Which Explains The Connection Between The Law Of Demand And Excess Demand?

Question: Which Explains The Connection Between The Law Of Demand And Excess Demand?

1. The law states that price decreases lead to greater demand and limited supply, which occur during excess demand.
2. The law states that price increases lead to greater demand and limited supply, which occur during excess demand.
3. The law states that price decreases lead to greater supply and equilibrium, which occurs during excess demand.
4. The law states that price increases lead to greater supply and equilibrium, which occurs during excess demand.

Answer: (1) Price decreases lead to greater demand and limited supply. Therefore, it occurs when there is excess demand.

So, for your inquiry, there are four alternative options that you can choose from. Four of these options suggest a relationship between the Law of demand and excess demand. But first, you have to find out the proper answer.

Although I have offered you the answer, let me explain it so that you have no problem understanding it.  Financial accounting services like Primasia are providing all types of solutions for managing your accounts.

So, in this article, I have explained why the first answer is the correct one. Also, it would help if you knew about excess demand and the Law of demand. For your information, I have also explained those terms in detail with examples.

Connection Between Law Of Demand And Excess Demand

So, Which Explains The Connection Between The Law Of Demand And Excess Demand? The first option is the correct answer. But why? Here is the explanation-

According to the Law of demand, when the price of a good decreases, the demand increases in the process. When the demand for that product is high, it will sell out fast and make the supply limited in the market. 

Once the supply is limited, demand will increase, creating excess demand for that product. Therefore, the Law of demand can help explain the excess demand for a product. For example, an efficient invoice & receipt template helps in sorting the demands of customers, which eventually makes up more time for product sales. 

What Is The Law Of Demand?

In economics, the Law of demand is one of the fundamental concepts. Working with the Law of supply explains how the market economies allocate resources and set the cost of products and services that we observe in day-to-day transactions.

According to the Law of demand, the purchased quantity is inversely proportional to the price. In short, the higher the price, the lower the demand quantity of the product becomes.

The reason behind this is the diminishing marginal unity. The Law of diminishing marginal unity refers to humans fulfilling their most urgent needs using the economic goods they purchase. Afterward, they use the rest of the units to serve the comparatively lower-valued ends.

Major Aspects Of The Law Of Demand

To understand the Law of demand better, you will need to understand what it really means. The Law of demand says that the price and demand of all goods and services are all interrelated with each other inversely.

In simple terms, when the price of goods and services increases, the demand for the product declines. Conversely, when the prices decrease, the demand increases.

However, there are some exceptions to this law. According to WallStreetMojo.com, “There are certain exceptions to the law of demand and there are certain assumptions of the law of demand. In the case of exceptional situations, the law of demand will not work.”It is interesting to know that the law of demand does not apply in times of war.

Law Of Demand Example

For example, let’s say you sell a banana for 1 dollar. But, one day, you decide to lower the price of your bananas by fifty cents. You will likely sell more bananas at a lower price than before. Now that the banana costs half the previous price, more people would love to purchase your bananas.

Now, if you sell the same banana at a higher price, the demand for the bananas will decrease. For example, if you are selling one banana for two dollars, the demand for your bananas will also decrease.

In the same way, the demand for bananas or any other product will remain constant if the price remains unchanged.

Also Read: What Is An Essential Business? Explained With Examples

What Is Excess Demand?

Excess demand is another crucial term in economics. It means that the demand for a certain product is higher than the supply in the market. When the market has less supply of a specific product than the demand, we call it excess demand. Excess demand results in the price rise of the demanded product.

Causes Of Excess Demand

Excess Demand happens when the demand for resources is more than the demand require for necessary utilization of resources. 

According to Keynesian economic theory, an equilibrium income level can be a situation where there is full employment, over employment, or underemployment of the resources in hand. Similarly, when the whole economy is not at employment, there can be situations of deficit demand and surplus demand. An excess demand (or surplus demand) corresponds to a situation of disequilibrium.

This occurs when the planned aggregate expenditure is more than the aggregate supply at the time of full employment of resources. This creates a gap between the demand and availability of resources. This gap is called the inflationary gap.

Here the overall demand is more than what is necessary to maintain it at full employment. The inflationary gap hence creates inflation which raises the prices of essentials, however, there is no increase in output or income levels.

The following are the major reasons for a rise in excess demand in an economy:

1. A rise in consumption expenditure leads to a rise in excess demand. This happens when there is an increased spending spree or decreased willingness to save.

2. Excess demand also increases due to major tax reductions from the government, as it leads to more disposable income. This, in turn, increases consumer demand.

3. When the government increases its expenditure, it results in excess demand.

4. Decline in imports and a rise in exports also create excess demand in the economy.

5. When interest rates fall, it increases private consumption expenditure, as it increases excess demand.6. When the government spends more money than what it makes through taxes, it causes deficit financing. This results in excess demand.

Excess Demand Example

Excess demand occurs when the price of a product is lower than the equilibrium price. For instance, the demand for oximeters has increased in the market. But there is less supply. Therefore, more and more people want to buy oximeters. But due to the lack of supply, there is an excessive demand in the market. This is an excess demand caused by lesser market supply.

If a bakery store offers discounts on a popular dessert, more buyers will want to buy the dessert. Eventually, the store will run out of supply, leaving the customers with more demand. This excess demand occurs due to the price reduction below the equilibrium price.

But, if there is an excessive supply of a good than the market demand, it is called excess supply. Excess demand and excess supply are two opposite phenomena.

Frequently Asked Questions (FAQs)

I hope that you have got your answer; however, for further queries, you can check out the question answers below-

Conclusion

Excess demand and the Law of demand are the two most fundamental principles of economics. It is crucial to know what these terms mean if you want to grasp the answer to the question you have asked. If you want to learn how to calculate excess demand and supply, you need to have a basic idea about these economic terms.

I hope that the present article was capable of answering: Which Explains The Connection Between The Law Of Demand And Excess Demand.

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