Question

As a general rule, is it safe to assume that a change in the price of a good will always have its most significant impact on the quantity demanded of that good, rather than on the quantity demanded of other goods? Explain.

Short answer

In general, it is safe to assume that a change in the price of a good will have its most significant impact on the quantity demanded of that good, rather than on the quantity demanded of other goods. This is because the impact of a price change on the quantity demanded of a good depends on its price elasticity of demand (PED), which is usually more substantial than the combined effects of income and substitution effects on other goods. However, this assumption may not hold true for all situations and depends on the specific characteristics of the good and the market.

Step-by-step solution

Understanding the purpose of the question

The purpose of this question is to determine if a change in the price of a good will predominantly affect the quantity demanded of that particular good or the quantity demanded of other goods. To answer this question, we need to understand the concept of 'price elasticity of demand'.

Defining price elasticity of demand

Price elasticity of demand (PED) is a measure of how sensitive the quantity demanded of a good is to a change in its price. It can be calculated using the following formula: PED = \(\frac{% \Delta Q_d}{% \Delta P}\) where \(Q_d\) is the quantity demanded of the good, and \(P\) is the price of the good. A good with a high PED is said to be elastic, meaning that a relatively small change in price will result in a significant change in demand for that good. On the other hand, a good with a low PED is said to be inelastic, meaning that the demand for the good will not change much even if its price changes significantly.

Impact of price change on the quantity demanded of the good itself

When a good's price increases, its PED determines how the quantity demanded for that good will change. If the good is elastic (high PED), an increase in price will lead to a significant decrease in the quantity demanded. However, if the good is inelastic (low PED), an increase in price will not lead to a significant change in its quantity demanded.

Impact of price change on the quantity demanded of other goods

The change in the price of one good can also affect the quantity demanded of other goods due to the substitution effect and the income effect. Substitution effect occurs when consumers shift to consuming substitute goods because the price of the original good has increased. Income effect takes place when the increase in the price of a good affects the consumer's real income, influencing their consumption pattern for other goods as well. However, the impact of a price change in one good on the quantity demanded of other goods is usually less significant than its effect on the quantity demanded of the good itself because the income and substitution effects are often smaller and more dispersed across multiple goods.

Conclusion

In most cases, it is safe to assume that a change in the price of a good will have its most significant impact on the quantity demanded of that good, rather than on the quantity demanded of other goods. The actual impact of a price change on the quantity demanded of a good depends on its price elasticity of demand and is usually more substantial than the combined effects on other goods due to income and substitution effects. However, this assumption may not hold true for all goods or market situations; it depends on the specific characteristics of the good and the market in question.