Demand, Supply, and Equilibrium - Term Paper Example

ID Number: Demand, supply, and equilibrium This report includes a discussion of the demand, supply and market equilibrium for normal goods. The report explains the terms and discusses the various dimensions associated with these concepts. The relevance of these economic factors in the practical markets is included. The relevant areas in which future research works can be done have also been mentioned at the end of the report. Introduction Demand and supply are the fundamental concepts used in economics. The factors of demand and supply form the backbone of the market economy. Demand is the measurement of the quantity of a product or a service that is desired by the buyers in a market. The amount of a product that people in a market are willing to buy is known as the demanded quantity. The existing relationship between quantity demanded and price is known as the demand relationship. The factor of supply indicates the quantity of a product or a service that can be offered by the market. The quantity supplied is the amount of any good or service that the producers are able to supply in return of a certain price. The factor of price is a reflection of the demand and supply in the market. The supply and demand relationship underlines the key decisions regarding the allocation of resources in a market. In the theories of market economy, the demand and supply theory is used to allocate the available resources in the best possible manner. Discussion Demand The demand for a product is the representation of how much the buyers are willing to buy at different prices. Thus, demand can be defined as the existing relationship between quantity and prices while maintaining all other relevant factors as constant. The law of demand states that the higher the price of the goods, lesser would be the demand for the goods, if the other relevant factors are kept constant (Gomes, King and Stonecash 215). This means that a higher price would incur a lower demand. According to the law of demand, the factors of quantity demanded and price are inversely proportional. Therefore, a lower price would mean a higher quantity demanded. The market demand represents the total of the demands of all the individual buyers in a market. Since at a higher price, both the price and the opportunity cost of the purchase of the goods and services increase, therefore the amount purchased by buyers at high prices is lesser. People generally try to avoid buying any product or service that will make them forgo the purchase and consumption of a product more important to them. Thus, a high opportunity cost often leads to a decrease in the quantity demanded. Demand is represented graphically in the form of a downward sloping curve with quantity in the horizontal axis and price in the vertical axis. The downward sloping curve of demand is given in the diagram below (Figure 1) Figure 1: Demand curve As seen from the graph, A, B and C are three points mapped on the demand curve. Each of the three points is used to represent a direct correlation between the factors of Price (P) and Quantity (Q). At the point A, the demand is Q1 while the price is P1, at the point B the demand is Q2 and the price is P1 and so on. The curve showing demand relationship illustrates the inversely proportional relationship between the quantity demanded and the price of the goods or services in a market. The higher price of a good would mean a lower demand of the product as shown in point A. On the other hand, a lower price of the good would mean a higher demand of the goods or services as indicated in point C. The main market factors that influence demand are as follows: Change in income: An increase in the income of a household will cause an increase in the demand which will cause the demand curve to shift to the right. This is associated with the prices of the goods and services being increased. Changes in the price of substitutes: The decrease in the prices of substitute products would decrease the quantity demanded for the goods and services. Also an increase in the prices of the substitute goods would increase the quantity demanded in the market. Change in the prices of complement goods: An increase in the price of complementary goods and services would mean an increase in the demanded quantity of the goods. Change in interest rates: An increase in the interest rates would cause the demand of goods to go down. This is because the consumption of many households is done through financial borrowing. Particularly, the demand for housing is highly affected in case of increase in the interest rate. Change in age distribution and size of general population: In case of a rapidly aging population with the number of children in each family being less, the demands of products and services that find use by older people would increase. External factors: Other external factors like shifts in trends and advertising can increase the demand for a product or a service. Consumer expectations and advances in technology are other factors that may contribute to an increase in demand. Supply Supply represents the quantity that the market can offer. The supplied quantity is the amount of goods or services that the producers are willing to or are able to supply in a market (Besanko and Braeutigam 182). The supply relationship is the correlation between the quantity of goods or services offered and the price of the goods and services. The law of supply is an important law in economics which is used to illustrate the quantities that are likely to be sold at certain points of prices. The law of demand is represented by a downward slope while the law of supply is represented by an upward slope. This is because the price and quantity factors in the law of supply are positively correlated. An increase in the price would mean an increase in the supplied quantity. The producers in a market are likely to supply more goods or services at higher prices because if they sell their products at higher prices it would bring more revenues for them. The supply curve is an upward sloping curve that has quantity represented on the horizontal axis and price represented on the vertical axis. The supply curve is given in the figure below (Figure 2). Figure 2: Supply curve A, B and C are three points mapped on the supply curve at three supplied quantities and three price values. An increase in the supply results in an increase in the price and vice versa. The law of supply can be analysed through the use of two different approaches. The first approach is that the law of supply represents the aggregate production along with the carryover stocks. The second context used in supply is the behaviour demonstrated by the producers in the markets. The aggregate supply in the market is representative of the quantity of products that the producers are interested to sell for a certain price in a given time period. An individual producer may be willing to supply a product as long as the cost of producing the products is equal to or leer than the market price. The aggregate supply in a market is the total of the individual supplied quantities of product by all the producers. There are many factors that affect supply other than a change in the price. The change in price makes the supplied quantity change. This is represented by a movement along the existing supply curve. But there are other determinants which influence a shift in the supply curve (Arnold 120). Some other key determinants of the shift in the supply curve are discussed as follows: Production cost: A high production cost would mean lower profits for a company and thus would restrain the supplying capabilities of the company. The goal of every company is to maximize profit. As such, they focus on keeping the production costs low so that they can supply more goods or services and thus make more profits. The main factors that may affect production cost and subsequently affect the supply in a market are input prices, tax rates, government regulations, wage rate etc. Technological advancement: The improvements in technological factors help the companies to reduce production cost. As a result of this, the supply of goods or services by these companies can also increase. Number of producers: A higher number of producers in the market generate more supply in the market. Expectation for future price: If the sellers and producers of goods expect the future prices of the products to go up, they would hold on to their stock of goods and offer their products in the market in future so as to sell the products at higher prices. Market Equilibrium A market economy is at equilibrium when the demand and supply in the market are equal. When the demand function and the supply function would intersect, the market economy would be at equilibrium. The allocation of goods and services is most efficiently done at the point of market equilibrium because the amount of supplied quantity of goods is equal to the amount of demanded quantity of goods. Market equilibrium is a condition in which all the entities including the firms, individuals and countries are satisfied with the prevailing economic conditions (Sloman 144). At this point, the consumers would be able to get the goods and services which they are demanding and the suppliers would be able to sell off all the goods or services that they are producing. The market equilibrium is represented in the graph below (Figure 3). Figure 3: Market Equilibrium As seen from the graph, market equilibrium occurs at the place where the demand curve and the supply curve intersect. At this point there are no allocation inefficiencies in the market. The price of goods and services at this point is P* while the quantity is Q*. Thus P* would indicate the equilibrium price and Q* would indicate the equilibrium quantity. The prices of products in practical market scenarios are changing constantly in response to the change in the demand and supply levels. Therefore, in the real markets, market equilibrium is a concept that is not practically achievable. Conclusion The demand and supply models find useful application in the modern day competitive markets. Both demand and supply are critical factors in a market because they are the key determinants of quantities and prices in a market. Demand, supply and market equilibrium are concepts that find importance not only in economics but also in business perspectives. The changes in the demand and supply affect the market and business conditions and are key concepts used to assess and explain the economic conditions of a nation. The determination of product quantities and market prices is done based on the level of demand and supply in market. Suggested areas for future research The demand, supply and market equilibrium discussed in this report are in reference to normal goods. There may be scope for research in the area of demand and supply relevant to giffen goods. How and why the giffen goods oppose the law of demand and supply can be a prospective topic for in depth research. Another area of future research may be how the factors like consumer expectations which are normally kept constant in the law of demand and supply can influence a shift in the demand and supply curves. The results of making these factures variable can create the scope for a valuable and interesting research. Works cited Arnold, Roger. Economics. Boston: Cengage Learning. 2008. Print. Besanko, David. & Ronald Braeutigam. Microeconomics. New Jersey: John Wiley. 2010. Print. Gomes, Joshua., King, Stephen. & Robin Stonecash. Principles of Economics. Australia: Cengage Learning. 2011. Print. Sloman, John. Economics. New York: Prentice Hall. 2006. Print. Read More