The law of demand states that as the price change the demand for the product moves in the opposite direction. This means that with a drop in the price of the goods consumers demand increases this in turn increases the sale of the product of that organization. Thus, with this effect it helps to increase the profit for that organization. However, the effect of price and demand for a product differs from goods to goods and also across various industries. Thus, there are goods for which the demand does not rise with a drop in price. This causes their profit either to remain same or fall in the long run. It might also happen that the drop in price does not lead to increase in demand due to excessive competition in the market for that product.
The report discuses about various theories and thoughts put forward on this topic. It further uses this theory on various goods and services to prove whether a drop in price leads to increase in demand and profit or it is just a myth.
Interpretation and analysis of Literature
Comparing Previous Literature
According to Nguyen and Le (2015), there is a given difficultly in analyzing the relation between demand, price and the profit of the organization. This is because there are various factors that influence the effect of drop in price on the demand of the product and the profit of the organization. The organization thus needs to make a systematic framework to get a clear picture of the effect. On the other hand, Minsky (2015) argues that a fall in price does increase the demand for the product and the profit of the company. This is because according to the author the financial growth and changes of the business are reduced due to instability in the business and not for the price of the product. Carvalho and Rezai (2015) have discussed that the demand of the people is not only influenced by the price of the product. It is also affected by the income of the consumers in the economy. Thus according to them even if there is a fall in price of the product, the demand might not rise due to income factor. Hirschey (2016) on the other hand showed that the price is affected with a rise in demand rather than price affecting demand. He has put forward a different side of law of demand that is not applicable in real world.
Analysis of General Principle to Giffen goods
The law of demand states that with a change in price of the product, the demand of that product also changes (Mankiw 2014). Further as demand affects the revenue of the product it helps in increasing or decreasing the profit of the firm. For example, if the price falls the demand increases and thus helps in increasing the revenue of the product. However, this theory is not true in case of giffen goods. This is because giffen goods consist of a type of inferior good for which the demand for the good falls with a fall in price. When the price falls for giffen goods, the consumers of those goods prefer having a better quality of goods and this causes the demand to fall for those goods even with a fall in price (Kubler, Selden and Wei 2013). Thus, for giffen goods it is seen that even with a fall in price the profit of the company producing such goods does not increases.
Application of Law of Demand on different goods
The law of demand also differs according to the type of goods produced by the organization. There are various types of goods found in the organization such as giffen goods, substitute goods, complementary goods, normal goods, luxury goods, and inferior goods. As seen above the theory of demand does not apply to giffen goods. The demand of a product is also affected by the availability of substitutes and complementary in the market. With a fall in price the demand of the product might increase with a fall in price because the price of that product has become comparatively less costlier than the substitute. Thus in substitute goods the law applies. However, n case of inferior good the law does not apply because the demand for inferior good is affected by the both the price of the good and the income of the consumer. This shows that the statement that a drop in price might increase its demand and the profit of the consumer is uncertain due to various factors.
Effect of Price Change on Demand across Industries
The type of industry the company is engaged in also affects the demand of the product. For example if the company is producing luxury good then its demand does not increase to a great extent because he consumer of such goods are very less and will buy the product even if the price of good is higher. Consumers buying luxury goods are mainly rich people and they are not affected by any change in price (Chongela, Nandala and Korabandi 2014). On the other hand, a change in price of normal good will affects its demand to a great extent and the profit of the organization. For example, grocery items, vegetables and other for which the consumers tend to buy more and store it when the price of such goods falls. Thus, the profit of the industry is influenced by its price depending o the type of industry it is engaged in and the perception of the consumer regarding it.
Differences in Analysis between Business and Consumer
From the above analysis, it can be seen that the law of demand does not apply on certain goods and industries and it also depends on the perception of the consumer regarding that product. For instance, a consumer might measure the quality of the good from its price and feel that a fall in price of the goods has also reduced its quality. This in turn reduces that demand for the product even with an increase in price. On the other hand, the demand also decreases in the long run when the other competitors in the market adjust their prices. Thus, the demand for a product differs from consumer to consumer and from business to business.
From the above analysis, it can be stated that not necessarily the drop in price will increase the demand of the product and in turn the profit of the business. This is because there are various factors that influence people’s demand for a product such as types of goods, industry, personal perception and many more.
Carvalho, L. and Rezai, A., 2015. Personal income inequality and aggregate demand. Cambridge Journal of Economics, 40(2), pp.491-505.
Chongela, J., Nandala, V. and Korabandi, S., 2014. Consumer demand system of agri-food in Tanzania. Journal of Development and Agricultural Economics, 6(1), pp.42-48.
Hirschey, M., 2016. Managerial economics. Cengage Learning.
Kubler, F., Selden, L. and Wei, X., 2013. Inferior good and Giffen behavior for investing and borrowing. The American Economic Review, 103(2), pp.1034-1053.
Mankiw, N.G., 2014. Essentials of economics. Cengage learning.
Minsky, H.P., 2015. Can" it" happen again?: essays on instability and finance. Routledge.
Nguyen, D.T. and Le, L.B., 2015. Risk-constrained profit maximization for microgrid aggregators with demand response. IEEE Transactions on Smart Grid, 6(1), pp.135-146.