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Current time:0:00Total duration:3:48

Substitution and income effects and the law of demand

MKT‑3 (EU)
MKT‑3.A (LO)
MKT‑3.A.5 (EK)

Video transcript

in other videos we have already talked about the law of demand which tells us and this is probably already somewhat intuitive for you that if a certain good is currently at a higher price that the quantity demanded will be quite low and then as the price were to decrease the quantity demanded would increase so if we were to graph demand and so this right over here is our demand curve where prices on our vertical axis and quantity is on our horizontal axis which is the standard convention and for most economists you would have a downward sloping demand curve what we're going to do in this video is take a little bit deeper into why we have that downward sloping demand curve and I know what some of y'all are saying well it makes common sense if the price goes down I would want more of that and so so would everyone else but let's dig into why you would want more of something as the price goes down so one category of reasons why you might want more of it as the price goes down economists will call the substitution effect substitution substitution effect and this is the idea that if we're looking at the price versus quantity say of candy and let's say at first the price is right over here at $4 and at $4 the quantity demanded in the market would be let's say that is 100 units of the candy maybe it's a hundred pounds of the candy that if the price were to then go to two dollars for some reason so let's say the price is at two dollars well then a lot of folks could say gee that candy is looking a lot better relative to other things that I might buy with my money so for example people might be picking between candy and fruit and maybe at first they were both four dollars a pound but now all of a sudden if the candy is two dollars a pound or two dollars per unit well then it's looking a lot better relative to the fruit so some of that quantity of fruit people would have bought they'll say hey now candy is a better deal I'm going to substitute the fruit with candy and so that's why you have a higher quantity of candy demanded this might maybe be now 250 units another major category why you would expect this downward sloping demand curve for normal Goods and we'll talk about things like inferior Goods in future videos is the income effect income effect and in some ways this might be the most intuitive well if the price went from $4 to $2 well the cost of those hundred units would now be half as much it would go from $400 to $200 and so the market would have an extra $200 to use to buy things with and some of that extra $200 they'll buy more candy with it and they might also buy other things with that now the last dimension that economists will often talk about for why the law of demand is downward sloping like this and we talked about this in other videos is this idea of decreasing decreasing marginal utility and that's that idea that that first if if you're just that first amount of candy there's gonna be people in the market who take a lot of value from it they are just addicted to candy they they're their bodies are dependent on that candy but as soon as those folks are satiated that next incremental amount that next marginal amount the utility might be a little bit lower and so as you have more and more candy the marginal utility goes down and so that's another way of thinking about why we have a downward sloping demand curve