Q.(a) Explain the Law of Demand and its exceptions.

(a) The law of demand states an inverse price-quantity relationship (downward demand curve), subject to exceptions like Giffen and prestige goods. (b) Under perfect competition, the industry sets price by demand and supply; the price-taking firm is in equilibrium at MC = MR = AR = Price, earning supernormal or loss in the short run and only normal profit in the long run.

PART (a): Law of Demand and its exceptions

Statement: "Other things remaining constant, the quantity demanded of a commodity increases when its price falls and decreases when its price rises." Price and quantity demanded are inversely related, so the demand curve slopes downward from left to right.

Assumptions (other things being equal): no change in consumers' income, tastes and preferences, prices of related goods, or expectations about future prices.

Reasons: the law of diminishing marginal utility, the income effect and the substitution effect, and the arrival of new buyers when price falls.

Exceptions to the Law of Demand (where more is bought at a higher price):

1. Giffen goods — inferior goods (e.g. coarse grain); a rise in their price may increase demand as poor consumers cannot afford costlier substitutes.
2. Prestige / Veblen goods — luxury articles (diamonds, branded goods) bought for show; higher price increases their prestige and demand.
3. Expectation of future price change — if prices are expected to rise further, people buy more now even at a higher price.
4. Ignorance — buyers may think a higher-priced good is of better quality and buy more.
5. Necessaries of life — essential goods (salt, medicines) are bought in needed quantities regardless of price.
6. Speculation — in share/commodity markets, people may buy more when prices rise.

PART (b): Price and output determination under Perfect Competition

Perfect competition has many buyers and sellers, a homogeneous product, free entry and exit, perfect knowledge, and free factor mobility. Each firm is a price-taker.

1. Price determination by the industry: the market price is fixed at the point where market demand equals market supply (equilibrium). This price is given to every firm.
2. The firm's demand curve is a horizontal straight line at that price, so Price = AR = MR for the firm. …