Price and Quantity Changes

 

The law of demand states that buyers of a good will purchase more of the good if its price is lower, and vice versa. This assumes that no other economic changes take place. If the price of apples decreases from $1.79 per pound to $1.59 per pound, consumers will buy more apples.

 

Ceteris Paribus

The law of demand assumes that no other changes take place. This assumption is called “ceteris paribus.” If we don’t make this assumption, then it is possible that the price of apples decreases from $1.79 per pound to $1.59 per pound, and that fewer, not more, pounds of apples are purchased.

 

One explanation for this may be that the price of oranges, a substitute product, has decreased more than the price of apples, so that consumers will substitute oranges for apples. Does this violate the law of demand? The answer is no. If we had not changed anything else (ceteris paribus), then we would have noticed an increasein the quantity purchased of apples as a result of a decrease in its price, and this conforms to the law of demand. 

Substitution and Income Effects

There are two primary reasons why people purchase more of a product as its price decreases. One is the “substitution effect.” The substitution effect states that as the price of a product decreases, it becomes cheaper than competing products (assuming the other products don’t decrease in price). Consumers will substitute the cheaper product for the more expensive product, and vice versa. For example, if apple juice decreases in price, then “ceteris paribus,” more people will purchase apple juice. Note also that fewer people will purchase orange juice, assuming that these products are substitutes.  

The other effect is the “income effect.” The income effect states that as the price of a product decreases, buyers will have more income available to purchase more products, and vice versa. For example, if someone purchases 4 DVDs per week at $15 per DVD, this buyer’s total expenditure on DVDs is $60. If the price of the DVD falls to $10, the total expenditure for 4 DVDs now equals $40. This means that this buyer now has $20 more income compared to when the price of the DVD was $15. In essence, this buyer’s real income has increased. This allows the buyer to purchase more DVDs.