Effects of Demand and Supply on Price and Quantity - Report Example

XXXX Number: XXXX XXXX XXXX XXXX XXXX Word Count: 1230(Excluding Bibliography) Effects of Demand and Supply on Price and Quantity Table of Contents Introduction ……………………………………………………………………………………… 2 Demand Increases Supply Increases ……………………………………………………………...3 Supply Falls Demand Increases ……………………………………………………………..……6 Conclusion……………………………………………………………………………...................9 Introduction: In 1890, Alfred Marshall published in his work – Principles of Economics, that the market price of goods are determined by both the demand of the good as well as the supply for it. This was one of the earliest writings on the effects of demand and supply on the price of goods. This has now become a fundamental concept. It is essential to firstly understand that the demand and supply curves are graphical representations of the relationships between quantity and price of the goods. It is useful and simpler to use this relationship as a straight line instead of a curved line. The demand curve represented as a straight line can be expressed as P = a – bQD. Where, a =Vertical axis intercept -b = Slope If the prices increases as $ a, the consumer demand will reduce to zero units, b is the rate at which the price would require to reduce so that the quantity demanded increases by one unit. If the formula is clearly seen ‘a’ is positive signed and ‘b’ is negative sign this indicates that quantity demanded and the price are inversely related. Similar to the demand curve the general equation for a supply linear curve is represented by P = c + dQs Where, c = Vertical axis intercept d = Slope In economic terms, the producers will offer zero unit for sale if the price of the good reduces down to $ c, and d stands for the rate at which the price is required to rise to so that the producers can offer more than one unit for sale. Similar to the demand curve d indicates a direct relationship between price and quantity. This report aims at using this fundamental concept to analyse the effects of demand and supply on the price and quantity of the goods in two conditions explained below. Also the different possibilities of how the demand and supply can affect the price and quantity of the goods are also discussed. In conclusion, all the other factors that might affect the demand of a good are also discussed in brief. This is mainly to help understand all the possible factors that affect the demand of the goods. Below are two different scenarios which are discussed to understand how price and quantity are affected when a) Demand increase and Supply Increases, b) Supply Decreases and Demand Increases. 2 Demand Increases and Supply Increases: An increase in demand and an increase in supply would lead to an increase in the quantity demanded. However the effects on the price will not be clear without having clear information as to the magnitude of the shift in both the demand and supply. Considering the case of the quantity, this is not definable unless the magnitude of the shift is clear. a) Assuming the demand and the supply curve move apart at equal distances: Here the intersection of the lines will be at the same price. Looking at the above figure, it is clear that with an increase in supply and demand the price remains the same however the quantity increases. b) Assuming the supply curve shifts more to the right than the demand curve towards the right: Here the equilibrium is more towards the right, which means the quantity supplied or demanded at the equilibrium price is lower. Looking at the above graph it is clear that with more increase in supply and lesser increase in demand the price of the product goes down and the quantity increases. c) Assuming the demand curve shifts more to the right than the supply curve towards the right: Here again the quantity supplied or demanded at the equilibrium is lower. In the case when the demand for the product is lesser than the supply, the price of the product will go up and the quantity of the product will reduce. 3 Supply falls and Demand Increases: It is firstly essential to understand how the curves shift. When there is a decrease in the supply or the demand the curve moves towards the left. Similarly when an increase is seen in the demand and supply, the curve tends to move to the right. In this case where the demand is increasing, the curve moves towards the right. Also the supply seems to be decreasing, which indicates that the curve moves towards the left. In a situation like this the price would be affected. Since the meeting point of the two curves in towards the higher end of the axis, it implies an increase in the price of the goods. Considering the case of the quantity, this is not definable unless the magnitude of the shift is clear. a) Assuming the demand and the supply curve move apart at equal distances: Here the intersection of the lines will be at the same quantity. From the above graph, it is clearly understood that if both the demand as well as the supply increase at a constant rate, the price of the product remains the same however the quantity increases. b) Assuming the supply curve shifts more to the left than the demand curve towards the right: Here the equilibrium is more towards the left, which means the quantity supplied or demanded at the equilibrium price is lower. Looking at the above graph it can be understood that with an increase in the demand at a rate lesser than that of the increase in the supply, the price of the product increases, however the quantity of the product reduces. c) Assuming the demand curve shifts more to the right than the supply curve towards the left: Here again the quantity supplied or demanded at the equilibrium is lower. Looking at the above graph, it is evident that, with an increase in demand which is much more than the increase in supply, the price of the product increases, however the quantity of the product that increases in relatively lower terms. 4 Conclusion: From the above diagrams it has clearly been understood that with: a) An increase in demand and supply – i) If the magnitude of change for both is equal, the price will remain the same and the quantity of the goods will increase. ii) If the magnitude of the change varies: 1) If the Supply increases more than the demand – Then the quantity of the goods is also increased and the prices are reduced. 2) If the Demand increases more than the supply – Then the prices of the goods increase and the quantity is reduced. b) An increase in demand and decrease in supply – iii) If the magnitude of change for both is equal, the price will increase and the quantity of the goods will remain the same. iv) If the magnitude of the change varies: 3) If the Supply decreases more than the demand increases – Then the price of the goods increases and the quantity of the goods decreases. 4) If the Demand increases more than the supply decreases – Then the prices of the goods increase and the quantity is increases as well however relatively lower than the price. From this it is clearly understood how the equilibrium of price and quantity is affected by changes in the demand and supply of the goods. Each of these factors affects the others in some way or another and thus it is important to understand the affects. It is also important to understand the other possible factors that might cause a change to the demand and supply of products. Some of the other factors are: a) Changes in the prices of Substitutes b) Changes in price of Complements c) Changes in size and age distribution of the general population d) Changes in interest rates and the availability of credit e) Changes in advertising and fashion can also effect the demand f) Seasonal Changes g) Changes in technologies and h) Changes in the consumer expectations (Ecoteacher, 2008). Each of the above mentioned factors do affect the demand of products. Of these the change in price of substitutes is the most common factor which affects the demand of goods. Thus this explains how the demand and supply of a product can be affected. Bibliography Ecoteacher, 2008, Factors affecting Demand’. 4 December 2008, < http://www.ecoteacher.asn.au/Demand/dslide1/d37.htm> John Sloman and Mark Sutcliffe, 2004, Economics for Business. Third edition. Prentice Hall. Read More