Previous Year Question
Consider the following statements. Other things remaining unchanged, market demand for a good might increase if:
Price of its substitute increases.
Price of its complement increases.
The good is an inferior good and the income of the consumers increases.
Its price falls.
Which of the above statements are correct?
1 and 4 only
2, 3 and 4 only
1, 3 and 4 only
1, 2 and 3 only
Correct Answer: A
Detailed Solution
Other things remaining unchanged—Ceteris Paribus means that determinants such as consumers’ income, preferences, population and prices of other goods are assumed to remain constant, except for the price or factor being examined.
Market demand is the sum of the quantities demanded by all consumers at a given price.
Statement 1 is correct. Substitute goods are goods that can be used in place of one another, such as tea and coffee. If the price of coffee rises, some consumers may shift towards tea. Consequently, the demand for tea may increase. Thus, the price of a substitute and the demand for the concerned good generally have a positive relationship.
Statement 2 is incorrect. Complementary goods are generally consumed together, such as cars and petrol or tea and sugar. If the price of a complementary good rises, using the combination becomes more expensive and demand for the related good generally falls. For example, a rise in petrol prices may reduce the demand for cars.
Statement 3 is incorrect. An inferior good is one whose demand falls when consumers’ income rises. Following an increase in income, consumers may replace the inferior good with a higher-quality normal good. Thus, the demand for an inferior good generally has an inverse relationship with consumers’ income.
The term “inferior” does not necessarily mean that the product is defective or of poor quality. It is an economic classification based on how consumer demand changes when income increases.
Statement 4 is correct. According to the law of demand, other things remaining equal, a fall in the good’s own price increases its quantity demanded. Existing consumers may purchase a larger quantity at the lower price, while additional consumers may also enter the market.
Technically, a change in the good’s own price causes movement along the demand curve and is called an increase in quantity demanded. A change in income, preferences or prices of related goods may shift the demand curve. The question uses “market demand might increase” in a broader sense; therefore, statement 4 is correct.