Theory of Demand

Demand is the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period

Income and Substitution Effects and the theory of demand

Income effect

• A fall in price increases the real purchasing power of consumers
• This allows people to buy more with a given budget
• For normal goods, demand rises with an increase in real income

Substitution effect

• A fall in the price of good X makes it relatively cheaper compared to substitutes
• Some consumers will switch to good X leading to higher demand
• Much depends on whether products are close substitutes