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Information > Financial Terms > This page Income Effect The
law of demand states that price and quantity demanded are inversely related,
all other factors remaining constant.
Graphically, the law of demand is illustrated as a downward sloping
demand curve. There are two reasons for this inverse relationship between
price and quantity demanded. The
first reason is known as the substitution effect and the second is known
as the income effect. When
the price of a product decreases, it is as if the consumer's purchasing
power increases because less total income is needed than before the price
decrease to purchase the same quantity of products.
Consumers will use this additional income to purchase more of all
normal goods and services, including the product whose price decreased.
When the price of a product increases, the reverse is true. Back to Information |