The Relationship Between Price and Demand: An Economic Analysis

This report provides a comprehensive analysis of the relationship between price and demand, focusing on normal, inferior, and Giffen goods. It explores how price changes affect consumer behavior, considering the income and substitution effects. The analysis includes the application of economic principles to understand the demand curve and the Marshallian law of demand. The report examines how these factors influence the quantity demanded for each type of good. The study also provides a comparative analysis of relevant literature to provide a detailed understanding of the topic and its implications.

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Contents
Introduction....................................................................................................................................................3
Comparative analysis of relevant literature...................................................................................................3
Relation in between Price and Demand: Normal Goods...............................................................................4
Relation in between Price and Demand: Inferior Goods...............................................................................5
Relation in between Price and Demand: Giffen Goods or Giffen Paradox:..................................................6
Conclusion.....................................................................................................................................................8
References......................................................................................................................................................9

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Introduction
Supply and demand are two of the significant components of an economic model in a market. in
a competitive market, the entity price for a good vary until it reconcile at a point somewhere the
quantity demanded will be equal to the quantity supplied by producers(Mapleton,2017). This
will result in equilibrium of price and quantity. Any fall in the price directly affects in an
increase in the demand. Majority of case witnesses similar income and substitution effect. Under
certain circumstances the effect may pull in different directions. It moves in a direction of
substitution effect is relatively certain. Hence it is obvious that, a fall in the comparative price of
a good constantly causes an enhancement in quantity demanded. It means that, substitution effect
constantly persuade the consumer to purchase goods at a cheaper price (Nicholson and Snyder,
2014).
Comparative analysis of relevant literature
The direction of income effect is not certain. It is an accepted fact that a rise in income will
increase the buying power of the customers. In case of inferior goods, an increase in his income
causes a fall in quantity demanded of those goods. As now he will be using superior goods as
substitution in place of the inferior goods. Consequently the income effect will either be positive
or negative. These goods do have a positive income effect. So, a fall in their price causes an
increase in the purchasing power. The income effect works in a similar direction like the
substitution effect. Mutually the factors are working towards increasing the quantity demanded.
In case of the inferior goods, income effect is negative; it is working in the reverse direction to
the substitution effect (Freeman, Herriges and Kling, 2014).

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The net consequence of change in price depends on the virtual strengths of these two factors.
Hence, price effect is related to the income effect and substitution effect. Theses process of
quantity demanded alter the consequence of the price change. This directly depends upon the
course and strength of the income effect.
Relation in between Price and Demand: Normal Goods
In case of the normal goods, price-demand association is established in the form of an
indifference curve. Through the Given price of two goods and income of an individual which is
symbolized by the budget line PL1. This line depicts that the consumer will be on equilibrium at
Q. If in case, the price falls, price of Y and income of an individual will remain unchanged. This
will result in a shift of budget line. The Price Effect will now Split up into Substitution and
Income Effects.

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The consumer will gain equilibrium at budget line PL2. In case if the equilibrium lies at the right
of Q, It means that the purchaser will buy additional quantity of good X than at Q. Hence it is
confirmed that a consumer can buy more normal goods at the new equilibrium point on budget
line PL2. This will result in an increase in quantity demanded resulting in a fall in price.
The change in quantity demanded as depend upon the track and strength of income effect and
substitution effect. The income effect is positive in case of normal goods. This will cause an
increase in the quantity demanded of good X when its price falls. Whereas in the case of
substitution effect, the quantity demanded actually reduces due to fall in price (Blair and
Kaserman, 2014).
In case of normal goods, the income and substitution effect works in a similar direction. Income
effect leads to an increase in quantity demand. Each force affects each other. The income effect
and substitution effect is the basis for a rise in quantity demanded. The quantity brought of a
normal good varies inversely with its price (Baumol and Blinder, 2015).
Relation in between Price and Demand: Inferior Goods
The inferior goods has an opposite income effect. When the price of the inferior goods cascade it
creates a negative income effect. It tends to decrease the quantity purchased, whereas the
substitution effect increases the quantity purchased. An individual spend a small part of income
on a particular product. In case, when the price falls, it creates a slight income. This generally
outweighs the substitution effect.
A fall in price of a good constantly induces the consumer to make more purchases. In most of the
cases the decline in price will increase quantity demanded. In case of inferior goods the quantity

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demanded changes with the price of the goods. In this case the Marshallian law of demand will
work (Gopinath, Helpman and Rogoff, 2014).
In case of inferior goods, the price-demand relationship has a weaker income effect.
In case if the income effect is functioning, it will induce the consumer to purchase lesser of good
X. However, the substitution effect persuades the consumer to purchase goods at a relatively
lesser price.
Consequently, the net effect on goods due to decline in good X causes an enhancement in
quantity demanded. The Quantity demanded does changes in case of a negative income effect. In
such a situation, weaker income effect creates a downward sloping demand curve (Rios,
McConnell and Brue, 2013).

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Relation in between Price and Demand: Giffen Goods or Giffen
Paradox:
In case of the Griffin gift there is a negative income effect that overshadows the substitution
effect. In a situation when the price of the goods falls, the quantity purchase will also decline.
However, when the price of the goods increases, the quantity purchase will also increase.
Griffin goods are those goods that have a direct relationship with the prices. A rise in the price of
the griffin goods increases the consumption. The income effect substantially affect consumer
spending to a very large proportion. A fall in the prices of the goods results in release of income.
An increase in the price of bread results in decline of the purchasing power of the poor people. It
becomes necessary to reduce the expenses of meat and other luxurious items. People tend to
consume the good more in quantity no matter when its price went up. Similarly, people pay out a
large amount of their income when the price of an inferior good increases (Newbery, 2016).
The decline in price of an inferior good to a very large portion of their income causes an increase
in purchasing power. This effect reduces the overall consumption due to fall in price and creates

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a negative income effect. A large portion of negative income effect overweights the substitution
effect.
The price-demand connection in case of Giffen goods is originally into equilibrium Due to a fall
in price of the good. This causes a shift in indifference curve IC2. This is due to the total effect
of the negative income effect. It provokes the consumer to purchase less of good X. In case of
Griffin Goods, the quantity demanded differs directly with the price. The quantity demanded of a
Giffen good differs directly with price. In this case, the negative income effect is more than the
substitution effect. Consequently, the demand curve in this situation will slope downward.
Conclusion
To conclude, the fall in price will not always causes an increase in demand. There are certain
situation in which there is a direct relationship in between the income and demand of the goods.
To understand the demand and the price effect, it is important to understand the three aspects:
Inferior goods, Griffin Goods and Normal Goods. The price and demand both varies differently
depending upon the type of goods. Hence it is concluded that, the fall in the price of the goods
will always not causes an increase in demand. Under certain circumstances the effect may pull in
different directions. It moves in a direction of substitution effect is relatively certain.

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References
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage
Learning.
Blair, R.D. and Kaserman, D.L., 2014. Law and economics of vertical integration and control.
Academic Press.
Canto, V.A., Joines, D.H. and Laffer, A.B., 2014. Foundations of supply-side economics: Theory
and evidence. Academic Press.
Freeman III, A.M., Herriges, J.A. and Kling, C.L., 2014. The measurement of environmental and
resource values: theory and methods. Routledge.
Gopinath, G., Helpman, E. and Rogoff, K. eds., 2014. Handbook of international
economics (Vol. 4). Elsevier.
Mapleton, C.2017. Demand and Supply: 500 Practice Problems Solving for Equilibrium.
Lulu.com
Moon, M.A., 2013. Demand and supply integration: the key to world-class demand forecasting.
FT Press.

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Newbery, D.G., 2016. A simple introduction to the economics of storage: shifting demand and
supply over time and space.
Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application.
Cengage Learning.
Rios, M.C., McConnell, C.R. and Brue, S.L., 2013. Economics: Principles, problems, and
policies. McGraw-Hill.