The Law of Demand

An Important Law in Microeconomic Theory

May 31, 2009 Miranda Miller

A law in microeconomics differs from the type found in the criminal justice system. The microeconomic principle (or law) of demand allows economists to make predictions.

In theoretical economics, economists develop models to explore economic activity and outcomes. They use a scientific method, observing facts, hypothesizing, testing, accepting or modifying based on results, and continually testing until a theory is so widely proven reliable that is becomes a principle.

These principles are critical in modern day business. Reliable statements about economic behavior enable the prediction of probable effects of specific actions. The law of demand is one such economic principle.

The Law of Demand Defined

All else equal, as price falls, the quantity demanded rises. As price increases, the quantity demanded falls.

All other things must be considered equal, because the real world is simply too complex. This is the ceteris paribus assumption. All variables except the one being measured must be held constant for the period of analysis. Economic experiments are not as reliable as their chemistry or physics counterparts for that very reason. However, considerable testing over time allows patterns to emerge, on which economic theories and principles are built.

The Relationship Between Price and Quantity Demanded

In accordance with the law of demand, price and quantity demanded have a negative, or inverse, relationship. That is, when one moves up, the other moves down. One will always move in the opposite direction of the other.

There are two reasons for this, the first being the income and substitution effects. A lower product price means that a consumer can buy more than they could at the higher price point; this is the income effect. The substitution effect means that other similar products now seem more expensive compared to the lower priced product.

The Law of Demand and Diminishing Marginal Utility

Diminishing marginal utility is the second reason for the inverse relationship between price and quantity. Over a specified period of time, consumers get less satisfaction from each additional unit of a product they consume. For example, the first gallon of milk purchased yields a certain amount of satisfaction known as utility. Each additional unit gives the consumer less and less satisfaction. They will only continue to buy if the price is reduced at each point.

The Demand Curve

Quantity demanded is customarily displayed on the horizontal axis, with price on the vertical axis. The demand curve slopes downward as a result of the inverse relationship between price and quantity demanded. A change in one of the determinants of demand, such as consumer income, tastes, or the number of consumers, causes the entire curve to shift to the right or left. A change in the quantity demanded does not move the entire curve; rather, it reflects a movement from one point on the curve to another.

For more information on the law of demand, refer to McConnell, Brue and Barbiero's Microeconomics, 10th Canadian Edition (McGraw-Hill Ryerson Ltd, 2005).

The copyright of the article The Law of Demand in Investment is owned by Miranda Miller. Permission to republish The Law of Demand in print or online must be granted by the author in writing.

The Law of Demand

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