Law of Demand

The inverse relationship between quantity and price – as price increases demand decreases. Similarly a decrease in price will result in greater demand.

 

The law of demand states that as long as other factors (like income, taste, price of related goods/services, etc.) remain the same there is an inverse relationship between price and demand. The higher the price, the lower the demand. Conversely lower prices will result in higher demand.

The chart below shows the relationship between price (on the vertical axis) and demand (on the horizontal axis).

Exceptions & Limitations

There are cases in which demand does not inversely relate to price as predicted by the law of demand...

 

Basic or Essential Goods

Increasing the price of things like medicine or fuel does little to decrease demand, at least in the short term. Likewise a decrease in price does not generate increased demand.

 

Veblen Good

Some products contradict the law of demand – higher prices actually increase demand. One such group of products are known as Veblen goods. The demand for some luxury goods like premium wines & spirits, purses and handbags, watches & jewelry, and high performance/exotic automobiles is based on their high price, which sends a powerful message about their quality, status and exclusivity. Decreasing prices would (contrary to the law of demand) decrease demand because the goods would no longer be perceived the same way. 

 

New Alternatives/Substitute Products

The arrival of alternatives or substitutes may lower demand regardless of the price of the original product. An example would be tablets, which reduced demand for traditional computing devices even as those prices remained constant (and sometimes even reduced). This is also seen in entertainment media where digital downloads replaced the CDs that replaced the cassettes that replaced eight-track cassettes, regardless of the price difference.

 

Changes in Taste

Most pronounced in fashion – one year everyone has to have Ugg boots or the Canada Goose jacket, and a year or two later something else becomes the rage. This kind of change in demand does not correspond with change in price but rather a change in taste.

 

Anticipated Change in Price and/or Availability

Demand may increase when prices are expected to rise and/or shortages are anticipated. For example the forecast of an early snow will often lead to increased short term demand for ice salt, snow shovels and snow tires. Demand may also decrease when prices are expected to fall.

 

Related Products

Demand for one product may be reduced by a rise in the cost of related products. For example an increase in airfares may decrease the demand for hotel rooms. An increase in fuel prices may reduce the demand for less fuel efficient vehicles and increase the demand for hybrids.

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Related Material

Veblen Goods: An Example From The Real World

Veblen goods (goods that increase in demand as their price goes up) might seem theoretical but they do exist. A look at a Veblen good from the real world.

Price Elasticity – Examples

Examples of price elasticity of demand – situations where changes in demand exceed changes in price.

Reverse Price Elasticity – Examples

In special cases the law of demand is reversed, and demand actually increased alongside price. This is referred to as reverse price elasticity (of demand).

Price Inelasticity – Examples

Examples of price inelasticity – situations where demand does not change correspondingly to price.

Price Elasticity (aka Price Elasticity of Demand)

Any research on pricing you will mention “price elasticity”. Shortened from “price elasticity of demand” it is important (but easy) to understand.

Veblen Good

Veblen goods contradict the law of demand. Demand for a Veblen good increases, rather than decreases, alongside increases in price.