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Law of demand

775 bytes added, 13:02, 1 August 2010
Levels of operation of the law
==Levels of operation of the law==
 
===For individuals and households===
Conceptually, the law of demand arises from two fundamental causes: first, the limited purchasing power of an individual or household, and second, the fact that the nature of preferences of the individual or household, i.e., the nature of the utility function that the individual or household is trying to maximize. The law of demand operates at multiple levels.
* ''For a given household and a given commodity'': The demand of a particular household for a particular commodity is expected to increase, or at least stay constant, as the price of the commodity falls. This relies on the assumption that the marginal benefit from every additional unit of the commodity is decreasing. There are two effects responsible for the law of demand: [[income effect]], which states that the higher the price, the less the household can spend on the good with the limited income it has, and the [[substitution effect]], which predicts that an increase in price makes the household substitute away from the good towards [[subsitute goods]]. {{further|[[Law of demand for individual buyers follows from diminishing marginal utility]], [[Income effect explains law of demand]], [[substitution effect explains law of demand]]}}
* ''For an aggregate of households and a given commodity'': The demand over an aggregate of households for a particular commodity is expected to increase, or at least stay constant, as the price of the commodity falls. This may happen because the consumption of individual households increases steadily, as well as because the number of households purchasing the commodity also increases steadily, as the price falls to the reservation price. The second effect is due to differences in [[reservation price]]s across households. Note that this effect is operational even when there is essentially no scope for a single individual or household to buy more than one unit of the commodity. {{further|[[Law of demand for multiple buyers following from differences in reservation prices]]}}
 
===For firms in their demand for inputs to production===
 
The law of demand also applies for firms that buy inputs to their production process (i.e., [[factor of production|factors of production]]) from other firms. When the price of an input into the production process of a firm increases, the demand of the firm for that input is likely to decrease. The firm typically does either one or both of the following: alter its production process to use less of that input and more of various substitutes, and/or scale back the quantity of its production.
 
Note that, as discussed in the apparent counterexamples, if the prices of substitute inputs increases ''more'', demand for the given input might increase even as the price increases.
==Causation versus correlation: superfical counterexamples==
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