The Inviolable Law of Demand

Abstract

We extend upon Reeves (2020), who attempts to demonstrate that classical violations of the Law of Demand are in actuality the result of a violation of the ‘ceteris paribus’ assumption. For example, price changes in Giffen goods create a chain reaction from the Giffen good through a substitute and back to the Giffen good. Specifically, a price change in the Giffen good is so large wrt the consumer’s income that it creates an income effect on a substitute good, whose decrease in demand sends a shock to the Giffen good’s demand curve, shifting it out through a change in preferences and, hence, violating ceteris paribus. To understand how preferences change, consider the consumer equilibrium condition, MU(x) = λp. When price increases and income (i.e. λ) is held constant, marginal utility must increase. In order for x to increase with price, marginal utility must increase with consumption, violating the Law of Diminishing Marginal Utility. Hence, the change in price must precipitate a change in preferences because for some values of x preferences comport with the Law of Diminishing Marginal Utility whereas for other values of x preferences do not. In this paper, we respond to the non-technical aspects of Jensen and Nolan (2007) by suggesting that the price and demand changes that they are measuring are likely changes along the supply curve, not an upward sloping demand curve. One possible reason for the purported oversight is that the research explores Giffen effects in (good1 , good2 )-space, which cannot capture shifts in the demand curve, defined in (good1 , price1 )-space.