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Law of demand

22 bytes added, 15:24, 25 September 2011
What matters are relative prices -- effects of inflation and simultaneous changes in prices of substitutes
===What matters are relative prices -- effects of inflation and simultaneous changes in prices of substitutes===
The analysis of the relation between quantity demanded and price is carried out in terms of ''real'' prices, i.e., prices ''relative'' to the prices of similar goods and the household income. An across-the-board inflation, that affects all prices uniformly, and also affects income (though wage rises) and savings (through interest) in the same proportion, should not in principle lead to a decrease in demandquantity demanded.
However, non-uniform inflation can lead to an ''increase'' in demand quantity demanded even with an increase in price, if the inflation is responsible for a ''greater'' increase in the price of substitutes. Similarly, an increase in the price of factors of production used for a certain good may lead to an increase in its price, but if it leads to a ''greater'' increase in the price of substitutes for those factors of production, there may be either an increase or a decrease in demand. What happens depends on the interplay between the [[income effect]] and the [[substitution effect]].
For instance, an increase in fuel prices may lead to an increase in train fares but a greater increase in the cost of car fuel. Thus, people may start traveling ''more'' by train even though train fares have increased.
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