Which of the following are reasons for the inverse relationship between price and quantity demanded?

Solution : The inverse relationship between price of the commodity and quantity demanded for that commodity is because of the following reasons: <br> (i) Income effect : <br> (a) Quantity demanded of a commodity changes due to change in purchasing power (real income), caused by change in price of a commodity is called Income Effect. <br> (b) Any change in the price of a commodity affects the purchasing power or real income of the consumers although his money income remains the same. <br> (c ) When price of a commodity rise more has to be spent on purchase of the same quantity of that commodity. Thus, rise in price of commodity leads to fall in real income, which will thereby reduce quantity demanded is known as Income effect. <br> (ii) Substitution effect : <br> (a) It refers to substitution of one commodity in place of another commodity when it becomes relatively cheaper. <br> (b) A rise in price of the commodity let coke, also means that price of its substitute, let pepsi, has fallen in relation to that of coke, even though the price of pepsi remains unchanged. So, people will buy more of pepsi and less of coke when price of coke rises. <br> (c ) In other words, consumers will I substitute pepsi for coke. This is called Substitution effect. <br> Price effect = Income effect + Substitution effect <br> (iii) Law of Diminishing Marginal Utility: <br> (a) This law states that when a consumer consumes more and more units of a commodity,every additional unit of a commodity gives lesser and lesser satisfaction and marginal utility decreases. <br> (b) The consumer consumes a commodity till marginal utility (benefit) he gets equals to the price (cost) they pay, i.e., where benefit = cost. <br> (c ) For example, a thirsty man gets the maximum satisfaction (utility) from the first glass of water. Lesser utility from the 2nd glass of water, still lesser from the 3rd glass of water and so on. Clearly, if a consumer wants to buy more units of the commodity, he would like to do so at a lower price. Since, the utility derived from additional unit is lower. <br> (iv) Additional consumer: <br> (a) When price of a commodity falls, two effects are quite possible: <br> New consumers, that is , consumers that were not able to afford a commodity previously, starts demanding it at a lower price. <br> Old consumers of the commodity starts demanding more of the same commodity by spending the same amount of money. <br> (b) As the result of old and new buyers push up the demand for a commodity when price falls.

When the price of a good falls, it has the following two effects that lead a consumer to buy more of that commodity.(i) Income effect: When the price of a commodity falls, the real income of the consumer, i.e., his purchasing power increases. As a result, he can now buy more of a commodity. This is called income effect. This causes increase in the quantity demanded of the good whose price falls. (adsbygoogle = window.adsbygoogle || []).push({}); (ii) Substitution effect: When the price of a commodity falls, it becomes relatively cheaper than others. This induces the consumer to substitute the cheaper commodity for the other goods which are relatively expensive. This is called as the substitution effect. This causes increase in quantity demanded of the commodity whose price has fallen.Thus, as a result of the combined operation of the income effect and substitute effect, the quantity demanded of a commodity increases with a fall in the price.

The classic microeconomics supply and demand model shows price on the vertical axis and demand on the horizontal axis. In between, them is a downward-slowing demand curve where price and quantity demanded to have an inverse relationship. The general concept is intuitive: as goods become more expensive, people tend to demand less of them.

Key Takeaways

• The law of supply and demand is a keystone of modern economics.
• According to this theory, the price of a good is inversely related to the quantity offered.
• This makes sense for many goods, since the more costly it becomes, less people will be able to afford it and demand will subsequently drop.

Supply & Demand

The law of supply and demand, one of the most basic economic laws, ties into almost all economic principles in some way. In practice, supply and demand pull against each other until the market finds an equilibrium price. For many simple markets, this inverse relationship holds true. If the cost of a shirt doubles, consumers buy fewer shirts, all else being equal. If the shirts go on sale, consumers tend to buy more. However, multiple factors can affect both supply and demand, causing them to increase or decrease in various ways.

There are several practical issues with the simple supply and demand model as depicted in the graph below. In addition to the theoretical existence of goods that actually rise in demand as the price goes up (known as Giffen and Veblen goods), a basic microeconomics chart like this one cannot possibly contain all of the various variables at work that impact supply and demand. Nevertheless, it is typically the case that price and quantity are inversely related: the more costly the same good becomes, they less people will want it - and vice versa.

Deducing the Law of Demand

The law of demand is actually a deductive, logical construct. It holds a few observations as true: resources are scarce, there is a cost to acquiring them, and human beings employ resources to achieve meaningful ends.

Cost does not necessarily mean a dollar amount. Cost simply represents what is given up to acquire something, even if it is time or energy. True cost also implies opportunity costs.

Since human beings act, economists deduce that their actions necessarily reflect value judgments. Every nonreflex action is taken to obtain or increase value in some sense; otherwise, no action takes place. This definition of value is incredibly broad and could be considered a tautology. As the cost of acquiring a good increases, its relative marginal utility decreases compared to other goods. Even if all relative costs increased by exactly the same proportion at the exact same time, consumers' resources are finite.

The Bottom Line

Consumers only enter into a voluntary trade if they believe, or ex-ante, they receive more value in return; otherwise, no trade occurs. When the relative cost of a good increases, the gap between value and cost shrinks. Eventually, it goes away. Thus, the law of demand really states: as a good's true cost increases, consumers demand relatively less of it.

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