Law of diminishing marginal utility states that marginal utility of a commodity diminishes when a consumer takes successive units of a commodity. In order to maximize satisfaction a consumer will stop the purchase of the commodity when MU equals its price (MUX = Px). When the price of the commodity falls the consumer will purchase more units of the commodity so that MU falls to equal the price. If the price rises, the opposite happens. 2.
Income effect:As the price of a commodity falls, the real income or purchasing power of the buyer increases because he can purchase the same quantity of the commodity with lesser amount of money at a lower price. A part of the increase in his real income may be used to purchase more of the cheaper commodity while remaining part may be spend on other goods. This is the income effect of fall in price.
Therefore, when price falls, the quantity demanded increases due to increased real income and vice-versa. 3. Substitution effect:When the price of a commodity falls, it becomes relatively cheaper in comparison to its substitutes. Therefore, the consumer would prefer to substitute this cheaper commodity for other goods whose Prices remain unchanged. This is the substitution effect of price effect. 4. Different uses:When the price of a commodity is high, it will be used only in its more important use. As the price of the commodity falls it will be used even in less important uses.
Thus, the demand increases will fall in price and vice-versa. Example of gram or electricity can be citied. 5.
Change in the number of Buyers:With the fall in the price of a commodity the number of its purchasers increase and vice-versa. Therefore, demand increases with fall in price and decreases with fall in price and decreases with rise in price.