Analysis of the Microeconomic Theory of Supply and Demand - Research Paper Example

Analysis of the Microeconomic Theory of Supply and Demand The theory of supply and demand is one that any economist cannot go without mentioning in microeconomics as it is seen as the core of this segment of economics and makes a focus on household economics that deals with the buying and selling and involves the market forces. This paper is aimed at analyzing the supply and demand theories as have been used it microeconomics. Demand is the total quantity of goods that a consumer is willing and able to buy from the market. There exists an individual demand as well as a market demand. An individual quantity demanded is the amount of goods a consumer is willing and able to buy at a particular price while a market quantity demanded is the total amount of goods that all buyers in the market would be willing and able to purchase at a particular price (Robert and Marc). One will realize that demand focuses on the buyer’s choice but not actually the amount that the buyer will purchase and the use of price is stressed in defining the quantity demanded. Market demand is the sum of all the individual demands for a particular good or service. Since market demand is derived from individual demands, it is affected by all the factors that affect each buyer in the market. For that reason, market demand can be said to depend on an individual’s income, taste, expectations as well as prices of related goods. A demand schedule usually shows what happens to the quantity of goods demanded with the variation in their prices with all the other variables affecting the demand held constant. Individual demand curves are summed up horizontally to come up with the market demand curve. The law of demand states that the price of a good will rise as the quantity falls, with all factors held constant (ceteris paribus). This becomes so evident when something becomes expensive in the market since people will buy less of it. This observation applies to virtually everything that people buy in the market including magazines, nuts, foodstuff education and the rest. The price and quantity then exhibit a negative relationship in all these goods and services-when quantity rises, the price falls and when quantity fall, price rises. The law of demand was then derived by economists from this negative relationship between price and quantity which was a regular phenomenon in the market. This law only applies when all other factors influencing the buyer’s choice remain unchanged and only price of the good changes. Demand schedule is a table with a list of different quantities of a product demanded at different prices, all the other factors affecting demand decision held constant. For instance, demand schedule will show us that when the price of a bottle of maple syrup is $3.00, the quantity demanded will be 2000 bottles per month and as the price increases to $4.00 per bottle, the quantity demanded will be 1500 bottles per month and the rest are shown in the table below. One will clearly notice that the demand schedule obeys the law of demand: as the price per bottle increases, the quantity demanded will reduce. Demand schedule for Maple Syrup in a given market Price per bottlee) Quantity demanded (per month) $1.00 3,000 2.00 2,500 3.00 2,000 4.00 1,500 5.00 1,000 When these values are plotted in x and a y ax, a curve is formed which is referred to as the demand curve as shown below: Price ($) 5 4 3 1500 2000 Quantity demanded Demand curve therefore, is a curve that shows the relationship between the prices of a good and quantity demanded at such prices with all other factors affecting demand held constant. Each point in the demand curve shows the quantity that buyers will buy at a specific price. The demand curve is also observed to follow the law of demand and according to the law of demand, graphically, the demand curve slopes downward. There exist a variety of events in the market that affect the choice of a buyer. Some of these events will cause a movement along the demand curve as others will cause a shift in the demand curve. For instance, when the price of a maple syrup increases from $3.00 to $4.00, the quantity demanded decreases from 2,000 to 1,500 bottles. This causes a movement along the demand curve from point B to point A as shown in the demand curve above. Hence, a change in the price of a good will cause a movement along the demand curve with a rise in price causing a leftward movement-a decrease in quantity demanded-as a fall in price will cause a rightward movement along the demand curve-an increase in quantity demanded. The curve above shows the relationship between the quantity of maple syrup at particular prices at a certain household income, of let’s say $20,000 per month. When the household income increases to maybe $30,000 per month, the quantity demanded will rise and the entire relationship will change. For instance, households initially bought 2,000 bottles of maple syrup at $3.00 per bottle when the income was $20,000 but would be willing buy 3,000 bottles, for instance, when the income increases to $30,000 per month. Due to this increase in income that would cause an entire change in the relationship between the price and quantity of maple syrup bought per month, the new demand curve will shift outwards, to the right of the old curve. This is known as an increase in demand (Dominick and Eugene). Hence, a change in other determinants of demand apart from price causes the demand curve to shift. If the buyers decide to buy more, the demand curve shifts rightwards and when they decide to buy less in response to changes in these determinants, other than price, the demand curve shifts leftwards. In this case, we find that the demand for normal goods relates positively to income or wealth of someone. A rise in income or wealth will increase the demand for these goods hence the demand curve shifts rightwards. Other determinants that cause the demand curve to shift are like: prices of related goods, population, and expectation of future events, tastes and preferences of the buyer among others. For instance, when the price of a substitute good rise, the demand for that good will increase causing a rightward shift in the demand curve, showing an increase in demand. However, a rise in the price of a complementary good decreases the demand for that particular good hence causes the demand curve to shift leftwards, showing a decrease in demand. Increase in population increases the number of buyers in a particular area, hence the demand for goods increase in that particular area. For instance, the growth in the US population over the 50 years has been a reason, but not the only reason, for the increase in the demand for food, rental apartments, telephone lines, and clothing among other goods. When the buyers for maple syrup, for example realize that its price will increase the following month, they will respond by buying a lot of the syrup and stock up in expectations of the price hike. And when people expect a price drop, they will postpone buying, expecting to take advantage of the future decrease in the prices and buy them. This concept of future expectations is particularly important in the stock and bond market when people would buy bonds and stock with the expectations that the price will increase in the future when they will sell them, making profits. This shifts the demand for items to the right (Stephen and Jan). Buyers normally show different attitudes, like or dislike preferences towards different products as others match their tastes and preferences while others do not. The demand for a particular good will increase when the taste change towards the good and this shifts the demand for a good to the right and vice versa. For instance, the change in taste away from cigarettes that has been accompanied by campaigns that cigarette is harmful to the health of smokers has seen the demand for cigarettes shift to the left. In summary, any changes that would raise the quantity of products the buyer would wish to purchase at a given price, would shift the demand curve to the right while any changes that reduces or lower the amount of products that the buyer would like to purchase, would shift the demand curve to the left. And, the demand curve shows what happens to the quantity of goods demanded with the variation of prices, with other factors or determinants affecting the quantity demanded remaining constant. When one of these other determinants is altered, there becomes a shift in the demand curve. On the other side, crossing over to supply, we now switch our focus to sellers instead of buyers as in the demand theory and look at the selling side of the market and how it differs and relate to the buying side. As we were discussing about the demand, we saw that a buyer will go to the market with a goal of making himself as well off as possible. This goal is also constrained by the fact that the buyer has a limited income to spend. This also applies to the sellers as they also go to the market with a goal to make as much profit as possible. And therefore it would follow suit that a seller will also face certain constraints assuming that the seller is a production unit, it will require certain inputs to make outputs out of. Such inputs are limited by the level of the firm’s production technology. Therefore, a firm’s production technology is the number of ways it can turn its raw materials (inputs) into goods and services (output). For example, a firm producing maple syrup will use raw materials/resources like land, labor, capital, fuel, glass bottles etc. So, when a competitive firm set in a market, it comes with a goal to maximize its profit but this is thwarted by some constrains the firm faces like the level of the production technology, the price at which it has to sell its products and the price it will pay for its inputs. Therefore, a firm’s quantity supplied of a particular good would be the amount it would choose to produce and sell at a particular price. Coming to the market quantity supplied of a particular good, it is the amount that all the firms in the market are willing to supply at a given price considering the price they would pay for the inputs and the other factors influencing the suppliers’ decisions. A market supply is found by summing up all the individual supplies in the market. The market supply in a particular market depends on the particular factors that affect individual supplies or sellers in the market some of which are: prices of input used to produce the good, expectations and the technology available. Moreover, market supply depends on the number of sellers. A supply schedule always shows what normally happens to the quantity supplied as the price increase and other factors affecting supply are held constant. Individual supply curves are summed up horizontally to obtain the market supply curve. So, when one wants to find the total quantity supplied at any one price, they will add the individual quantities on the horizontal axis of each individual supply curve. The market supply curve shows therefore, how the total quantity of the products supplied vary with the price of the good. The law of supply states that the quantity supplied will increase when the prices of a given product increase, all other factors held constant, (ceteris paribus). When there is a rise in price for a particular good, let’s say laptop computers, the manufacturers in this case will shift the use of resources from the production of desktop computers to produce more laptops. Hence, the price and quantity supplied of laptops are positively related such that when the price increases, the quantity supplied also increases. It is about this positive relationship between the price and the quantity supplied of a product that economists derived the law of supply. Supply schedule is a list of various quantities of products suppliers are able and willing to supply in the market at a given price, all other factors remaining constant. The supply schedule will also obey the law of supply such that, when the price of maple syrup increases, the quantity supplied in this particular market increase as all other factors remain constant. A supply curve is then produced by the plotting of these figures of price against quantity supplied on the x and y axes, with price being on the Y axis and quantity on the X axis. The supply curve therefore is a curve that shows the relationships between the quantity supplied and the price at which they are supplied, other factors affecting supply decisions held constant. Each point on the curve, like point A and point B, shows different quantities that sellers would choose to sell at particular prices. According to the law of supply, the graphical representation of supply curve indicates that it slopes upwards. Various variables will cause the supply curve to either move along the curve or shift the entire supply curve. For instance, changes in prices of a product will cause movements along the supply curve while changes in other variables other than price will cause a shift in the supply curve. More specifically, a rise in the price of a particular good will cause a rightward movement along the supply curve-shoeing an increase in the quantity supplied-while a fall in the price of a commodity will cause the supply curve to move to the left-showing a decrease in quantity supplied. The supply curve and supply schedules are constructed with the assumption of other variables that might affect the quantity supplied other than price. For example, the supply schedule of maple syrup might have assumed that the maple syrup workers are paid $8.00 per hour, what if the maple syrup workers were paid $5.00 per hour? The resulting supply schedule would change totally since the sellers would be making more profit than usual hence tending to increase the supply of the maple syrup since making and selling maple syrup involves lower wages. This will make the new supply curve to shift to the right indicating an increase in supply. Therefore, a change in any influence on supply, other than that caused by the price of a good, cause a shift in the supply curve known as a change in supply (Fetter). When this phenomenon makes the sellers to sell more products, the supply curve will shift to the right indicating an increase in supply while when the effect make their sales to fall, the supply curve will shift to the left indicating a decrease in supply. Some of those other variables that can cause a change in supply hence a shift in supply curve include: prices of inputs, profitability of alternative goods, technology, productivity capacity, expectations of future prices among others (Mankiw). For instance, a decrease in the price of inputs will cause the supply to increase shifting the supply curve to the right (Robert and Marc). On the contrary, a rise in the prices of inputs will cause the supply to fall shifting the supply curve to the left. When an alternative good gets more profitable to produce, because of the rise in its prices, or the cost of its production falls, the supply curve for the particular goods will shift to the left. Technological advances that lead to cost saving, increases the supply of a good hence shifting the supply to the right. An increase in sellers’ productive capacity that might be caused by weather or increased number of firms, increases supply hence shifting the supply rightwards as a decrease in the sellers’ productive level will shift the supply to the left, meaning, fall in supply. A rise in the future expected price of a good decreases the supply of the good hence shifting the supply curve to the left. In summary, we can say that any changes that raises the quantity of goods that the seller would wish to produce at a given price will shift the supply curve to the right and any changes in that reduces or lowers the sellers the amount of goods sellers are willing to produce at a given price will shift the supply curve to the left. Putting supply and demand together, an equilibrium position is attained. This is the state created by drawing the supply and the demand curves together and the point where they cross each other becomes the equilibrium point which cannot be changed unless the factors held constant change. Any change that tries to shift the supply curve to the left in a competitive market will increase the equilibrium price and reduce the equilibrium quantity and any change that shifts the demand curve rightwards increases both the equilibrium price and equilibrium quantity in the market. At the equilibrium price, the possible quantity of goods that the buyers are able to and willing to purchase, exactly balances that quantity of goods that the sellers are also willing and able to sell in a particular market In a nutshell, supply and demand models are very powerful tools in understanding all sorts of economic events that one would think of. For instance, the government often intervenes in markets, by creating price ceilings or price floors, or imposing taxes and subsidies. A surplus situation exists when the suppliers are not able to sell all they want at the going price. Therefore, this is a situation when a quantity of goods that the suppliers supply in the market becomes greater than the quantity that is demanded by the buyers in the market. On the other side, a shortage situation exists when demanders are not able to buy all they want at the going price. Therefore, a shortage situation is created when the quantity of goods demanded in the market is greater than the quantity that the suppliers are willing and able to supply in the market. Thus, the activities of the sellers and the buyers automatically act towards pushing and creating the equilibrium situation where transaction will take place in the market. Works Cited Dominick, Salvatore and A . Diulio Eugene. Outline of Theory and Problems of Principles of Economics. 2nd Edition. New York: McGRAW-Hill, 2003. Fetter, Frank A. Principles of Economics with Applications to Practical Problems. New York : The Century CO. 1905 Publishers, 2003. Mankiw, N.G. Ten Principles of Economics. 5th Edition. New York: McGRAW-Hill, 2001. Robert, E. Hall and Liebernman Marc. Economics; Principles and Applications. London: John Weilly & Sons, 2009. Stephen, F. LeRoy and Werner Jan. Principles of Financial Economics. Santa Barbara: University of California, 2000. Read More