Posted by Anjali Kaur on Jul 26, 2020
Law of demand

The law of demand and its determinants

We have seen the meaning and types of the demand curve. Today, I will be explaining the law of demand and its determinants. Determinants of demand are also known as the factors affecting demand. Let’s learn.

What is the law of demand?

This law states that there exists an inverse relationship between price and the quantity demanded of a good, keeping other things constant (Ceteris Paribus). In other words, this law says that the quantity demanded of a good will increase if the price decreases and the quantity demanded of a good will decrease if the price increases, ceteris paribus (Keeping other things constant). As shown below, a demand curve with its demand schedule, reflecting an inverse relationship between quantity demand and its price.

Demand curve with its schedule

Assumptions to the law of demand

  • The income of the consumer remains unchanged.
  • The price of related goods remains constant.
  • The taste and preferences of the consumer remain constant.
  • Future expectations remain unchanged.

Determinants of demand or the factors affecting the demand

Many factors affect the demand for a commodity. In this blog, I will be discussing only the important factors that affect the demand for any commodity. These are:

  • Price of the commodity
  • The income of the consumer
  • Price of related goods
  • Tastes and preferences
  • Future expectations

Trick to memorize them ‘PETIR’ where P- Price of the commodity, E- Expectations for future, T – Taste, and preferences, I- Income of the consumer and R- Related goods prices.

Now, I will be discussing each of these factors in detail.

Price of the commodity

This factor says that, as the price of a commodity increase, the quantity demanded falls, keeping other things constant. This happens due to a decrease in the satisfaction level of the consumer. Let’s explain this with a graph and a schedule.

When the price of the commodity increases from 4 to 6, the quantity demanded falls from 3 to 2. As you can see, the consumer is moving along the demand curve from point A to point B. This is called an upward movement along the demand curve.

Upward movement along the demand curve

The reverse will happen, if the consumer starting position was point B and the price falls from 6 to 4, the quantity demanded rises from 2 to 3. The movement from point B to point A is called downward movement along the demand curve.

Downward movement along the demand curve

So, basically this factor is stating the law of demand of statement.

The income of the consumer

The demand for the commodity is also affected by the income of the consumer. But the effect of change in income on demand depends on the nature of the commodity. Two types of goods are related to the income of the consumer;

Inferior Good (Poor quality good)

These goods are of poor quality and are inversely or negatively related to the income of the consumer. So, if the income of the consumer rises, the demand for inferior good falls, keeping other things constant. Similarly, if the income of the consumer falls, the demand for inferior goods increases, keeping other things constant (Like the price of the commodity, price of related goods, taste and preferences, and future expectations will remain the same).

Normal good (Better quality good)

These goods are of better quality and they are directly related to the income of the consumer. When the income of the consumer increases, the demand for normal goods increases keeping other things constant. similarly, if the income of the consumer falls, the demand for the normal goods falls, keeping other things constant (Like the price of the commodity, price of related goods, taste and preferences and future expectations will remain the same).

Trick to memorize When you explain INcome as a factor affecting the demand curve, I stand for Inferior goods and N stands for normal goods. This way, you always remember it.

Price of the related goods

The demand for the commodity is also affected by the change in the price of the related goods. Related goods are of two types:

Substitute Goods

These are those goods which can be used in place of each other for consumption or those goods which can replace each other. So, if the price of one good increases then demands of there substitute good increases, that is, why substitute goods have a positive cross elasticity of demand. Let’s take an example, Tea and coffee are substitute goods. If the price of coffee increases, the demand for tea will increase because a consumer can substitute tea with coffee. How? Well, when the price of coffee rises, the demand for coffee falls (Law of demand) causing an increase in the demand for tea. The demand curve of tea would shift to its right. As shown below with a demand graph and its schedule.

Substitute goods

As you can see, one good is positively affecting the other good, that is why they have positive or direct cross elasticity of demand. You must try the effect of a decrease in the price of one good on its substitute. Share the result with me on Contact@LearnWithAnjali.com I will give you solution credit for the same.

Complimentary goods

These are those goods that are consumed together to obtain satisfaction. For example, Car and petrol are used together, the pen and ink are used together. These goods have negative cross elasticity of demand, this means that a good demand will increase when the price of the other good falls and vice versa. For example, if the price of ink increases, the demand for that particular pen will fall, keeping other things constant (Income, price of the commodity, tastes and preferences, and future expectations are held constant). As shown below the demand graph with its schedule.

Complimentary goods

Complimentary goods have negative cross elasticity of demand because one good is affecting negatively on the other good. You must the case where the price of ink falls, and how it affects the demand for the pen. Just email me your results.

Taste and preferences

The taste and preferences of the consumer directly influence the demand for a commodity. They include a change in fashion trends, habits, etc. Take an example, if a commodity is in fashion or it is preferred by a consumer, then the demand for such a commodity will increase or vice versa.

Future Expectations

If the price of a certain commodity is expected to increase shortly, then people will buy more of that good, as compared to what they normally buy. For example, if the price of petrol is expected to rise shortly, its current or present demand will increase. Due to COVID-19, the demand for the essential commodities increased, as people expected that their prices will rise shortly (Which is true, that is happening).

After going through the above, do read the exceptions to the law of demand.

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