Explanation of Law of Demand

Explanation of Law of Demand

Downward sloping demand curve is a fundamental proposition of consumer demand theory. The revealed preference approach explains this simply from an analysis of the way a 'rational' consumer would behave without observing the spending pattern of an actual consumer as under indifference curves.

An analysis shows that price and quantity are negatively correlated as substitution effect and income effect reinforce each other. This is so because substitution effect can never work to reduce the consumers' purchases of a good whose price has fallen, that is, it can never be negative. This could be possible only if the consumer chooses A in A-situation when all points on line MA were open to him and now chooses a point between SA. But this situation is inconsistent. The income effect however may be negative. Thus:

• if the positive substitution effect is big, and the negative income effect weak, the demand curve will slope downwards, and

• if the negative income effect is strong enough to outweigh substitution effect then the demand curve will slope upwards. This is possible where a consumer spends a large proportion of his income on the good in question - as with a giffen good.

Tags, Macroeconomics, Economics, Managerial Economics

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