Answer to Question #246654 in Macroeconomics for dua

Question

. What is law of demand? Explain why there exists a negative relationship between the price of a product and its quantity demanded? Note: discuss the three reasons why the law holds. (Income, substitution effects and law of diminishing marginal utility)

Answer 1

The law of demand states that the higher the price, the lower the quantity demanded. Based on law of diminishing marginal utility, the law states that consumers use the first units of an economic good to satisfy the most urgent needs and then use additional unit of the good for lower valued needs.

Income effect is described as change in consumption of goods based on income. Consumers will spend more if they experience an increase in income and spend less when income declines.

Substitution effect takes place when consumers replace cheaper items with ones that are more expensive.