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Difficulty: HardConcept and Law of Demand

Match each demand phenomenon or theoretical principle under the Law of Demand with its corresponding economic description.

  • Income effect of a price reductionAn increase in quantity demanded resulting from an increase in the consumer's real purchasing power when price falls.
  • Substitution effect of a price reductionAn increase in quantity demanded resulting from consumers replacing relatively higher-priced alternative goods with the cheaper commodity.
  • Law of Demand core premiseAn inverse relationship between the price of a good and its quantity demanded, holding all other determinants constant.
  • Giffen Paradox exceptionA situation where a price increase causes quantity demanded to rise because the powerful negative income effect outweighs the substitution effect.

Answer

Income effect matches the increase in purchasing power from a price fall; Substitution effect matches replacing expensive alternatives; Law of Demand matches the inverse price-quantity relationship ceteris paribus; Giffen Paradox matches an upward-sloping demand curve driven by a dominant negative income effect.
Each concept correctly identifies a distinct theoretical driver or exception of consumer demand behavior. The Income effect captures changes in real purchasing power; the Substitution effect reflects relative price adjustments; the Law of Demand defines the fundamental downward-sloping demand relationship; and the Giffen Paradox highlights an exception where negative income effects dominate substitution effects.

Step-by-Step Solution

1
Identify the mechanism behind income shifts caused by price changes.
A drop in price raises real purchasing power, enabling higher consumption of normal goods (Income effect).
Lower prices mean less money is required for the same quantity, freeing up budget.
2
Identify the mechanism behind relative price comparisons.
Consumers swap out relatively dearer alternatives for the cheaper good (Substitution effect).
Utility maximization dictates favoring cheaper substitute goods.
3
Define the foundational rule of demand analysis.
Price and quantity demanded move in opposite directions, assuming ceteris paribus (Law of Demand).
This forms the downward slope of standard demand curves.
4
Analyze the exception cases where price and quantity move in the same direction.
For Giffen goods, a price rise leads to higher demand as poor consumers spend more of their limited income on the essential inferior commodity (Giffen Paradox).
The strong negative income effect overwhelms the substitution effect.

Key Concept

Concept and Law of Demand
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Topics

Concept and Law of Demand

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