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UNDERSTANDING DEMAND In a market system, the interaction of buyers and sellers determines the price of most goods as well as what quantity of a good will be produced LAW OF DEMAND When a good’s prices is lower, consumers will buy more. When the price is higher, consumers will buy less The law of demand is the result of two separate behavior patterns that explain why an increase in price decreases the quantity purchased Substitution effect Income effect SUBSTITUTION EFFECT As the price of a good rises it becomes more expensive compared to another good As a result as the price of one good goes up the consumers become more likely to buy a another good as a substitute Consumers react to a rise in prices of one good by consuming less of that good and buying more of another good What must be true for this to be right? INCOME EFFECT Rising prices make us feel poorer. As prices increase an individuals budgets just will not buy as much as it once did Individuals can no longer afford to buy the same combination of goods When the price goes up the quantity demanded goes down Income effect also is true when prices go down. When prices go down the quantity demanded goes up