Demand curve is a graphical representation of customers' willingness to purchase a certain commodity at a certain time and price. It is drawn with price on vertical axis and quantity on the horizontal axis. A downward-sloping demand curve demonstrates the changes in demand in relation to changes in prices. This curve shows that the quantity of goods demanded increases when prices decline and declines when prices increase.
Diminishing Marginal Utility
Diminishing marginal utility refers to a trend whereby demand for goods and services is ignited by customers’ need to purchase additional units of a product to be able to satisfy their needs. This trend is known as the law of marginal utility, and it means customers can be able to purchase the additional products required to meet their needs only when the prices of the products are reduced. This trend is synonymous with a downward-sloping demand curve.
This is an economic concept that explains the consequences of price reductions to the purchasing abilities of customers. The income effect concept states that consumers’ disposable income increases when commodity prices are reduced and this translates to increased purchasing power of consumers. The increased purchasing power as a result of reduced prices, therefore, ignites an increase in demand for goods and services, thereby creating a downward-sloping demand curve.
A downward-sloping demand curve that's attributable to substitution effect arises from selective changes in related commodities that can be substituted for each other. When the price of one of the products is reduced and the rest of the products remain the same, the demand for the commodity with reduced price increases. This is why the trend results in a downward-sloping demand curve.
Keynes’s Interest Rate Effect
Keynes’s interest rate effect occurs when the price of commodities directly controls the quantity of goods demanded by consumers. That means that the higher the cost of goods, the more consumers will spend, and when the price is low they spend less. Therefore, consumers will reduce their savings, while banks experience reduced customer deposits. This leads to a decrease in the interest rates offered by banks. Price reductions enable consumers to increase their savings, effectively triggering an increase in demand for commodities or services.
Paul Merchant started writing in 2005. His articles have appeared in “JSTOR Journals” and “Wileys Management Journals.” He is a certified public accountant and a qualified project management expert. Merchant holds a Bachelor of Arts in communication from the University of Nairobi.