Rationale of the Law of Demand
Normally, the demand curves slope downwards. This means people buy more at lower prices. We shall now try to understand why do demand curves slope downwards? Diuerent economists have given diuerent explanations for the operation the of law of demand. These are given below:
(1) Law of diminishing marginal utility: A consumer is in equilibrium (i.e. maximises his satisfaction) when the marginal utility of the commodity and its price equalize. According to Marshall, the consumer has diminishing utility for each additional unit of a commodity and therefore, he will be willing to pay only less for each additional unit. A rational consumer will not pay more for lesser satisfaction. He is induced to buy additional units only when the prices are lower.The operation of diminishing marginal utility and the act of the consumer to equalize the utility of the commodity with its price result in a downward sloping demand curve.
(2) Price euect: The total fall in quantity demanded due to an increase in price is termed as Price euect. The law of demand can be dubbed as “Negative Price Euect” with some exceptions. The price euect manifests itself in the form of income euect and substitution euect.
(a) Substitution euect: Hicks and Allen have explained the law in terms of substitution euect and income euect. When the price of a commodity falls, it becomes relatively cheaper than other commodities. Assuming that the prices of all other commodities remain constant, it induces consumers to substitute the commodity whose price has fallen for other commodities which have now become relatively expensive. The result is that the total demand for the commodity whose price has fallen increases. This is called substitution euect.
(b) Income euect: When the price of a commodity falls, the consumer can buy the same quantity of the commodity with lesser money or he can buy more of the same commodity with the same amount of money. In other words, as a result of fall in the price of the commodity, consumer’s real income or purchasing power increases.This increase in the real income induces him to buy more of that commodity. Thus, the demand for that commodity (whose price has fallen) increases. This is called income euect.
(3) Arrival of new consumers: When the price of a commodity falls, more consumers start buying it because some of those who could not auord to buy it earlier may now be able to buy it. This raises the number of consumers of a commodity at a lower price and hence the demand for the commodity in question.
(4) Diuerent uses: Certain commodities have multiple uses. If their prices fall, they will be used for varied purposes and therefore their demand for such commodities will increase. When the price of such commodities are high (or rises) they will be put to limited uses only. Thus, diuerent uses of a commodity make the demand curve slope downwards reacting to changes in price. For example Olive oil can be used for cooking as well as for cosmetic purposes. So if the price of olive oil rises we can limit our usage and thus the demand will fall.
Goods and Service Tax Book (Updated upto 20th January 2018)
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GST (Goods and Services Tax) Book -A student friendly Book. - Bharat Gurukul
GST Student friendly Book most relevant/Useful for CA Intermediate/IPCC, CS executive , CWA Intermediate
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