Page 2 - Lesson Note 6

Fig 3.1 clearly shows that more units of commodity are demanded, when the price of the commodity falls. Demand
curve DD slopes downwards indicating an inverse relationship between price and quantity demanded.
Important Facts about Law of Demand

1. Inverse Relationship- Increase in the price will tend to reduce the quantity demanded and a fall
in price will lead to an increase in the quantity demanded.

2. Qualitative not Quantitative- Indicates the direction of change in the amount demanded and
does not indicate the magnitude of change.

3. No Proportional Relationship-If the price rises by 10 % quantity demanded may fall by any
proportion.

4. One –Sided – It only explains the effect of change in price on the quantity demanded. Does
not say anything about change in quantity demanded on the price of the commodity.

Reasons for the Law of Demand

1. Law of Diminishing Marginal Utility:
Law of diminishing marginal utility states that as we consume more and more units of a commodity, the utility
derived from each successive unit goes on decreasing. So, demand for a commodity depends on its utility.

If the consumer gets more satisfaction, he will pay more. As a result, consumer will not be prepared to pay the same
price for additional units of the commodity. The consumer will buy more units of the commodity only when the
price falls.

Law of diminishing marginal utility is considered as the basic reason for operation of ‘Law of Demand’.

2. Substitution Effect:
Substitution effect refers to substituting one commodity in place of other when it becomes relatively cheaper. When
price of the given commodity falls, it becomes relatively cheaper as compared to its substitute (assuming no change
in price of substitute). As a result, demand for the given commodity rises.

For example, if price of given commodity (say, Pepsi) falls, with no change in price of its substitute (say, Coke),
then Pepsi will become relatively cheaper and will be substituted for coke, i.e. demand for Pepsi will rise.

3. Income Effect:
Income effect refers to effect on demand when real income of the consumer changes due to change in
price of the given commodity. When price of the given commodity falls, it increases the purchasing power