Understanding Price Effects and Quantity Demanded

This question asks us to evaluate two statements related to the effect of a price reduction on the quantity demanded of a commodity. We need to analyze the Assertion (A) and the Reason (R) based on economic principles.

Analyzing Assertion (A): Price Reduction and Quantity Demanded

Assertion (A) states: A price reduction leads to an increase in the quantity demanded of the commodity.

This statement describes the fundamental concept of the Law of Demand. The Law of Demand posits an inverse relationship between the price of a good and the quantity demanded, assuming all other factors remain constant (ceteris paribus). When the price of a commodity falls, consumers are typically willing and able to purchase more of it, leading to an increase in the quantity demanded.

There are some exceptions to the Law of Demand, such as Giffen goods and Veblen goods. However, in the absence of any specific mention, the assertion aligns with the general principle of the Law of Demand which applies to most goods.

Therefore, Assertion (A) is generally considered correct in standard economic theory.

Analyzing Reason (R): Components of Price Effect

Reason (R) states: It results from price effects comprising income and substitution effects which are always positive.

The "It" in Reason (R) refers to the increase in quantity demanded due to a price reduction mentioned in Assertion (A). The price effect, which explains the change in quantity demanded when the price of a good changes, is indeed composed of two effects:

1. Substitution Effect: When the price of a good falls, it becomes relatively cheaper compared to other goods. This encourages consumers to substitute away from relatively more expensive goods towards the cheaper good, leading to an increase in the quantity demanded of the good whose price has fallen. The substitution effect is always positive or non-negative; a decrease in price always leads to an increase in quantity demanded due to substitution.
2. Income Effect: A fall in the price of a good increases the consumer's real income or purchasing power. How this increased real income affects the quantity demanded depends on the type of good:
   • For a normal good, an increase in real income leads to an increase in the quantity demanded. The income effect is positive.
   • For an inferior good, an increase in real income leads to a decrease in the quantity demanded. The income effect is negative.

Reason (R) claims that both income and substitution effects are always positive. As explained above, the income effect can be negative for inferior goods. While the substitution effect is always positive (for a price decrease, quantity demanded increases), the income effect is not always positive.

Therefore, Reason (R) is incorrect because it incorrectly states that both components of the price effect (income and substitution effects) are always positive.

Evaluating Assertion and Reason Relationship

We have determined that:

• Assertion (A) is correct. A price reduction generally leads to an increase in the quantity demanded.
• Reason (R) is incorrect. The income effect, which is part of the price effect, is not always positive; it is negative for inferior goods.

Since Reason (R) is an incorrect statement, it cannot be the correct explanation for Assertion (A).

Based on this analysis, Assertion (A) is correct, but Reason (R) is incorrect. This matches option 3.

Conclusion on Assertion and Reason

Assertion (A) is correct, stating that a price reduction typically increases quantity demanded. Reason (R) is incorrect because it incorrectly characterises the income and substitution effects as always positive; the income effect is negative for inferior goods.

Revision Table: Key Economic Effects

Additional Information: Types of Goods and Price Effects

Understanding the types of goods helps clarify the income effect and its role in the price effect:

• Normal Goods: Demand increases as income increases. For a price fall, both substitution and income effects are positive, leading to an increase in quantity demanded. The Law of Demand holds.
• Inferior Goods: Demand decreases as income increases. For a price fall, the substitution effect is positive, but the income effect is negative (as real income increases, people buy less of the inferior good). If the positive substitution effect is stronger than the negative income effect, the quantity demanded increases overall, and the Law of Demand holds.
• Giffen Goods: A specific type of inferior good where the negative income effect is so strong that it outweighs the positive substitution effect. For a price fall, the quantity demanded decreases. These are rare exceptions where the Law of Demand does not hold.

The assertion in the question relates to the general case where the Law of Demand holds, implying the price effect results in increased quantity demanded when price falls. Reason (R) fails because it makes a universal claim about the positivity of both income and substitution effects, which is not true for inferior goods.