Carefully explain why a typical demand curve slopes downwards.
Solution
Economists give three basic reasons for the law of demand and thus for the downward slope. First is the \"income effect\": When prices drop (or rise), people can buy more (or less) of a good for the same amount of money. Second is the \"substitution effect\": If consumers don\'t see a meaningful difference between products, they\'ll buy the one with the lowest price, so a price increase will drive them toward substitutes, while a reduction will draw them in. Third is the concept of \"diminishing marginal utility\": If you already have plenty of something, you have less of a need to buy more of it. An increase in the price of umbrellas, for example, might not stop someone who needs an umbrella from buying one, but it might stop someone who already has an umbrella from buying a second in a different color.
Elasticity
The slope of the demand curve -- how steep it is -- helps you visualize how \"elastic\" the demand is. Elasticity refers to how responsive demand is to price. If a 5 percent change in the price results in a 15 percent change in demand, the demand is highly elastic. The more elastic, the more horizontal or \"flat\" the downward slope of the curve. On the other hand, if a 5 percent change in price produces only a 0.1 percent change in demand, the demand is highly inelastic. The more inelastic the demand for a good, the more vertical the slope of the curve.
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Carefully explain why a typical demand curve slopes downwards-Solution.docx
1. Carefully explain why a typical demand curve slopes downwards.
Solution
Economists give three basic reasons for the law of demand and thus for the downward slope.
First is the "income effect": When prices drop (or rise), people can buy more (or less) of a good
for the same amount of money. Second is the "substitution effect": If consumers don't see a
meaningful difference between products, they'll buy the one with the lowest price, so a price
increase will drive them toward substitutes, while a reduction will draw them in. Third is the
concept of "diminishing marginal utility": If you already have plenty of something, you have
less of a need to buy more of it. An increase in the price of umbrellas, for example, might not
stop someone who needs an umbrella from buying one, but it might stop someone who already
has an umbrella from buying a second in a different color.
Elasticity
The slope of the demand curve -- how steep it is -- helps you visualize how "elastic" the
demand is. Elasticity refers to how responsive demand is to price. If a 5 percent change in the
price results in a 15 percent change in demand, the demand is highly elastic. The more elastic,
the more horizontal or "flat" the downward slope of the curve. On the other hand, if a 5 percent
change in price produces only a 0.1 percent change in demand, the demand is highly inelastic.
The more inelastic the demand for a good, the more vertical the slope of the curve.
