Question

What does a downward-sloping demand curve mean about how buyers in a market will react to a higher price?

Short answer

A downward-sloping demand curve means that as the price of a good or service increases, the quantity demanded by consumers decreases due to the income effect and the substitution effect. The income effect states that higher prices reduce a consumer's purchasing power, leading to decreased consumption. The substitution effect suggests that as the price of a good or service increases, consumers are more likely to switch to a relatively cheaper alternative. Therefore, buyers in a market will tend to buy less of the good or service as its price increases, as represented by the downward-sloping demand curve.

Step-by-step solution

Understanding the Demand Curve

A demand curve shows the relationship between the price of a good or service and the quantity demanded by consumers. In a simple diagram, price is plotted on the vertical axis, and quantity demanded is plotted on the horizontal axis. A downward-sloping demand curve indicates that as the price of a good or service increases, the quantity demanded by consumers decreases. Conversely, as the price decreases, the quantity demanded increases.

Law of Demand

The observation represented by the downward-sloping demand curve stems from a fundamental economic principle called the Law of Demand. The Law of Demand states that, holding all else equal, when the price of a good or service increases, the quantity demanded by consumers decreases. This negative relationship between price and quantity demanded can be explained by two major factors: the income effect and the substitution effect.

The Income Effect

The income effect focuses on the change in a consumer's purchasing power as a result of a change in the price of a good or service. When the price of a good or service increases, the consumer has less purchasing power, meaning they are less able to afford that product or other products. As a result, the consumer will reduce their consumption of that good or service, leading to a decrease in quantity demanded.

The Substitution Effect

The substitution effect explains how an increase in the price of a good or service makes it less attractive or more expensive compared to other available alternatives. As the price of a good or service increases, consumers are more likely to switch to a relatively cheaper alternative, ultimately leading to a decrease in quantity demanded for the more expensive good or service.

Effect of Higher Price on Buyers' Reaction

To answer the question of how buyers in a market will react to a higher price given a downward-sloping demand curve, we can apply the concepts explained above. If the price of a good or service increases, it will reduce the consumer's purchasing power (income effect) and make it less attractive compared to cheaper alternatives (substitution effect), causing the quantity demanded to decrease. Thus, buyers in a market will tend to buy less of the good or service as its price increases, which is represented by the downward-sloping demand curve.