The Law of Supply and Demand as Big Principles of Economics - Term Paper Example

Supply and Demand Introduction Supply and demand are two of the most important and fundamental principles of economics. Supply is the terminology that defines the quantity of goods and services that producers and manufacturers are willing to avail to the market. Demand on the other hand defines the willingness of buyers to purchase a commodity in the market at a certain price. Price, therefore, can be termed as one of the key factors that determine the supply or demand for commodities in the market (Fisher 22). This is due to the fact that the sole intention of suppliers is to make maximum profit while that of consumers is to acquire items, which they can afford. In order to maximize profit, suppliers have to sell their goods and services at high prices but this has to consider the purchasing power of the intended market. This paper is a critical evaluation of supply and demand as principles of economics. Concepts of Supply and Demand The Law of Demand The law of demand states that the higher the price of a commodity, the lower the quantity demanded cateris paribus, while the lower the prices the higher the demand (Fisher 36). Cateris paribus in this case implies that all other factors that influence demand are held at a constant. These are for example weather, taste and preferences, income among others. This is due to the fact that the law of demand is basically dependent on two variables i.e. quantity demanded and price. The following diagram is a demand curve, which is a graphical depiction of the law of demand. Fig 1 From the diagram, it can be noted that the quantity demanded was highest, (Q3), at the lowest price, P1, while it was lowest at price P3, which was highest. However, it is important to note that not all goods abide by the law of demand. These are for example giffen goods and products that act as status symbols. Giffen goods are defined as inferior commodities whose demand goes up with rising prices while the vice versa is also true (Baye 42). Inferior, in this context, does not necessarily imply that the goods are of poor quality. For example, if the staple food in a family is rice, products such as meat may be perceived as superior. If the price of rice goes up, it would be normal to find people buying more rice and less of meat and when the prices go down, more meat is bought in comparison to rice. The two goods are not substitutes and in this case, it is assumed that the consumer can afford both items therefore eliminating opportunity cost. On the other hand, status symbols are goods whose value creates a perceivable higher social standing in the society (Gorman 29). For example, if the price of a Mercedes Benz makes it unaffordable for the common market as opposed to that of a Toyota sedan, then, any person owning a Mercedes would be perceived as having an economic advantage over the owner of a sedan. It therefore goes without saying that a reduction in the price of a Mercedes would make it lose its value as a status symbol and that would definitely make it lose its demand to other more expensive and luxurious vehicles. On the other hand, an increase in its price would increase its value as a status symbol thus increasing its demand thereby defying the law of demand. Movements along a Demand Curve versus Shifts in Demand Curve A movement along a demand curve is dependent on one variable only which is price. From the diagram below, DD1and DD2 represents the demand for a commodity, with prices plotted on the Y axis while quantity demanded on the X axis. DD1 will be used to illustrate movement along a demand curve while DD2 illustrates a shift in a demand curve. Fig. 2 On the DD1 curve, it is notable that when the price was at p1, the quantity demanded was highest at Q3. However, after the prices increased to p2 and p3, the quantity demanded moved to the lower side i.e. from Q3 to Q2 and Q1 respectively. However, the demand curve shifted entirely to the right as a result of an increase in income. Notice that prices p1 to p3 remained static but still, the quantity demanded increased to Q4 at p1 and more than Q2 at p3. An increase in income means that the buyers have more purchasing power and hence can afford to buy more of the commodity at the prevailing market prices. Other factors which may contribute to shifts in a demand curve include and not limited to; changes in fashion, future expectations, population increase or decrease among others (Nayak 37). Law of Supply The law of supply states that the higher the prices the higher the supply cateris paribus and the lower the prices, the lower the quantity of goods the suppliers will be willing to avail to the market (Fisher 63). If, for example, the market price of milk goes up considerably, more new farmers would become interested in dairy farming while the already established ones would acquire more cows to increase milk production, so as to maximize profits. On the other hand, a fall in milk prices would demoralize dairy farmers resulting to some of them abandoning the activity in favor of other more profitable economic activities. Fig 2 illustrates the law of supply for normal goods. From the diagram, it is notable that when the price was lowest at p1, the quantity supplied was the lowest at Q1. As the market prices increased to p2 and p3, the quantity also increased to Q2 and Q3 respectively. As in the case of demand curves, a change in price causes a movement along the supply curve while other factors result to shifts in supply curves. Fig 2 Shifts in a Supply Curve There are various factors which contribute to shifting in supply curves. These are for example, government policies. The government plays a key role in creating an enabling environment for producers and manufacturers to engage in business. One way it does so is through taxation and providing subsidies. High taxation tends to limit the amount of profits as well as increasing the cost of production (Nayak 56). High taxation, for example, on farm implements and inputs such as fertilizer and machinery makes it difficult for poor farmers to engage in large scale production. In some cases, such farmers may opt to plant without applying fertilizers thus lowering the output. On the other hand, subsidizing such inputs and equipment lowers the cost of production thus making it possible to produce more at a cheaper cost. Similarly, a shift in supply curve may occur as a result of speculation (Baye 100). In this context, producers may be prompted to shift from one area of specialization to another in anticipation that his new line of production will be more profitable after a certain period of time or his current products will lose value after some time. Other factors include and not limited to; advancement in technology, natural disasters and availability of suppliers meaning that if few persons are willing to supply a commodity to the market, then the market will suffer a shock (Nayak 91). The following diagram illustrates a positive shift in a supply curve for a normal good. Fig 3 Conclusion Supply and demand are two of the most important terminologies in economics. Supply refers to the amount of goods and services that producers avail to the market. Demand refers to the ability and willingness of buyers to purchase goods and services available in the market. The law of demand states that the lower the price of a commodity the higher the demand cateris paribus. However, inferior goods and status symbols defy this law as an increase or decrease in their demand is highly dependent on factors other than price. The law of supply maintains that as market prices continue to increase, suppliers are motivated to avail more of the goods to the market as long as all other factors remain the same. Works Cited Baye, Michael. Managerial Economics and Business Strategy. Irwin Professional Publishing, 2004. Print Fisher, Byron. The Supply and Demand Paradox: A Treatise on Economics Book. Surge Publishing, 2007. Print Gorman, Tom. The Complete Idiot's Guide to Economics. Ace Books, 2003.Print Nayak, Sudha. Engineering Economics & Financial Accounting. S. Chand Group, 2005. Print Read More