, you might not mind paying a higher price for the new phone that just came out. If you get a new job and your income goes up, you might not mind paying higher prices for certain goods because of your newfound wealth.
In simple language, we can say that when the price of a good rises, people buy less of that good. When the price falls, people buy more of it, with other things remaining the same. The main reason economists believe so strongly in the law of demand is that it is so believable, even to people who don’t study economics. The law of demand is ingrained in our way of thinking about everyday things. Let’s see if a few examples help reinforce this.
When the price of an apple goes from $0.95 to $0.75, the quantity demanded will go up. Many people who weren’t willing to buy apples at $0.95 are now willing to purchase them at $0.75.
When your local Starbucks raises the prices of a coffee from $1.75 to $2.25, the quantity of coffee demanded will decrease. Less people will buy coffee because of the price increase. Some people may decide to make their own coffee at home, and others will cut back on their number of weekly trips.
Ask any grocery store expert, and they will tell you that shoppers buy more strawberries when they are in season and the price is low. This is evidence for the law of demand: only at the lower, in-season price are consumers willing to buy the higher amount available.
Have you ever tried to sell a house that has sat on the market for a long time? If so, what did the realtor eventually tell you? I bet he or she said you needed to lower the price. All realtors know that the number of potential buyers for any given house increases as the price decreases. You want to sell that house, lower the price.
When Best Buy promotes a sale on all televisions, they are simply trying to attract those new individuals that are willing to buy a television at the new lower price – the law of demand at work.
Exceptions to the Rule
There are a few exceptions worth noting. In rare situations, sometimes a lower price doesn’t increase quantity demanded of a product, or an increase in price doesn’t reduce the quantity demanded of a product.
Here are a few of those rare cases:
- Prestige goods – There are certain commodities, like diamonds or sports cars, that are purchased as a mark of distinction in society. If the price of these goods rise, the demand for them may increase instead of falling. These goods can be seen as status or symbols of wealth.
- Price expectations – If people expect a further rise in the price of a particular good, such as gas, they may buy more regardless of the rise in price.
- Ignorance of the consumer – If the consumer is ignorant about the rise in price of goods, he or she may buy more at a higher price.
One of the most fundamental building blocks of economics is the law of demand. The law of demand states that the quantity demanded for a good rises as the price falls, with all other things staying the same. In simple language, we can say that when the price of a good rises, people buy less of that good. When the price falls, people buy more of it. This is most likely ingrained in your everyday behaviors. How many times you decide to go to the local coffee shop, how much fruit you buy at the grocery store, and how many people buy your product on eBay, are all results of the law of demand.
Once you’ve finished with this lesson, you should have the ability to:
- Describe the law of demand
- Explain factors that affect demand
- Identify three exceptions to the law of demand