Demand and Supply Analysis - Term Paper Example

Economists assume all factors are held constant (ie do not change) except one – the price of the product itself. A change in a factor being held constant invalidates the ceteris paribus assumption. (Riley, 2006) There is an income effect when the price of a good falls because the consumer can maintain current consumption for less expenditure.  Provided that the good is normal, some of the resulting increase in real income is used by consumers to buy more of this product. (Riley, 2006) There is also a substitution effect when the price of a good falls because the product is now relatively cheaper than an alternative item and so some consumers switch their spending from the good in competitive demand to this product.

(Riley, 2006) Firstly, there is a profit motive. Whether the increases in market prices (for example, after a surge in demand), it is more advantageous for companies to increase production. Signs of higher prices for companies that can increase profits by market demand. Production and cost: With increasing production, increasing production costs of a company, so a higher price is necessary to justify the additional production and cover the additional costs of production. New competitors enter the market: rising prices create an incentive for other companies to enter the market leading to increased supply.

The price where the demand and supply meet is known as equilibrium price or market price. This is the point where the buyers and sellers come together at a common point. In a market a good will always be traded at its market price as this maintains equilibrium between the supply and the demand. (Sloman, 2006) The outward shift in the demand curve causes a movement (expansion) along the supply curve and a rise in the equilibrium price and quantity.  Firms in the market will sell more at a higher price and therefore receive more in total revenue.

Similarly a backward/inward shift creates the opposite