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How is law of demand derived from utility analysis? |
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Answer» Solution :The inverse relation between price and demand of a commodity can be explained with the help of two priciples used in utility ANALYSIS. (i) On the basis of principle `MU_(X) = "Price"_(X)` We know that a consumer is at equilibrium when `MU_(X)=P_(X)`. Assuming that the price of commodity X FALLS implying that now `MU_(X) gt P_(X)`, it will INDUCE him to buy more of X. He will continue to buy more until `MU_(X)` falls and reaches at equilibrium again. It shows that when price of commodity falls, its demand rises (inverse relation between price and demand). (ii) On the basis of principle `(MU_(X))/(P_(X))=(MU_(Y))/(P_(Y))` The EQUALITY between two determines condumer equilibrium. Assuming that the price of GOOD X falls implying that now `(MU_(X))/(P_(X)) gt (MU_(Y))/(P_(Y))`, it will induce the consumer to buy more of X as it given him more utility than Y. He will continue to buy more of X till he reaches equilibrium again. The above discussion shows that when price of a good falls its demand rises (inverse relation between price and demand). |
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