While it applies to most things we encounter on a daily basis, there are exceptions to the law of demand. Two of them are Veblen items and Giffen items . They show a positive relationship between their price and the quantity demanded by consumers.
In some cases, consumers do not only consider price in making purchasing decisions. They take other aspects into account. For example, they take into account income. So, when prices go up, they keep increasing their purchases because they have more money to spend.
Before discussing exceptions to the law of demand, let’s briefly discuss what the law of demand is and why it matters.
What is the law of demand?
The law of demand is a principle in microeconomics , underlining the inverse relationship between price and quantity demanded. It forms the basis for building a demand curve.
Another concept is the law of supply , which underlies the supply curve. It expresses a positive relationship between price and quantity supplied.
According to the law of demand, quantity demanded rises when price falls. Thus, consumers want more quantity at a lower price. But, if they have to pay a higher price, they will ask for less. Or in other words, the quantity demanded decreases as the price increases.
On the other hand, according to the law of supply, a decrease in price causes the quantity supplied to fall. Manufacturers are willing to supply less. But, if the price rises, the quantity supplied increases because they are willing to supply more.
The two forces are then settled in the market. And, the supply-demand curve represents the interests of each: consumers and producers. If the two curves intersect, it results in market equilibrium . At the equilibrium point, price and quantity are determined, which represents the best outcome for both consumers and producers.
How the law of demand works
As I mentioned, according to the law of demand, an increase in price causes the quantity demanded by consumers to fall. On the other hand, a decrease in price causes the quantity demanded to increase. Remember, in explaining the relationship, we are isolating other factors. We assume they are constant, unchanging or ceteris paribus .
Say, at $10, a customer is willing and able to buy 20 units. But, if the price goes up to $15, he’s only asking for 10 units. Conversely, if it drops to $5, he asks for 30 units.
We need to remember, economists define demand as the willingness of consumers to buy and supported by the ability to buy. Finally, we associate consumers with having enough money to buy. When they want a product but don’t have enough money, it doesn’t generate demand. On the other hand, having money but not wanting the product doesn’t lead to demand either.
Now, take the orange for example. When the price goes up, customers may still want the product. However, they may limit demand due to insufficient budget (limited ability to pay). Thus, the quantity demanded is less when the price rises.
Meanwhile, when the price drops, consumers can buy more for the same dollar amount. So, they can add some oranges to their shopping cart. After all, cheaper prices don’t come twice. So, by buying more, they have stock. They can store it in the refrigerator and consume it for a few days.
In addition, some other consumers may switch from apples to oranges, considering they are cheaper than before. Remember, in this case, we are assuming the price of apples has not changed. Thus, the decline in the price of oranges pushes the quantity demanded to rise.
What are the exceptions to the law of demand?
While applicable in most cases, there are exceptions to the law of demand. These exceptions are usually because consumers do not fully consider price as the main consideration. For example, they may be more concerned with quality, self-image and income.
But, before we discuss one by one, let’s talk a little about the income effect and the substitution effect. Both are important when we talk about Giffen stuff and Veblen stuff later.
Both concepts tell us what will happen to the quantity demanded if the price of a product changes. We then relate it to the consumer’s real income and its relative price to the related product.
Income effect . When prices fall, consumers’ real incomes increase, prompting them to ask for more. For the same dollar amount, they can buy more. Say, previously, with $20 in hand, they got 10 units at $2. And, if the price drops to $1, they can get 20 units.
Conversely, when prices rise, real income falls, prompting them to reduce the quantity demanded. Even if they buy the equivalent dollar amount, they get less. For example, in the previous case, if the price rose to $4, they could only buy 5 units.
substitution effect . It explains how we change our choices when the price of an item changes. We will tend to switch from expensive goods to cheaper ones if they are both satisfying and meet the same needs.
Now, we assume the price of the substitute good has not changed. When the price of a product rises, some consumers will switch to substitute products because the relative price is lower, reducing the quantity demanded. Conversely, if the price falls, some consumers switch from substitutes to those products, increasing the quantity demanded.
Giffen Goods are a specific case of inferior goods. Thus, when consumers’ incomes rise, the demand for them falls. On the other hand, when income falls, the demand for them increases.
But, unlike other inferior goods, a fall in the price of Giffen goods actually causes consumers to reduce their demand for them. Thus, price and quantity demanded have a positive correlation.
Take used clothes for example. Consumers usually associate lower prices with poorer quality so they think it’s not worth it.
Such a positive correlation occurs because the negative income effect outweighs the positive substitution effect when prices fall. Let’s break it down. When the price drops:
- Real income rose. However, since Giffen goods are inferior goods, it causes the quantity demanded to fall. Thus, it produces a negative income effect.
- The substitution effect is positive. As prices fall, some consumers switch from substitutes to Giffen goods, increasing the quantity demanded.
Thus, if the price of a Giffen good falls, the quantity demanded actually decreases because the income effect exceeds the substitution effect. On the other hand, if the price increases, the demand will be higher because the income effect exceeds the substitution effect. As a result, the demand curve is upward sloping.
Veblen goods are the second exception to the law of demand. However, they are not inferior goods. They have an upward sloping demand curve. Their demand rises when the price increases. Higher prices make them more desirable to consumers. T
Why did such a relationship occur? For most goods, price is a cost. But, for Veblen items, it was a function of utility or satisfaction. So, if they are expensive, they are considered to have more value or utility. Thus, their demand increases.
We can say Veblen items as positional items, where buying them shows one’s status. It’s common for conspicuous consumption ( conspicuous consumption ). Higher prices are preferred to indicate a high status symbol.
Luxury goods such as diamonds and luxury cars are good examples. Higher prices indicate higher prestige, enabling wealthy consumers to actualize their self-image with higher social status.
Conversely, if producers lower their prices slightly, their attractiveness to wealthy individuals decreases. Because they are status conscious, a lower price can damage their image, prompting them to stay away from it.
Necessary and essential goods
In some cases, the demand for essential goods remains unchanged despite changes in prices. Take table salt forexample . When prices rise, consumers will not necessarily reduce demand. Conversely, when prices fall, they will not increase demand either.
Another example is cold medicine and headache medicine. We need it to stock up and just in case one day we need it. We buy them not solely for price considerations, but their availability and their benefits. So, when their prices go up or down, it doesn’t necessarily encourage us to reduce or increase the demand for them.
Expected price changes
There are times when consumers do not consider the current price. Instead they look at future price trends. That may be because the price of the goods they want to buy is expensive and has a long economic life. Or, it’s because their budget is limited. So, they have to make wise decisions in spending money. Another reason is to buy for resale not for consumption.
When they expect prices to rise in the future, they will spend money and buy more now before prices rise further. Thus, when the current price decreases slightly, it does not affect their spending decisions.
Or when buying for resale, a rising price trend is an opportunity to take profit. They buy now at a lower price and resell it at a profit when the price rises in the future.
On the other hand, if consumers anticipate falling prices in the future, they delay buying to take advantage of lower prices. And, as with price increases, the current slight drop in prices does not affect their decision.
Finally, the quantity demanded and the current price are not inversely related. Rather, they have a positive relationship. Consumers base their purchases on expectations of future prices rather than current prices.
Change in income
The decision to buy is not only influenced by the price, but also the money owned by the consumer. In other words, they are less concerned about price but more concerned about their income.
When their income increases, they have more dollars, prompting them to buy more even if prices go up.
Take the decision to buy a car as an example. When income increases, we are likely to add more cars. Say, now we have one car for our transportation to the office. If our income increases, we can plan to buy a car for our wife or children.
Then, take the specific case during a recession as another example. Consumer incomes fall because they are unemployed. Employment opportunities are shrinking and it is difficult to find new jobs.
In this situation, consumers must be more frugal and wise in allocating money. Thus, although prices are generally on a downward trend, they do not necessarily increase demand.