What is Law Of Demand?

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The law of demand is one of the most fundamental concepts in economics. It works with the law of supply to explain how market economies allocate resources and determine the prices of goods and services that we observe in everyday transactions.The law of demand states that the quantity purchased varies inversely with price. In other words, the higher the price, the lower the quantity demanded. This occurs because of diminishing marginal utility. That is, consumers use the first units of an economic good they purchase to serve their most urgent needs first, then they use each additional unit of the good to serve successively lower-valued ends.

Definition

The Law of Demand is one of the most fundamental concepts in economics. Along with the Law of Supply, it explains how market economies allocate resources and determine the prices of goods and services observed in everyday transactions. The Law of Demand states that the quantity purchased varies inversely with price. In other words, the higher the price, the lower the demand. This is due to diminishing marginal utility, meaning consumers use the first few units of an economic good they purchase to satisfy their most urgent needs, and each additional unit is used to satisfy less urgent needs.

Origin

The concept of the Law of Demand dates back to the late 18th and early 19th centuries when economists like Adam Smith and David Ricardo began studying market behavior. The theory of marginal utility, developed in the late 19th century by economists such as William Stanley Jevons and Carl Menger, further explained the basis of the Law of Demand.

Categories and Features

Demand can be categorized into individual demand and market demand. Individual demand refers to the quantity of a good a single consumer is willing to purchase at various price levels, while market demand is the sum of all individual demands. Features of demand include price elasticity, income elasticity, and cross elasticity. Price elasticity describes how sensitive the quantity demanded is to price changes; income elasticity describes how demand responds to changes in consumer income; cross elasticity involves the demand for one good in response to price changes of another good.

Case Studies

A typical case is Apple's pricing strategy when launching a new iPhone. Initially, the new iPhone is priced high, resulting in lower demand, but as the price decreases over time, demand increases, illustrating the Law of Demand. Another example is Netflix's subscription service. As prices rise, some users may cancel their subscriptions, leading to a decrease in demand, which also reflects the Law of Demand.

Common Issues

Investors applying the Law of Demand might encounter issues such as overlooking other factors affecting demand, like changes in consumer preferences, availability of substitutes, and market trends. Additionally, the Law of Demand assumes ceteris paribus, which is challenging to achieve in reality.

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Oversupply

Oversupply, also known as excess supply, occurs when the quantity of a good or service available in the market exceeds the quantity demanded by consumers. This situation typically results in a decrease in the price of the good or service, as suppliers reduce prices to clear excess inventory or minimize losses.

Law Of Supply And Demand

The Law of Supply and Demand is a fundamental economic principle that describes the relationship between the availability of a product (supply) and the desire for that product (demand). Specifically:Law of Supply: All else being equal, an increase in the price of a good will result in an increase in the quantity supplied. Conversely, a decrease in the price will result in a decrease in the quantity supplied. This occurs because higher prices can lead to higher profits, attracting more producers to the market.Law of Demand: All else being equal, an increase in the price of a good will result in a decrease in the quantity demanded. Conversely, a decrease in the price will result in an increase in the quantity demanded. This happens because higher prices reduce consumers' purchasing power or willingness to buy.

Supply Curve

The supply curve is a graphical representation that shows the relationship between the price of a good or service and the quantity that producers are willing and able to supply at various price levels. Typically, the supply curve slopes upwards from left to right, indicating that as the price increases, the quantity supplied also increases.

Law Of Supply

The Law of Supply states that, all else being equal, an increase in the price of a good or service will result in an increase in the quantity supplied, and a decrease in the price will result in a decrease in the quantity supplied. This principle reflects producers' response to price signals, where higher prices typically lead to higher profits, thereby incentivizing producers to supply more.

Supply Shock

A supply shock refers to a sudden and unexpected event that causes a significant change in the supply of a good or service. These shocks can be positive (increasing supply) or negative (decreasing supply) and are typically caused by external factors such as natural disasters, technological innovations, changes in government policies, or international trade events. Supply shocks can have substantial impacts on market prices and overall economic activity.