Why the demand curve slopes downwards

Overview

Law of demand and the condition under which it holds, income effect of a price fall and substitution effect of a price rise.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   State the law of demand and the condition under which it holds.

   Model answer

   The law of demand states that, other things being equal, the quantity of a good demanded rises as its price falls and falls as its price rises. The condition matters: incomes, tastes, the prices of other goods and expectations must all be held constant. Without that condition, price and quantity can move together, but that reflects a shift of the curve rather than a violation of the law.

2. 2

   Explain the income effect of a price fall.

   Model answer

   When the price of a good falls, a consumer who continues to buy the same quantity has money left over, so their real income, meaning what their money can buy, has risen. For a normal good that extra purchasing power leads them to buy more of the good, and of other goods too, so the income effect reinforces the substitution effect and is one reason quantity demanded rises as price falls; for an inferior good it pulls the other way, because a higher real income reduces the quantity bought. Either way the income effect is strongest for goods that take a large share of the budget.

3. 3

   Explain the substitution effect of a price rise.

   Model answer

   When the price of a good rises while other prices are unchanged, it becomes relatively more expensive than the alternatives. Consumers therefore switch some of their spending towards the goods that now look cheaper by comparison, so less of the dearer good is bought. This substitution effect operates even if the consumer's real income were somehow unchanged, because it depends on relative prices.

4. 4

   Use the income and substitution effects together to explain the shape of the demand curve for rail travel.

   Model answer

   If rail fares fall, travellers find rail cheaper relative to driving and flying, so some switch modes, which is the substitution effect and raises the quantity of rail journeys demanded. Those already travelling by rail also have money left over, raising their real income, and some use it to make additional journeys, which is the income effect. Both effects push in the same direction, so quantity demanded rises as fares fall and the demand curve slopes downwards.

5. 5

   State the law of diminishing marginal utility.

   Model answer

   The law of diminishing marginal utility states that as a consumer consumes successive units of the same good within a given period, the additional satisfaction obtained from each extra unit eventually falls. Total satisfaction may still be rising, but it rises by smaller and smaller amounts. The law is about the extra unit, not about the total.

6. 6

   Distinguish between total utility and marginal utility.

   Model answer

   Total utility is the whole satisfaction a consumer derives from consuming a given quantity of a good. Marginal utility is the addition to total utility from consuming one more unit. Marginal utility is the increment; total utility is the running sum of all the increments consumed so far.

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