Monday, May 19, 2014

Law of Demand: Assumptions and Exceptions

Law of Demand
Among the many causal factors affecting demand, price is the most significant and the price- quantity relationship called as the Law of Demand is stated as follows: "The greater the amount to be sold, the smaller must be the price at which it is offered in order that it may find purchasers, or in other words, the amount demanded increases with a fall in price and diminishes with a rise in price" (Alfred Marshall).
In simple words other things being equal, quantity demanded will be more at a lower price than at higher price. The law assumes that income, taste, fashion, prices of related goods, etc. remain the same in a given period. The law indicates the inverse relation between the price of a commodity and its quantity demanded in the market. However, it should be remembered that the law is only an indicative and not a quantitative statement. This means that it is not necessary that such variation in demand be proportionate to the change in price.
Assumptions to law of demand
The statement of the law of demand, demonstrates that that this law operates only when all other things remain constant. These are then the assumptions of the law of demand. We can state the assumptions of the law of demand as follows:

1. Income level should remain constant: The law of demand operates only when the income level of the buyer remains constant. If the income rises while the price of the commodity does not fall, it is quite likely that the demand may increase.
2. Tastes of the buyer should not alter: It often happens that when tastes or fashions change people revise their preferences. As a consequence, the demand for the commodity which goes down the preference scale of the consumers declines even though its price does not change.
3. Prices of other goods should remain constant: Changes in the prices of other goods often affect the demand for a particular commodity. Therefore, for the law of demand to operate it is imperative that prices of other goods do not change.
4. No new substitutes for the commodity: If some new substitutes for a commodity appear in the market, its demand generally declines. This is quite natural, because with the availability of new substitutes some buyers will be attracted towards new products and the demand for the older product will fall even though price remains unchanged. Hence, the law of demand operates only when the market for a commodity is not threatened by new substitutes.
5. Price rise in future should not be expected: If the buyers of a commodity expect that its price will rise in future they raise its demand in response to an initial price rise which violates the law of demand. Therefore, it is necessary that there must not be any expectations of price rise in the future.
6. Advertising expenditure should remain the same If the advertising expenditure of a firm increases, the consumers may be tempted to buy more of its product. Therefore, the advertising expenditure on the good under consideration is taken to be constant.

Exceptions of the 'Law of Demand'
The law of demand does not apply in every case and situation. The circumstances when the law of demand becomes ineffective are known as exceptions of the law. Some of these important exceptions are as under.
1. Giffen goods: Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties of this category like bajra, cheaper vegetable like potato come under this category. Giffens’s Paradox describes a peculiar experience in case of such inferior goods. When the price of an inferior commodity declines, the consumer, instead of purchasing more, buys less of that commodity and switches on to a superior commodity.
2. Conspicuous Consumption: Conspicuous Consumption refers to the consumption of those commodities which are bought as a matter of prestige. Naturally with a fall in the price of such goods, there is no distinction in buying the same. As a result the demand declines with a fall in the price of such prestige goods. Gold, Diamond etc are the examples of such commodities.
3. Conspicuous necessities: Certain things become the necessities of modern life. So we have to purchase them despite their high price. The demand for T.V. sets, automobiles and refrigerators etc. has not gone down in spite of the increase in their price. So they are purchased despite their rising price.
4. Ignorance: A consumer’s ignorance is another factor that at times induces him to purchase more of the commodity at a higher price. This is especially so when the consumer is haunted by the phobia that a high-priced commodity is better in quality than a low-priced one.
5. Emergencies: Emergencies like war, famine etc. negate the operation of the law of demand. At such times, households behave in an abnormal way. Households accentuate scarcities and induce further price rises by making increased purchases even at higher prices during such periods. During depression, on the other hand, no fall in price is a sufficient inducement for consumers to demand more.
6. Future changes in prices: Households also act speculators. When the prices are rising households tend to purchase large quantities of the commodity out of the apprehension that prices may still go up. When prices are expected to fall further, they wait to buy goods in future at still lower prices.

7. Change in fashion: A change in fashion and tastes affects the market for a commodity. When a broad toe shoe replaces a narrow toe, no amount of reduction in the price of the latter is sufficient to clear the stocks.