Law of Demand

Law of Demand

The law of demand states that, ceteris paribus, as the price of a good rises, the quantity demanded falls; as the price falls, the quantity demanded rises. This inverse relationship underpins how markets allocate goods and helps explain price formation.

How it works: diminishing marginal utility

Consumers derive less additional satisfaction (marginal utility) from each extra unit of a good they consume. Because each successive unit is valued less, people are only willing to buy larger quantities at lower prices.

Example: A castaway with six bottles of water will use the first bottle for the most urgent need (drinking), later bottles for progressively less urgent uses. Each additional bottle is valued less, so willingness to pay declines with quantity.

The market demand curve aggregates how many units all consumers are willing to buy at each price and typically slopes downward.

Demand vs. quantity demanded

• Demand (the demand curve): the relationship between price and quantity demanded across all prices; a shift in demand means the whole curve moves.
• Quantity demanded: a specific point on the curve. Changes in price cause movement along the demand curve (a change in quantity demanded), not a shift in demand.

Factors that shift demand

The demand curve shifts when underlying conditions change, not when price changes. Major factors include:
– Income (normal vs. inferior goods)
– Tastes and preferences
– Prices of related goods (substitutes reduce demand; complements increase demand)
– Expectations about future prices or income
– Population and demographics
– Perceived or actual changes in quality

Law of Supply (brief)

The law of supply states that, other things equal, higher prices incentivize producers to supply more of a good, and lower prices reduce quantity supplied. Interaction of supply and demand determines market prices.

Exceptions and special cases

• Veblen goods: higher prices can increase demand because the product is seen as a status symbol.
• Giffen goods: for some basic necessities with few substitutes and strong income effects, higher prices may increase consumption among low-income consumers.

Real-life application

Understanding the law of demand helps interpret everyday behavior—e.g., when gas prices rise, people drive less; when prices fall, consumption tends to increase. Firms use this knowledge to forecast sales and set production.

Explain like I’m five

When something costs more, people buy less of it. When it costs less, people buy more. Sellers usually make more of something when its price goes up.

Key takeaways

• Price and quantity demanded are inversely related (downward-sloping demand curve).
• Movement along the curve is caused by price changes; shifts of the curve are caused by non-price factors (income, tastes, prices of related goods, etc.).
• Exceptions exist (Veblen and Giffen goods), but the law of demand is a core principle for analyzing markets.

Bottom line

The law of demand is a fundamental economic rule explaining how consumers respond to price changes and, together with the law of supply, determines market prices and quantities.