The law of demand is a fundamental economic principle according to which the higher the price of products, the lower the demand for them (and the number of products purchased). The law helps understand the rules of resource allocation and price formation of products and services.
In this article, we’ll unveil the importance of the law of demand and the 10 factors that affect it. We’ll also review the exceptions, elasticity, and demand curve.
Why is the law of demand important?
The law of demand is a fundamental concept in economics that defines the demand and supply of products among customers and companies. According to this law, the amount of products people buy depends on their price. The higher the price, the less the quantity of goods customers purchase and vice versa. This is since customers purchase the unit of products to serve their urgent needs, and those that come next are only necessary to fulfill the secondary needs. There are many reasons why the law of demand is important.
First of all, it helps companies set the prices for their products. Sellers can identify the demand for goods if the price is high and also if the price is low. After studying this information, a business owner can decide whether to increase or decrease the price of a commodity.
Along with the law of supply, the law of demand provides you with an understanding of price formation principles. You can figure out why companies charge customers a certain price for different goods. Besides, consumers can determine opportunities to purchase products at a lower price.
The benefits of the law of demand are clear, so let’s uncover the 10 factors influencing demand.
10 Factors Affecting Demand
The demand for a product doesn’t only rely on the product’s price and the customer’s willingness to pay. More factors influence the demand. We can highlight the following factors that affect it:
- product’s price;
- price of complements;
- the number of customers;
- product seasonality;
- customers’ preferences;
- changes in trends;
- consumers’ budget;
- change in product’s actual or perceived value and quality;
- close substitutes’ price and their availability.
It’s time to learn the exceptions in the law of demand you might encounter when exploring this topic deeper. Let’s delve into the special cases and learn about them more.
Exceptions to the Law of Demand
In most cases, you can see the fulfillment of the generally accepted law of demand. However, economics and other sciences have their exceptions to the rule. According to the law of demand, the curve is downward sloping, yet some goods defy this concept. Let’s review goods that exist contrary to generally accepted rules and concepts.
- Giffen goods. These are non-luxury products, the consumption of which increases along with its price. Giffen goods are often foods that fulfill our basic living needs. Products like rice, potatoes, and bread are goods that are the most affordable and necessary once the price for food rises. For instance, potatoes were a Giffen good during the Great Famine of Ireland. Once the price increased, people refused more expensive products (meat and vegetables) and consumed potatoes instead.
- Veblen goods. These are high-quality premium products the demand for which rises when the price goes up. Veblen goods are luxurious, expensive, and exclusive items like diamond watches, exclusive cars, paintings in one copy, and high-quality clothes. The exclusivity of such goods challenges the fundamental law of demand and makes the demand curve upward-sloping. The sellers of these goods focus on wealthy people who appreciate status, exclusivity, and uniqueness.
- Basic goods. These are goods people buy despite their price. The demand for such products will be the same even if the price goes up. Let’s take medicine, for example. If people get sick, they go to their doctors to receive their medicine covered by assurance. At this point, their price isn’t the main factor. So, people will take medicine despite its price increase.
- Expectations of a price change. One more example that defies the fundamental law of demand is when people expect sellers to increase the price after its initial increase. Many people start purchasing a commodity in large quantities to avoid a further rise in prices and more expenses. If the price for products falls, people might postpone their purchase.
Now when the exceptions are clear, let’s proceed to the next section to learn about the elasticity of demand.
Elasticity of Demand
Changes in economics such as price or income fluctuations often affect the demand for a specific product. Demand elasticity shows how sensitive the demand for a certain good is during different unfavorable economic scenarios. The measure helps businesses stay in the know of the possible changes in demand. They can calculate it by considering the most common factors that affect the demand. They are price and the entry of competitive goods. If a change in price makes a demand shift, the product is elastic. A market with many substitutes for an item has an elastic demand. The more substitutes the market has, the more elastic the demand is.
Demand Elasticity = Percentage Change in Quantity Demanded / Percentage Change in Price
The demand is elastic if the quotient is higher than or equal to one.
Depending on the factor that influences the demand, there are different types of elasticity: income, price, and substitute elasticity of demand. Price is the common factor used to define demand elasticity. For instance, the change in motorbike’s price will affect the number of people who will buy it.
The other factor is income. Incomes of certain populations influence the elasticity of demand as well. To create a more efficient structure of organizations, the government can initiate job cuts. As a result, workers become unemployed and lose their earnings. During this time, people refrain from buying unnecessary goods, resulting in these products becoming more elastic.
Substitutes for an item also affect the demand and make it more elastic. For instance, if Dell increases the price for its laptops and makes it 20% higher, it can encourage customers to brand switching and purchase Asus laptops.
Now let’s see find out how the demand curve looks like.
The Demand Curve
The demand curve represents the relation between the good’s price and the quantity people need at a certain timeframe. Based on the law of demand, the curve is downward sloping. If the price of a commodity grows, its demand goes down.
Below you can see an example. Say, you want to buy strawberries, but their price constantly increases, and you decide to purchase them during the strawberry season when the price decreases.
Congrats, now you know the 10 aspects that impact the demand and know the basics of the demand curve. Hope that this information will come in handy for understanding the formation of prices and other essential processes.
- This article provides readers with the importance of the law of demand.
- In this article, you’ll find a definition of the law of demand and several examples.
- This article uncovers factors affecting demand.
Last Updated: 06.01.2022