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Law of demand

1,259 bytes added, 22:03, 21 September 2011
Causation versus correlation: superfical counterexamples
[[File:Demandexpansionandmarketprice.png|thumb|300px|right|An expansion of the demand curve leads to an increase in the market price and an increase in equilibrium quantity demanded/supplied, but this simultaneous increase of price and quantity demanded does not violate the law of demand.]]
To understand how the causation and correlation issue can be confused, consider a shift in the demand curve due to a change in one of the other [[determinants of demand]] (i.e., an [[exogenous parameter]] in the interaction between demand and price). If the shift is outward (also called an ''expansion'' of the demand curve), i.e., if demand increases for every given price, this causes a tendency for the [[market price]] (the price at which the market clears) to rise. Similarly, if the shift is inward (also called a ''contraction'' of the demand curve), there is a tendency for the market price to fall.
This does {| class="sortable" border="1"! Item !! Value|-| What happens from an observer's viewpoint || both the equilibrium price (i.e., [[market price]]) ''notand'' contradict the quantity demanded at that price increase.|-| Mistaken argument that this contradicts the law of demand || <toggledisplay>The law of demandclaims that as the price increases, because the quantity demanded decreases. But here, the price and quantity demanded are both increasing.</toggledisplay>|-| Reason why the argument is mistaken || The increase in price as well as increase in quantity demanded are caused by a change in an [[exogenous parameter]], which causes the demand curve to shift outward.|-| Explanation of why this actually ''demonstrates'' the law of demand || In the absence of market clearing forces, an expansion of the demand was due curve would simply lead to exogenous factorsan increase in quantity demanded with no effect on price (in the figure, this would mean landing at point A). ''However'', market clearing forces lead to a moderation of the effect on quantity demanded by ''shifting'' some of the effect to an increase in price. The fact that these market clearing forces cause an ''increase'' in the price in order to bring demand back down illustrates the law of demand.|} Similarly, if the shift is inward (also called a ''contraction'' of the demand curve), there is a tendency for the market price to fall. Thus, an observer sees both the market price and equilibrium quantity drop, but this does not contradict the law of demand.
===What matters are relative prices -- effects of inflation and simultaneous changes in prices of substitutes===
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