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Law of demand

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Conceptually, the law of demand arises from two fundamental causes: first, the limited purchasing power of an individual or household, and second, 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 quantity demanded for 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 [[substitute 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 quantity demanded 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 follows from differences in reservation prices]]}}
===For firms in their demand for inputs to production===
===What matters are relative prices -- effects of inflation and simultaneous changes in prices of substitutes===
The analysis of the relation between demand quantity demanded and price is carried out in terms of ''real'' prices, i.e., prices ''relative'' to the prices of similar goods and the household income. An across-the-board inflation, that affects all prices uniformly, and also affects income (though wage rises) and savings (through interest) in the same proportion, should not in principle lead to a decrease in demand.
However, non-uniform inflation can lead to an ''increase'' in demand even with an increase in price, if the inflation is responsible for a ''greater'' increase in the price of substitutes. Similarly, an increase in the price of factors of production used for a certain good may lead to an increase in its price, but if it leads to a ''greater'' increase in the price of substitute goods, there may be either an increase or a decrease in demand. What happens depends on the interplay between the [[income effect]] and the [[substitution effect]].
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