Law of Demand

The law of demand states that other thing remaining equal, the quantity demanded of a commodity increases when its price falls and decreases when its price rises.

The law indicates an inverse relationship between the price and quantity demanded of a commodity.

The law of demand is based on the following main assumptions:

1) There should be no change in income of the consumer.

2) There should be no change in tastes and preferences of the consumers.

3) Prices of the related commodities should remain unchanged.

4) Size of the population should not change.

5) The distribution of income should not change.

6) The commodity should be a normal commodity.

Explanation of law of demand/Why demand curve slope downwards to the right/why demand curve has a negative slope

1) Law of diminishing marginal utility : 

This law states that as consumption of a commodity increases, the utility from each successive unit goes on diminishing. So for every additional unit to be purchase the consumer is willing to pay less and less price.
Thus more is purchase only when own price of the commodity falls.

Explanation through example:

Units of shirt	Marginal utility
1 2 3 4 5	700 650 600 500 350

Price of the shirt is Rs. 600

In the above table we can see that as units of shirt is increasing the marginal utility derived from each unit is decreasing.
When the consumer purchase one unit of shirt, here Mu > price i.e. 700>600, so to further increase his satisfaction he will purchase the second unit of shirt, still his marginal utility is more than price, so will purchase the third unit of shirt, here marginal utility = price. 

In the fourth unit of shirt Mu< price, so to increase his satisfaction he will reduce his purchase, consumer will not like to purchase the fourth unit of shirt because it gives him less utility.

A consumer will maximize his satisfaction when

Marginal utility of a commodity = price of commodity

When the price of a commodity falls the consumer price and utility equilibrium is disturbed i.e. price becomes smaller than utility.
The consumer in order to restore the new equilibrium between price and utility buys more of it so that the Mu falls with the rise in the amount demanded.

So long the price of a commodity fall, the consumer will go on buying more and more amount of it so as to reduce the Mu and make it equal with new price.

Thus it follows that a consumer would purchase a larger amount of a commodity only when its price falls because the marginal utility from additional units falls.

2) Price Effect :

The sum total of income effect and substitution effect is price effect.

a) Income effect:

A change in demand on account of change in real income resulting from the change in the price of a commodity is known as income effect.

For example. A consumer buys 1 kg apples at Rs.20, now if the price of apples falls to Rs.15 and still he buys 1 kg apples, he is saving Rs. 5.It means his real income (in terms of apples) has increased.

The consumer may use this increased real income (i.e. Rs. 5 saved in purchasing the original quantity of apples at a lower price) in purchasing more apples.

Price - falls

real income - rises

Quantity demanded - rises 

b) Substitution Effect:

It is the effect that a change in relative prices of substitute goods has on the quantity demanded.

For example: If the price of coffee falls, the price of tea remaining the same, coffee is now cheaper as compared to tea, consumer demand for coffee will increase, they will shift from the consumption of tea to coffee. This is substitution Effect.

Income effect + substitution effect = Price effect

3) Increase in number of consumers:

When the price of commodity falls, there is an increase in number of consumers due to income and substitution effect also as the people who were not able to afford the commodity at higher price can now afford,  as it’s within their reach now.

At still lower price even the poor person can afford it.

For example- when the price of apples are 50/kg few people will buy but when the price falls to 20/kg, apples are within the reach of people who could not afford to purchase it earlier.

4) Several uses of a commodity: 

There are some goods that have multiple uses ex milk, electricity, steel etc. When the price of such commodities are very high, they are used for more important uses, but when their  price falls, they are put to less important uses also.
For example, when the price of electricity is very high, it is used for lighting purposes, when its price falls, it will be used for cooking as well.