Law of Demand

Definition

The law of demand states that, all else equal, as the price of a good rises, the quantity demanded of that good falls, and as the price falls, the quantity demanded rises. This inverse relationship between price and quantity demanded is a fundamental principle of microeconomics.

5 Must Know Facts For Your Next Test

1. The law of demand explains the downward-sloping shape of the demand curve, which is a fundamental concept in the analysis of market equilibrium and changes in equilibrium price and quantity.
2. The law of demand is based on the principle of diminishing marginal utility, where consumers derive less additional satisfaction from each successive unit of a good consumed.
3. The law of demand holds true for most goods and services, with the exception of Giffen goods and Veblen goods, which exhibit an upward-sloping demand curve.
4. The law of demand is a key component in understanding how changes in supply and demand affect the equilibrium price and quantity in a market, as described in the four-step process.
5. The law of demand is a crucial concept in the analysis of price elasticity of demand, as it helps explain why the quantity demanded responds differently to price changes for different types of goods.

Review Questions

• Explain how the law of demand relates to the downward-sloping demand curve and the concept of equilibrium in a market.
  • The law of demand states that as the price of a good rises, the quantity demanded falls, and vice versa. This inverse relationship between price and quantity demanded is reflected in the downward-sloping shape of the demand curve. The demand curve, along with the supply curve, determines the market equilibrium, where the quantity demanded equals the quantity supplied at the equilibrium price. The law of demand is a fundamental principle that helps explain how changes in supply and demand affect the equilibrium price and quantity in a market.
• Describe the relationship between the law of demand and the principle of diminishing marginal utility, and how this contributes to the inverse relationship between price and quantity demanded.
  • The law of demand is based on the principle of diminishing marginal utility, which states that as a consumer consumes more of a good, the additional satisfaction (utility) derived from each additional unit of the good decreases. As the price of a good rises, the consumer's marginal utility from consuming an additional unit of the good decreases, leading them to demand a lower quantity of the good. Conversely, as the price falls, the consumer's marginal utility from consuming an additional unit increases, leading them to demand a higher quantity of the good. This inverse relationship between price and quantity demanded is the essence of the law of demand.
• Analyze how the law of demand is a crucial concept in understanding the relationship between price elasticity of demand and the market system as an efficient mechanism for information.
  • The law of demand is a central concept in understanding price elasticity of demand, which measures the responsiveness of quantity demanded to changes in price. The law of demand explains why the quantity demanded of some goods is more responsive to price changes than others, leading to different degrees of price elasticity. This knowledge is essential for understanding how the market system acts as an efficient mechanism for information. When prices change, the law of demand dictates how consumers will respond, and this information is communicated through the price system, allowing resources to be allocated efficiently. The law of demand is thus a fundamental principle that underpins the market's ability to coordinate supply and demand and transmit information through the price mechanism.

Related terms

Demand Curve: A graphical representation of the law of demand, showing the relationship between the price of a good and the quantity demanded of that good, with price on the vertical axis and quantity on the horizontal axis.

Ceteris Paribus: The assumption that all other factors that may influence demand, such as income, prices of related goods, consumer tastes and preferences, and expectations, are held constant when analyzing the relationship between price and quantity demanded.

Diminishing Marginal Utility: The principle that as a consumer consumes more of a good, the additional satisfaction (utility) derived from each additional unit of the good decreases, which contributes to the inverse relationship between price and quantity demanded.