Blackwell Reference Online

Extract

A fundamental principle of economics states that an inverse relationship exists between a change in the price of any product and the resulting change in its quantity demanded in the market. More formally the law of demand states that, ceteris paribus , as the price of a good rises, its quantity demanded falls, and as the price of a good falls, its quantity demanded rises in the market. It is important to note that the motivating force behind the change in consumer behavior here is a change of price rather than, and without, any other change occurring in variables such as consumer tastes and income, which also make up the demand function . The price change influences the adjustment in quantity demanded through two separate effects. The income effect is that portion of the change in quantity demanded which is due to the change in consumer purchasing power resulting from the price change. For example, when the price of a product decreases, the existing (and unchanged) level of consumer income now has greater real purchasing power. This makes consumers of the good in question richer and induces an increase in the number of units purchased. The substitution effect recognizes that in the calculus of consumer decision‐making, individuals are also concerned with the price of a product relative to the prices of any substitutes that are available. Since the ceteris paribus condition ... log in or subscribe to read full text