Question

Use the following theories to explain the law of demand:

(i) Income effects

(ii) Substitution effects

Please include the reasoning involved with theory to explain the law of demand

Answer 1

The law of demand states that when the price of a product increases the quantity demanded for that product decreases and when the price decreases the quantity demanded for that product increases. Therefore, the relationship between price and quality is inverse in case of demand. That's why the curve of the demand curve slopes downwards.

Now, the slope is downwards due to two reasons. The first reason is due to income effect and the second reason is substitution effect. The income effects states that when the price of a commodity decreases the purchasing power of the individual increases, that is the relative incone increases. The substitution effect explains this downward sloping demand curve by stating that when there is a fall in the price of a commodity, the person shifts or substitutes his consumption towards the goods that is comparatively of lower price. Basically the consumer prefers to consumer a substitute that is cheaper in the market.

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