Price Reform: Quantity Substitution Analysis

This is the new addition to old Price Demand Theory which focuses essentially upon relationship between demand and price rises of a close substitute in a market. A market brings buyers and sellers of goods or services together and encourages commerce between them. These marketplaces include anything from haggling in open-air markets to doing online transactions with strangers all across the globe.

A market is made up of buyers who are willing and able to buy a certain item and suppliers who are ready and eager to provide the commodity. The price is established by the market, which brings together those who provide and want the commodity.

For instance, the quantity of apples a person would be willing and able to purchase each month relies in part on apple pricing. If the sole variable is price, then a customer is willing and able to purchase more apples at lower pricing. The amount of apples requested declines as the price increases (again, assuming everything else remains the same). This connection between a product’s price and demand for it in terms of quantity is captured by the Law of Demand. It asserts that the price of an item and the amount desired are inversely (or negatively) related.

Law of Demand: A New Approach to Substitution Model

As we can see on the demand graph, there is an inverse relationship between price and quantity demanded. Economists call this the Law of Demand. If the price goes up, the quantity demanded goes down (but demand itself stays the same). If the price decreases, quantity demanded increases. This is the Law of Demand. On a graph, an inverse relationship is represented by a downward sloping line from left to right.

Why?

Why is the law of demand true? Why is the demand curve downward sloping from left to right? Why do people buy more at lower prices and less at higher prices?

As social scientists, economists try to explain human behavior. It is common sense that people behave this way – but how can we explain it? Economists have three explanations:

  1. diminishing marginal utility
  2. income effects
  3. substitution effects

A substitute is something that takes the place of the good. Instead of buying an apple, one could buy an orange. If the price of oranges goes up, we would expect an increase in demand for apples since consumers would move consumption away from the higher priced oranges towards apples which might be considered a substitute good.  Complements, on the other hand, are goods that are consumed together, such as caramels and apples. If the price for a good increases, its quantity demanded will decrease and the demand for the complements of that good will also decline.  For example, if the price of hot dogs increases, one will buy fewer hot dogs and therefore demand fewer hot dog buns, which are complements to hot dogs.

Professor Jacob Miller

is an astrophysicist with expertise in the field of star formation, with a particular in interest in radio and submillimetre observations of young stars and protostellar systems. He has held a Junior Research Fellowship at Queens' College, Cambridge; a Royal Society University Research Fellowship, and he is currently Professor of Physics in the Astrophysics Group at the Cavendish Laboratory.