In a hypothetical economy it has been observed that when the price of a good was...

In a hypothetical economy it has been observed that when the price of a good was $5 per unit consumers bought 1,000 units of the good. When the price of the good rose to $8 and $10 per unit consumers increased their purchase level to 2,000 and 3,000 units, respectively. Is this evidence that the law of demand was violated in that economy? Explain.

Expert Solution

The law of demand states that keeping other things constant, quantity demanded rises as price falls. This means quantity demanded and price have an inverse relationship.

In this case, the price increase has led to increase in quantity demanded which is in violation of the law of demand. This happens in exceptional cases when the goods are giffen (low quality) and luxury goods.

In luxury goods as price increases, people buy more to demonstrate. This is called Demonstration effect. In the above case, the good does not seem ultra-luxury, Its price ranged from $5 to $10.

Under Giffen good case the quantity demanded increases as people think the quality has improved when prices are increased so they buy more.

Hence Giffen good violates law of demand.

Rahul Sunny answered 2 years ago

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