yego.me
💡 Stop wasting time. Read Youtube instead of watch. Download Chrome Extension

Substitution and income effects and the Law of Demand | APⓇ Microeconomics | Khan Academy


3m read
·Nov 11, 2024

In other videos, we have already talked about the law of demand, which tells us—and this is probably already somewhat intuitive for you—that if a certain good is currently at a higher price, then the quantity demanded will be quite low. As the price were to decrease, the quantity demanded would increase.

So, if we were to graph demand, this right over here is our demand curve, where price is on our vertical axis and quantity is on our horizontal axis, which is the standard convention. For most economists, you would have a downward sloping demand curve. What we're going to do in this video is dig a little bit deeper into why we have that downward sloping demand curve.

I know what some of y'all are saying: "Well, it kind of makes common sense. If the price goes down, I would want more of that, and so would everyone else." But let's dig into why you would want more of something as the price goes down.

One category of reasons why you might want more of it as the price goes down, economists will call the substitution effect. This is the idea that if we're looking at the price versus quantity, say of candy, and let's say at first the price is right over here at four dollars. At four dollars, the quantity demanded in the market would be, let's say, that is 100 units of the candy—maybe it's 100 pounds of the candy.

If the price were to then go to two dollars for some reason—let's say the price is at two dollars—well then a lot of folks could say, "Gee, that candy is looking a lot better relative to other things that I might buy with my money." For example, people might be picking between candy and fruit. Maybe at first they were both four dollars a pound, but now all of a sudden, if the candy is two dollars a pound or two dollars per unit, well then it's looking a lot better relative to the fruit.

Some of that quantity of fruit people would have bought, they'll say, "Hey, now candy is a better deal! I'm going to substitute the fruit with candy." That's why you have a higher quantity of candy demanded. This might maybe be now 250 units.

Another major category why you would expect this downward sloping demand curve for normal goods—and we'll talk about things like inferior goods in future videos—is the income effect. In some ways, this might be the most intuitive. If the price went from four dollars to two dollars, the cost of those hundred units would now be half as much. It would go from four hundred dollars to two hundred dollars.

So the market would have an extra two hundred dollars to use to buy things with, and some of that extra two hundred dollars they'll buy more candy with it, and they might also buy other things with that.

Now, the last dimension that economists will often talk about for why the law of demand is downward sloping, like this—and we talk about this in other videos—is this idea of decreasing marginal utility. That's the idea that that first amount of candy, there are going to be people in the market who take a lot of value from it. They are just addicted to candy; their bodies are dependent on that candy.

But as soon as those folks are satiated, that next incremental amount, that next marginal amount, the utility might be a little bit lower. So as you have more and more candy, the marginal utility goes down. That's another way of thinking about why we have a downward sloping demand curve.

More Articles

View All
P-values and significance tests | AP Statistics | Khan Academy
Let’s say that I run a website that currently has this off-white color for its background, and I know the mean amount of time that people spend on my website. Let’s say it is 20 minutes, and I’m interested in making a change that will make people spend mo…
Warren Buffett: 90 Years of Investment Wisdom Summed Up in 15 Minutes (2021)
Whenever someone asks me how they can learn more about investing, the first thing I tell them is study Warren Buffett. He has an amazing ability to make complicated finance concepts seem so simple. Here are my five favorite clips of Warren Buffett explain…
SpaceX and Commercial Space Exploration | StarTalk
I think people conflate two different things here when they talk about the moving frontier of space exploration. If you’re going to advance a space frontier, you have gone farther than anyone has gone before. To me, that’s advancing a space frontier. Anyt…
Units of the rate constant | Kinetics | AP Chemistry | Khan Academy
[Voiceover] In this video, we’re going to be talking about how you can find the units for your rate constant k. So the two things you should know before we get started are that, one, rate constant k has units. So this isn’t always true of constants in c…
15 Expensive Things That Are NOT Worth the Money
You dream about becoming rich so you can afford everything you ever wanted, only to find out that you hate having to take care of so many things. Most expensive things are just a clever way to separate rich people from their money. If last Sunday, we look…
Warren Buffett: MAJOR Updates from the Berkshire Hathaway Shareholders Meeting 2023
Well, we made it everyone! I’m here in Omaha with Hamish, and just a few days ago we were lucky enough to go to the Berkshire Hathaway annual shareholders meeting to get all the latest news from the man himself, Mr. Warren Buffett. And of course, the real…