Studied by 6 peopleThe income effect (demand assumption)
As the price of a product falls, the real income of customers increase. In other words they are able to buy more products at lower prices. In contrast, an increase in the price of a good or service reduces peoples real disposable incomes, which in turn reduces the quantity demanded.
The substitution effect (demand assumption)
As the price of a good or service falls, more customers are able to buy the product, so choose this over rival or substitute products that they might have previously bought. (essentially, the substitution effect causes consumers to replace higher priced products with lower priced ones)
The law of diminishing marginal utility (demand assumption)
As individuals consume more of a particular good or service, the utility (return or satisfaction) gained from the additional unit of consumption declines, so customers will only purchase more at lower prices. At some point consumers will not want any more, because the marginal utility of consumption drops to zero.
The law of diminishing marginal returns (DMR) (Supply assumption)
Describes how output is affected when a firm uses more variable inputs (factors of production) while maintaining at least one factor of production as fixed in the short run. By employing additional variable factors of production (such as labour), the marginal returns (additional output) for each additional unit of input will eventually decline. This applies only in the short run!
Increasing marginal costs (supply assumption)
Marginal cost refers to the cost of producing an additional unit of output. In general, marginal costs rise with each successive unit produced owing to diminishing marginal returns. Hence, firms are willing and able to increase production only if they receive a higher price for the additional units of output. Therefore, the principle of increasing marginal costs underpins the law of supply.
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