How can the law of demand be explained with the help of SE and IE?
The law of demand states that there is an inverse relationship between the price of a product or service and the quantity demanded, assuming that all other factors remain constant. This means that as the price of a good increases, the quantity demanded decreases, and vice versa.
To understand the law of demand using the concepts of supply and demand, we can apply both the concept of supply elasticity (SE) and income elasticity (IE).
1. Supply Elasticity (SE):
Supply elasticity refers to the responsiveness of the quantity supplied to changes in price. In the context of the law of demand, SE helps explain why an increase in price results in a decrease in quantity demanded.
a. Assuming that supply is relatively inelastic:
When the supply of a product or service is relatively inelastic, meaning that the quantity supplied does not change significantly in response to price changes, an increase in price will result in a relatively smaller decrease in quantity demanded. This is because suppliers are unable to quickly adjust their production to meet higher demand, causing the quantity demanded to be less affected by price changes.
b. Assuming that supply is relatively elastic:
Alternatively, when the supply of a product or service is relatively elastic, meaning that the quantity supplied changes significantly in response to price changes, an increase in price will result in a relatively larger decrease in quantity demanded. This is because suppliers can easily adjust their production levels to meet higher demand, thereby making consumers more sensitive to price changes.
2. Income Elasticity (IE):
Income elasticity measures the responsiveness of the quantity demanded to changes in consumer income. In the context of the law of demand, IE helps explain how changes in income affect the demand for goods and services.
a. Assuming normal goods:
Normal goods are those for which demand increases as consumer income increases. In this case, a decrease in price will result in an increase in quantity demanded. This is because consumers can afford to purchase more of the normal goods as their income rises.
b. Assuming inferior goods:
Inferior goods are those for which demand decreases as consumer income increases. In this case, a decrease in price will result in a decrease in quantity demanded. As consumers' incomes rise, they are likely to switch to higher-quality substitutes, reducing their demand for inferior goods.
By considering both supply elasticity and income elasticity, we can gain a deeper understanding of how the law of demand operates and how various factors, such as price changes and income fluctuations, impact the quantity demanded.