In any economy, prices are driven by supply and demand. In competitive markets, the price of a good keeps moving as long as demand and supply are unequal, and it settles only when the two are in balance, at equilibrium.
The law of demand says that people buy less of a good when its price rises. In some situations, however, the opposite happens. These are the main exceptions.
Giffen goods
The idea is named after the economist Sir Robert Giffen. Giffen goods are inferior goods, usually cheap staples, with an unusual feature: when their price rises, the quantity demanded also rises. That is why they are an exception to the law of demand.
The Irish Potato Famine is the classic textbook illustration. Potatoes were the staple of the Irish diet. When their price rose sharply, poor families could no longer afford costlier foods such as meat, so they cut those out and bought even more potatoes to fill their stomachs. As the price of potatoes went up, so did the quantity demanded, the reverse of what the law of demand predicts.
Veblen goods
The economist Thorstein Veblen described these goods in his theory of "conspicuous consumption". Some goods seem more valuable and desirable precisely because they are expensive. When the price goes up, buyers see more worth in them, and demand rises.
This happens mostly with luxury goods: gold, platinum, precious stones and diamonds, and luxury cars such as a Porsche. As their price rises, they become stronger symbols of status, and demand increases.
Expectations of price changes
If people expect a price to keep rising, they buy more now, before it goes up further. In the same way, if they expect a price to fall further, they may delay buying so as to benefit from the lower price later.
For example, when the prices of certain vegetables and fruits rise steeply, buyers sometimes purchase and store more of them for fear of a further rise, and demand increases along with the price.
At other times, shoppers buy and store essential goods because they fear a shortage. Even though the price is rising, demand rises too, because people worry the item may disappear from the shelves.
Necessities
People go on buying necessities such as medicines and staples like salt, rice and sugar even when their prices rise. For these goods, a change in price has little effect on the quantity demanded.
Change in income
Buying behaviour also changes with income. If a family's disposable income rises, it may buy more of an item even though its price has gone up. Similarly, if income falls, it may put off a purchase even when the price has come down. So a change in the consumer's income can also override the law of demand.
Other exceptions
Luxury goods: buying of luxury goods such as gold or real estate does not stop even when their prices rise.
Consumer ignorance: consumers are sometimes unaware of price changes in the market, and may go on buying, or even pay more than the maker's price.
Demonstration effect: middle-income consumers often copy the buying habits of the better-off and purchase the same products, whatever the price.
Tastes, preferences and fashion: when a product is in fashion, consumers are willing to spend more on it, so a rise in price need not reduce the quantity demanded.
Trading on stock exchanges: the law of demand does not hold in speculative markets. When share prices rise, people often buy more shares, expecting prices to rise further.
Why the exceptions matter to a manager
The law of demand holds for most goods most of the time, which is why it is taught first. But a manager who assumes that a price rise will always cut sales can be caught out. A seller of luxury goods may find that a lower price actually weakens the brand, while a trader in staples may find that customers keep buying despite a price rise. Knowing when the usual rule bends helps a firm price its products sensibly.
Key terms
- Giffen good
- An inferior staple whose quantity demanded rises when its price rises.
- Veblen good
- A luxury good that becomes more desirable as its price rises, because a high price signals status.
- Conspicuous consumption
- Buying expensive goods mainly to display wealth or status.
- Demonstration effect
- The tendency of people to copy the consumption habits of those better off than themselves.