Suppose that the price of fried clams, P_C, rises. The price increase doesn’t change the marginal utility a consumer gets from an additional pound of clams, MU_C, at any given level of clam consumption. However, it does reduce the marginal utility per dollar spent on fried clams, MU_C/P_C. And the decrease in marginal utility per dollar spent on clams gives the consumer an incentive to consume fewer clams when the price of clams rises.

To see why, recall the utility-maximizing principle of marginal analysis: a utility-maximizing consumer chooses a consumption bundle for which the marginal utility per dollar spent on all goods is the same. If the marginal utility per dollar spent on clams falls because the price of clams rises, the consumer can increase his or her utility by purchasing fewer clams and more of other goods.

The opposite happens if the price of clams falls. In that case the marginal utility per dollar spent on clams, MU_C/P_C, increases at any given level of clam consumption. As a result, a consumer can increase her utility by purchasing more clams and less of other goods when the price of clams falls.

So when the price of a good increases, an individual will normally consume less of that good and more of other goods. Correspondingly, when the price of a good decreases, an individual will normally consume more of that good and less of other goods. This explains why the individual demand curve, which relates an individual’s consumption of a good to the price of that good, normally slopes downward—that is, it obeys the law of demand. And since—as we learned in Chapter 3—the market demand curve is the horizontal sum of all the individual demand curves of consumers, it, too, will slope downward.

An alternative way to think about why demand curves slope downward is to focus on opportunity costs. When the price of clams decreases, an individual doesn’t have to give up as many units of other goods in order to buy one more unit of clams. So consuming clams becomes more attractive. Conversely, when the price of a good increases, consuming that good becomes a less attractive use of resources, and the consumer buys less.

This effect of a price change on the quantity consumed is always present. It is known as the substitution effect—the change in the quantity consumed as the consumer substitutes other goods that are now relatively cheaper in place of the good that has become relatively more expensive. When a good absorbs only a small share of the consumer’s spending, the substitution effect is essentially the complete explanation of why the individual demand curve of that consumer slopes downward. And, by implication, when a good absorbs only a small share of the typical consumer’s spending, the substitution effect is essentially the sole explanation of why the market demand curve slopes downward.

However, some goods, such as housing, absorb a large share of a typical consumer’s spending. For such goods, the story behind the individual demand curve and the market demand curve becomes slightly more complicated.