Law of Demand

Definition

The law of demand is an economic principle that states that as the price of a good or service increases, the quantity demanded of that good or service decreases, and vice versa. This inverse relationship between price and quantity demanded is a fundamental concept in microeconomics.

5 Must Know Facts For Your Next Test

1. The law of demand is a fundamental principle that explains the behavior of consumers in a market economy.
2. The law of demand holds true because of the diminishing marginal utility of a good - as consumers acquire more of a good, the additional satisfaction they derive from each successive unit decreases.
3. The law of demand is a key factor in understanding market equilibrium, as it determines the quantity demanded at a given price.
4. The law of demand is essential for understanding how changes in supply and demand affect prices and quantities in a market system.
5. The law of demand is a crucial concept in analyzing the price elasticity of demand, which measures the responsiveness of quantity demanded to changes in price.

Review Questions

• Explain how the law of demand relates to the concept of demand, supply, and equilibrium in markets for goods and services.
  • The law of demand is a central concept in understanding the demand side of the market. It states that as the price of a good or service increases, the quantity demanded of that good or service decreases, and vice versa. This inverse relationship between price and quantity demanded is a key factor in determining the equilibrium price and quantity in a market. The law of demand, along with the law of supply, which describes the positive relationship between price and quantity supplied, interact to establish the market equilibrium, where the quantity demanded equals the quantity supplied at a specific price.
• Describe how the law of demand is related to shifts in demand and supply for goods and services.
  • The law of demand is crucial in understanding how shifts in demand and supply affect prices and quantities in a market. When demand shifts, the law of demand explains how the quantity demanded changes in response to the price change. Similarly, when supply shifts, the law of demand determines how the quantity demanded adjusts to the new equilibrium price. For example, if there is an increase in demand for a good, the law of demand predicts that the quantity demanded will increase as the price rises. Conversely, if there is a decrease in supply, the law of demand explains how the quantity demanded will decrease as the price rises to the new equilibrium.
• Analyze how the law of demand relates to the market system as an efficient mechanism for information and how changes in income and prices affect consumption choices.
  • The law of demand is a fundamental principle that helps the market system function as an efficient mechanism for information. By describing the inverse relationship between price and quantity demanded, the law of demand conveys important information to producers and consumers about the value of a good or service. This information, in turn, guides the decisions of both producers and consumers, leading to an efficient allocation of resources. Additionally, the law of demand explains how changes in income and prices affect consumption choices. As incomes rise, consumers can afford to purchase more of a good, leading to an increase in quantity demanded. Conversely, as prices increase, the law of demand predicts that quantity demanded will decrease, as consumers substitute towards other goods or reduce their overall consumption.

Related terms

Demand Curve: A graphical representation of the law of demand, showing the negative relationship between the price of a good and the quantity demanded.

Ceteris Paribus: The assumption that all other factors influencing demand, besides price, remain 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 or utility derived from each successive unit decreases, leading to the law of demand.