Law of demand is violated when?

Negative income effect is greater than substitution effect.

The correct answer is Option (3) → Negative income effect is greater than substitution effect.

Law of Demand: Law of Demand states that other things being equal, there is a negative relation between demand for a commodity and its price. In other words, when price of the commodity increases, demand for it falls and when price of the commodity decreases, demand for it rises, other factors remaining the same. This law holds true because of two reinforcing effects:

1. Substitution effect – When the price of a good falls, it becomes relatively cheaper compared to other goods, so consumers substitute it with the now cheaper good. This effect is always positive (supports the law of demand).

2. Income effect – A fall in price increases the real income (purchasing power) of the consumer. For normal goods, this effect is positive (more is demanded). But for inferior goods (especially Giffen goods), the income effect is negative (less is demanded as real income increases).

However, there are some goods the demands for which move in the opposite direction of the income of the consumer. Such goods are called inferior goods. As the income of the consumer increases, the demand for an inferior good falls, and as the income decreases, the demand for an inferior good rises. Examples of inferior goods include low quality food items like coarse cereals. 

For a Giffen good, the negative income effect (decrease in demand due to higher real income from lower price) is larger than the positive substitution effect (increase in demand due to lower relative price). The net result is that when the price falls, the quantity demanded also falls, violating the Law of Demand.