Which of the following explain the inverse relationship between the demand and price?

The inverse relationship between price and demand occurs because of two reasons. They are:

1. Income effect and
2. Substitution effect.

1. Income effect: When the monetary income of the consumer remains constant, but price of- the good falls then his real income rises. Real income means the purchasing power of money income. When real income rises, a consumer can buy more quantity of a good and therefore its demand may rise. This is known as income effect on demand.

Example:

• If the amount of money that a consumer has is ₹ 50 and the price of milk is ₹ 50 per litre than the consumer can buy (demand) only 1 litre of rriilk.
• If the price of milk falls to ₹ 10, the consumer can demand 5 litres of milk with money income of ₹ 50.
• Here, money income of consumer has not risen but because of fall in demand his purchasing power i.e. his real income has indirectly increased.
• Mostly, normal goods have a positive income effect whereas inferior goods have a negative income effect. This means when the price of inferior goods fall, the real income of the consumer increases but the demand for these goods falls. Coarse food grains and bus-transportation are two such examples of inferior goods.

2. Substitution effect:

• When price of the concerned good falls, it becomes relatively cheaper than its substitutes.
• Hence, a consumer wHI reduce the consumption of substitute goods and increase the demand for the concerned good. This is called substitution effect.

Example:
Consider two varieties of pants, namely, a pair of cotton pants and denim pants. If the price of cotton pants falls and that of denim pants remains the same .then the consumer finds the cotton pants cheaper compared to the denim pants. Hence, the demand for cotton pants will rise.

The inverse relationship between price and quantity demanded of the commodity is explained by the Law of Demand. This law states that other things remaining constant, the demand of a good move opposite to the movement in the price of the good. This law can be explained with the help of the following demand schedule. 

In the schedule, we can analyse that as price of the commodity X increases from Rs 7 to Rs 8, the quantity demanded of X falls from 50 units to 45 units. This confirms the negative relationship between the quantity demanded and the price of the commodity. 

The classic microeconomics supply and demand model shows price on the vertical axis and demand on the horizontal axis. In between, them is a downward-slowing demand curve where price and quantity demanded to have an inverse relationship. The general concept is intuitive: as goods become more expensive, people tend to demand less of them.

Key Takeaways

• The law of supply and demand is a keystone of modern economics.
• According to this theory, the price of a good is inversely related to the quantity offered.
• This makes sense for many goods, since the more costly it becomes, less people will be able to afford it and demand will subsequently drop.

Supply & Demand

The law of supply and demand, one of the most basic economic laws, ties into almost all economic principles in some way. In practice, supply and demand pull against each other until the market finds an equilibrium price. For many simple markets, this inverse relationship holds true. If the cost of a shirt doubles, consumers buy fewer shirts, all else being equal. If the shirts go on sale, consumers tend to buy more. However, multiple factors can affect both supply and demand, causing them to increase or decrease in various ways.

There are several practical issues with the simple supply and demand model as depicted in the graph below. In addition to the theoretical existence of goods that actually rise in demand as the price goes up (known as Giffen and Veblen goods), a basic microeconomics chart like this one cannot possibly contain all of the various variables at work that impact supply and demand. Nevertheless, it is typically the case that price and quantity are inversely related: the more costly the same good becomes, they less people will want it - and vice versa.

Deducing the Law of Demand

The law of demand is actually a deductive, logical construct. It holds a few observations as true: resources are scarce, there is a cost to acquiring them, and human beings employ resources to achieve meaningful ends.

Cost does not necessarily mean a dollar amount. Cost simply represents what is given up to acquire something, even if it is time or energy. True cost also implies opportunity costs.

Since human beings act, economists deduce that their actions necessarily reflect value judgments. Every nonreflex action is taken to obtain or increase value in some sense; otherwise, no action takes place. This definition of value is incredibly broad and could be considered a tautology. As the cost of acquiring a good increases, its relative marginal utility decreases compared to other goods. Even if all relative costs increased by exactly the same proportion at the exact same time, consumers' resources are finite.

The Bottom Line

Consumers only enter into a voluntary trade if they believe, or ex-ante, they receive more value in return; otherwise, no trade occurs. When the relative cost of a good increases, the gap between value and cost shrinks. Eventually, it goes away. Thus, the law of demand really states: as a good's true cost increases, consumers demand relatively less of it.

Which explain the inverse relationship between the demand and price?

What is the relationship between demand and price?

Is there is an inverse relationship between price and quantity demanded?

What are the two reasons for the inverse relationship between price and quantity demanded?