The law of demand is an economic principle that states that consumer demand for a good rises when prices fall while conversely, consumer demand falls when prices rise.

However, the relationship between prices and demand is derived from the law of diminishing marginal utility, which states that consumers buy or use goods to satisfy their urgent needs first. Utility refers to the satisfaction or benefit that results from consuming a good. In other words, the first good or unit typically has the highest utility or benefit, and with each additional unit consumed utility decreases. As a result, the price consumers are willing to pay for a good declines as their utility decreases.

Law of Demand and Pricing

Companies use the law of demand when setting prices and determining the level of demand for their products. Consumers use the law of demand in deciding the quantity of goods to buy. Below are examples of the law of demand and how consumers react to prices as their utility or satisfaction changes.

Restaurants

For example, if a consumer is hungry and buys a slice of pizza, the first slice will have the greatest benefit or utility. With each additional slice, the consumer becomes more satisfied, and utility declines. In theory, the first slice might fetch a higher price from the consumer. However, by the fourth slice, the consumer might be less willing to pay for a slice because of declining utility. In other words, if the pizza restaurant lowered the price of their slices, it would have less of an impact on demand because utility has decreased—their customers were full or satisfied.

Key Takeaways

  • The law of demand is an economic principle that states that consumer demand for a good rises when prices fall and decline when prices rise.
  • The law of demand comes into play during Black Friday sales—when consumers rush to buy products at deep discounts.
  • Diminishing marginal utility occurs eventually because consumers satisfy their urgent needs first.
  • If the utility gained from a product isn't enough to justify a product's price, the price will likely be lowered, or demand will decline.

Groceries

Another example includes how grocery customers would likely prefer to consume more food but are limited by price. Promotional grocery pricing frequently offers discounted prices on the condition that a certain number of items are purchased. The existence and success of this promotional pricing model exemplifies consumer willingness to purchase higher quantities at lower prices. However, consumers will demand lower prices as they receive more groceries since their needs decline as consumption increases. Once consumers have satisfied their urgent needs first, they'll likely want lower prices because their utility will have declined.

The Holidays

The law of demand can impact companies since they can only lower their prices by only so much before it has little to no impact on consumer demand. We can see the law of demand play out during the holiday season when consumers rush to stores on Black Friday in search of discounts. When prices are lowered, it leads to a huge jump in demand.

As we get closer to the holiday, however, the markdowns must be greater to entice consumers to buy more products. Consumers' utility declines as their needs are met (shopping list is finished). In other words, prices are higher than the added utility or benefit from buying additional products as we near the holidays. The result is deep price discounts, especially after the holidays.

The utility or satisfaction gained by a consumer must be greater than the price offered by the seller of the good.

Concerts

Consider a hypothetical scenario in which tickets for a sporting event are being sold by scalpers on the secondary market. Suppose the scalpers expect the game will be highly attended and are charging $200 per ticket. For many people, this price point is too high to justify. As the start of the game approaches, the scalpers realize they were wrong about projected attendance. The quantity demanded at $200 is not sufficient to sell out the game. The ticket price on the secondary market drops to $50, and more people are willing to meet this price to see the game. The change occurred because ticket suppliers altered the prices, and consumers responded to a change in price only.

Movies

If movie ticket prices declined to $3 each, for example, demand for movies would likely rise. As long as the utility from going to the movies exceeds the $3 price, demand will rise. As soon as consumers are satisfied that they've seen enough movies, for the time being, demand for tickets will fall.