2 reasons why there is an inverse relationship between price and quantity demanded

The inverse relationship between price and quantity demanded of the commodity is explained by the Law of Demand. This law states that other things remaining constant, the demand of a good move opposite to the movement in the price of the good. This law can be explained with the help of the following demand schedule. 

In the schedule, we can analyse that as price of the commodity X increases from Rs 7 to Rs 8, the quantity demanded of X falls from 50 units to 45 units. This confirms the negative relationship between the quantity demanded and the price of the commodity. 

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.

Recommended textbook solutions

Statistical Techniques in Business and Economics

15th EditionDouglas A. Lind, Samuel A. Wathen, William G. Marchal

1,236 solutions

Century 21 Accounting: General Journal

11th EditionClaudia Bienias Gilbertson, Debra Gentene, Mark W Lehman

1,009 solutions

Statistics for Business and Economics

13th EditionDavid R. Anderson, Dennis J. Sweeney, James J Cochran, Jeffrey D. Camm, Thomas A. Williams

1,691 solutions

Introductory Business Statistics

1st EditionAlexander Holmes, Barbara Illowsky, Susan Dean

2,174 solutions

What are the two reason for the inverse relationship between price and quantity demanded?

Is there an inverse relationship between price and quantity demanded?

Why is there a negative relationship between price and quantity demanded?

What are the reasons for the inverse relationship between P and QD explained in law of demand?