The classic microeconomics supply and demand model shows price on the vertical axis and demand on the horizontal axis. In between, them is a downward-slowing demand curve where price and quantity demanded to have an inverse relationship. The general concept is intuitive: as goods become more expensive, people tend to demand less of them.

For many simple markets, this inverse relationship holds true. If the cost of a shirt doubles, consumers buy fewer shirts, all else being equal. If the shirts go on sale, consumers tend to buy more.

There are several problems with the simple supply and demand model, however. In addition to the theoretical existence of Giffen and Veblen goods, a basic microeconomics chart cannot contain all of the possible variables that impact supply and demand.

Deducing the Law of Demand

The law of demand is actually a deductive, logical construct. It holds a few observations as true: resources are scarce, there is a cost to acquiring them, and human beings employ resources to achieve meaningful ends.

Cost does not necessarily mean a dollar amount. Cost simply represents what is given up to acquire something, even if it is time or energy. True cost also implies opportunity costs.

Since human beings act, economists deduce that their actions necessarily reflect value judgments. Every nonreflex action is taken to obtain or increase value in some sense; otherwise, no action takes place. This definition of value is incredibly broad and could be considered a tautology. As the cost of acquiring a good increases, its relative marginal utility decreases compared to other goods. Even if all relative costs increased by exactly the same proportion at the exact same time, consumers' resources are finite.

Consumers only enter into a voluntary trade if they believe, or ex-ante, they receive more value in return; otherwise, no trade occurs. When the relative cost of a good increases, the gap between value and cost shrinks. Eventually, it goes away. Thus, the law of demand really states: as a good's true cost increases, consumers demand relatively less of it.