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Question
Price and demand move in opposite directions. Give two reasons justifying this statement.
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Solution
Price and demand move in opposite directions. This is because of :1. Income Effect: When price of the commodity rises,real income of the people decreases,whereas money income remains the same. In other words, consumers can now buy less amount of goods with the same money they have. This is called income effect. For example, let the money income of consumer be Rs.100 , price of the commodity be Rs.10 so the quantity demanded is 10 units. Now if the price rises to Rs 20 per unit , quantity demanded will be 5 units. Hence as price increases demand decreases.
2. Substitution Effect: When commodity becomes cheaper ,it is substituted for other commodities which are expensive. This is known as substitution effect. For example , price of tea is Rs 50 and price of coffee is Rs 60 , now tea being cheaper than coffee will work as substitute for coffee and hence demand for tea will increase.
1. Income Effect: When price of the commodity rises,real income of the people decreases,whereas money income remains the same. In other words, consumers can now buy less amount of goods with the same money they have. This is called income effect. For example, let the money income of consumer be Rs.100 , price of the commodity be Rs.10 so the quantity demanded is 10 units. Now if the price rises to Rs 20 per unit , quantity demanded will be 5 units. Hence as price increases demand decreases.
2. Substitution Effect: When commodity becomes cheaper ,it is substituted for other commodities which are expensive. This is known as substitution effect. For example , price of tea is Rs 50 and price of coffee is Rs 60 , now tea being cheaper than coffee will work as substitute for coffee and hence demand for tea will increase.
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