Suppose we are in a market with a perfectly inelastic supply curve. The government imposes a binding price ceiling. What happens to price and quantity in this market?
A Price increases, the quantity purchased remains the same
B Price decreases, the quantity purchased decreases
C Price increases, the quantity purchased decreases
D Price decreases, the quantity purchased remains the same.
The correct answer and explanation is:
Correct Answer:
Price increases, the quantity purchased decreases
This statement reflects the law of demand, a fundamental principle in economics. The law of demand states that, all else being equal, as the price of a good or service increases, the quantity demanded by consumers decreases. Conversely, if the price decreases, the quantity demanded typically increases.
This behavior occurs because higher prices discourage consumers from purchasing as much of a product. For example, if the price of bread doubles, many consumers may buy less bread or switch to alternatives. Lower prices make goods more attractive, leading to higher purchases. This inverse relationship between price and quantity demanded is represented graphically as a downward-sloping demand curve.
The law of demand operates because of two effects:
- Substitution Effect: As the price of a good rises, consumers may replace it with a cheaper alternative.
- Income Effect: A price increase reduces the purchasing power of a consumer’s income, limiting how much they can buy.
There are exceptions to the law of demand, such as Giffen goods and Veblen goods. Giffen goods are inferior goods where a price increase might lead to higher demand due to limited alternatives. Veblen goods are luxury items where higher prices may make them more desirable for status reasons. However, these exceptions are rare.
The other option, “Price decreases, the quantity purchased remains the same,” contradicts typical consumer behavior. Unless the good is perfectly inelastic (very rare), a decrease in price usually encourages more consumption.
In summary, the correct economic behavior is that when the price of a product increases, the quantity purchased decreases, aligning with standard demand theory in microeconomics.