What is the law of demand and its exceptions?

The Law of Demand is a fundamental principle in economics that describes the relationship between the price of a good or service and the quantity consumers are willing and able to purchase. It signifies that, with all other factors remaining constant (ceteris paribus), the price and demand for a commodity share an inverse relationship. This means that as the price of a particular good or service increases, its demand decreases, and conversely, when the price decreases, its demand increases.

This inverse relationship is often represented by a downward-sloping demand curve on a graph, illustrating that consumers typically buy more of a product at a lower price and less at a higher price.

Why Does the Law of Demand Hold True?

The law of demand is underpinned by several economic principles that explain why consumers behave in this predictable manner:

• Income Effect

  When the price of a good falls, consumers' real income (purchasing power) effectively increases. With more purchasing power, they can afford to buy more of that good, even if their nominal income remains the same. Conversely, a price increase reduces real income, leading to reduced purchases.

• Substitution Effect

  If the price of a good decreases, it becomes relatively cheaper compared to its substitutes. Consumers will tend to substitute the now cheaper good for other, more expensive alternatives. For instance, if the price of coffee falls, some tea drinkers might switch to coffee. The opposite occurs if the price rises.

• Law of Diminishing Marginal Utility

  This law states that as a consumer acquires more units of a specific good, the additional satisfaction (marginal utility) derived from each successive unit tends to decrease. Therefore, consumers are only willing to purchase additional units if the price is lower, compensating for the reduced satisfaction.

Exceptions to the Law of Demand

While the law of demand is a widely applicable concept, there are certain situations and specific products where this inverse relationship does not hold true. In these cases, demand might increase with a price increase, or decrease with a price decrease. These are known as exceptions to the law of demand:

• Giffen Goods

  These are rare, inferior goods for which demand increases as the price rises, and falls as the price drops. This phenomenon occurs when a significant portion of a poor household's income is spent on the good, and there are no close substitutes. For example, during times of severe poverty, if the price of a staple like potatoes or rice increases, poor families might be forced to cut back on more expensive food items (like meat) and instead buy more of the staple, despite its higher price, as it's still the cheapest way to get calories.

• Veblen Goods (Goods of Ostentation/Prestige Goods)

  Named after economist Thorstein Veblen, these are luxury goods whose demand increases as their price increases, simply because their high price makes them more desirable as status symbols. Consumers perceive higher prices as an indicator of higher quality, exclusivity, or social status. Examples include high-end designer clothing, luxury cars, expensive jewelry, or exclusive art pieces.

• Speculative Goods

  For certain assets or goods, consumers might anticipate future price increases and, therefore, buy more of them even as prices are currently rising. This is common in financial markets like stocks, bonds, or real estate, where rising prices can stimulate further demand as investors expect to sell them at an even higher price later. Similarly, during a potential shortage of essential goods, panic buying can occur irrespective of rising prices.

• Necessities/Basic Goods

  For essential goods like salt, basic foodstuffs (like staple grains in some contexts), or life-saving medicines, demand remains relatively inelastic regardless of price changes. Consumers will continue to purchase nearly the same quantity even if prices increase significantly, as these items are indispensable for survival or daily life.

• Ignorance or Irrationality

  Sometimes, consumers may mistakenly perceive higher-priced goods as being of higher quality, even if they are not. Due to a lack of information or simply irrational decision-making, they might prefer more expensive options, thus defying the law of demand.

• Emergency or Panic Buying

  In times of crisis, natural disasters, or pandemics, consumers may engage in panic buying, stockpiling goods regardless of price increases. The perceived urgency and fear of scarcity override the typical price-demand relationship. For instance, during a health crisis, the demand for hand sanitizers or face masks might surge even as their prices skyrocket.

Here's a summary of the exceptions: