Useful Notes on the 2 Explanation to the Downward Slope of the Demand Curve

Demand curve for a normal good slopes downward from left to right as already shown in Figures 2.1 and 2.2. Demand varies inversely with price for normal goods. The inverse relationship may be of either of the following two types

(i) Additive inverse type, as depicted by the equation

Q^D = a – bP, where, a and b are fixed numbers,

(ii) Multiplicative inverse type, as depicted by the equation

Q^D = A/B P, where, A and B are fixed numbers.

The additive inverse type of relationship between price and demand yields a linear demand curve sloping downward as depicted in Figure 2.1, and the multiplicative inverse type of relationship yields a non-linear demand curve, again sloping downward, as depicted in Figure 2.2.

Image Source: 185.26.182.219

Whichever the type, demand curve for a normal good has a downward slope which is a consequence of inverse variation of demand with price. There are two explanations for the inverse relationship:

(i) The law of diminishing marginal utility:

Marginal utility is the change in total utility caused by an additional unit of a commodity consumed. If the total utility derived from the first three apples is 50 units and that from the first four apples, 60 units; the marginal utility of the fourth apple is 10 units (60 – 50 = 10).

The law of diminishing marginal utility states that ‘the additional utilities derived from the successive units of a commodity consumed in one continuity depict a diminishing trend’. To demonstrate, suppose an individual sets himself to consume a bunch of bananas in one go and utility is numerically measurable, as assumed by Alfred Marshall. Let the total utilities after each banana consumed be as given in Table 2.1.

Table 2.1:

Total utility when first banana is consumed is 20 units, so is the marginal utility.

Total utility from first two bananas is 38 units; hence, the marginal utility of the second banana is 18 units (38 – 20 = 18). Proceeding likewise, total utility from first three bananas is 54 units and the MU of the third banana is 16 units (54 – 38 = 16).

Total utility of first 11 bananas is 110 while that from first 10 bananas is also 110 units. The MU of eleventh banana is thus zero. The MU of the twelfth banana is –2. That means that the eleventh and the twelfth bananas should not be consumed by the consumer (Figure 2.7).

As the MU goes on diminishing with successive consumption of bananas, the consumer’s keenness for bananas also goes on diminishing with it. If the consumer had to buy bananas piece-by-piece, and if the seller too charges price on piece-by-piece basis, starting from one rupee a piece, the seller would have to lower the price for successive units of bananas to induce the consumer to go on buying them. The seller has to do this because the utility of the successive units of bananas to the consumer is not the same as that of the preceding units.

In other words, it has a diminishing trend. In order to sell more units to a consumer, the seller would have to lower the price, as more would be demanded only at lower prices due to the diminishing marginal utility of the successive units to the consumer. The discussion, thus, leads to an inverse relationship between price and demand and hence to the downward slope of the demand curve.

(ii) The price effect:

The second explanation to the downward slope of the demand curve is provided by the price-effect which has two components:

Income effect:

When price of a product falls, the real income of the consumer rises, and as a result, he consumes more of the product. A numerical illustration would drive the point home. Suppose a consumer has a sum of Rs 100 to buy chocolates, each priced at Rs 10. The number of chocolates he buys is 10.

This means that the consumer’s real income is 10 chocolates. Rs 100, in cash, is his nominal income. Now suppose price of chocolates falls to Rs 5 each. The consumer’s real income goes up to 20 chocolates. Thus, a fall in price leads to a rise in the consumer’s real income due to which he buys more of the chocolates. Hence the inverse relationship between price and demand.

Substitution effect:

Under the substitution effect a consumer substitutes a costlier product by a cheaper one. When price of a product rises, some of the consumers, finding the product beyond their reach settle for cheaper substitutes even though they may be poorer in quality, provided such substitutes exist.

The rise in price, thus, boosts demand of the substitutes, lowering the demand of the costlier product. This again gives rise to the inverse relationship between the price of the product and its demand, imparting it the downward slope.