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Law of demand

197 bytes added, 08:29, 10 December 2013
Causation versus correlation: superfical counterexamples
Note that, as discussed in the apparent counterexamples, if the prices of substitute inputs increases ''more'', demand for the given input might increase even as the price increases.
==Causation versus correlation: superfical superficial counterexamples==
It is important to understand that the law of demand discusses the effect of a change in price on the demand quantity demanded for the good. Thus, it does not predict that an increase in price is always accompanied by a decrease in demandquantity demanded. Rather, it says that, [[ceteris paribus]], an increase in price is responsible for a decrease in demandquantity demanded.
===Independent shifts of the demand curve===
[[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 quantity demanded increases for every given price, this causes a tendency for the [[market price]] (the price at which the market clears) to rise (assuming that the [[law of supply]] holds, i.e., the supply curve is upward sloping).
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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 quantity demanded.
However, non-uniform inflation can lead to an ''increase'' in 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 a decrease in its pricethe quantity of those factors of production demanded (i.e., a reconfiguration of the production process to use less of those factors of production), 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 demandthe quantity demanded. 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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