Quiz 4: Background to Demand: Consumer Choices
Law of demand: Law of demand states that demand for goods and services is inversely related to its price. As the price of goods and services increases, the demand for those goods and services would fall. Examples: If the price of pizza increases, the consumer has to pay more than he did earlier. Hence, they will get to reduce their pizza consumption. Increase in the price of movie tickets will reduce the number of people watching movies in theaters. The law of demand is related to the demand curve in the following ways: - The more the price of the product the less will be the demand of the product - The law of demand shows the downward fall or upward rise in slope of the demand curve
The following factors determine the demand for a normal good: Income level of the consumer: Change in income changes the purchasing power of a consumer. A consumer can buy more products if his/her income increases and vice-versa. Hence, the demand for normal goods is positively associated with the income level of the consumer. Change in price of other commodities: Consumer's budget is sensitive to the price of other commodities. If the price of other commodities increases, then the consumer will have a deficit budget; hence, he/she will reduce his/her demand for normal goods and maximize his/her utility. On the other hand, if the price of other commodities decreases, then the consumer will have surplus budget; hence, he/she will increase his/her demand for normal goods and maximize his/her utility. Change in consumer's taste and preference: If consumers start disliking a particular product, then the demand for that product will decrease. Hence, taste and preference of the consumer is a key factor in determining the demand for normal goods. Increase or decrease in number of consumers: If the number of consumers increases, then the consumption of goods and services will increase. Hence, the number of consumers also determines the demand for normal goods. Complementary goods Some normal goods are complementary goods; it means the demand for a good relies on the price of the other goods. For example, car and petrol are interdependent; hence, an increase in the price of fuel will reduce the demand for cars. Therefore, in the case of complementary normal goods, the fall in the price of a good does not increase the demand for that good.The normal good is the goods which is directly proportional to the income level of the consumer. If the normal good is reduced, the consumer feel like it is not accepted by the most of the people in the market. And the social status doesn't allow the consumer to move towards buying the reduced normal good. Being the new arrivals the consumer doesn't believe in the normal goods.
Differences between substitution and income effect: Substitution effect implies that consumer is willing to purchase a commodity when its relative price falls when compared to that of the other goods. Income effect implies that consumer is willing to purchase a commodity when the income of the consumer increases. Substitution effect is the cause of change in real income of a consumer, whereas income effect is the cause of change in nominal income of a consumer. If the price of a good increases the substitution effect have a negative effect , as the consumer try to search for the other available products with lower prices. Whereas the income effect has a positive effect , as the consumer tends to buy the increased product with the increase in the income level.
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