Supply, Demand, and Price Equilibrium - Coursework Example

Contents Introduction 2 Law of Demand 2 Law of Supply 3 Equilibrium between Supply, Demand & Price 4 A contemporary example of Supply Demand Theory 5 References 8 Introduction The supply demand theory is one of the basic concepts in economics. It is the fundamental theory which rules the market performance of any product or service. This theory has wide applications spread across the field of physics; mathematics and microeconomics (Nien, 2006). Demand refers to the quantum of a product or service desired by the consumers. On the other hand supply refers to the quantum of the product or service that the market can offer. (Investopedia, 2008). There are two theories allied with supply and demand. The relationship between these factors determines the planning process involved in the economic scenario. These relative forces determine the quantum of resource allocation in an economic environment. Law of Demand Law of demand states that price is inversely proportional to demand in an economic environment, irrespective of other factors (Nair &, 2006, C.N 1). In other terms when the price of a particular product is high, the demand for the same product decreases. The following graph represents the relationship between price and demand. The downward slope clearly indicates that the demand decreases with increase in price. In a larger context this theory has larger importance in the economic scenario of a nation. The scenario in which the price increases in a national count relates to the term inflation. The rate at which prices rise which is called inflation is a tool of macroeconomic analysis of a nation. (Moffatt, M 2008). This ratio is often calculated through Consumer Price Index and GDP deflator. (Barnes, R 2008). This measurement tool itself confirms the relation of price with demand. (Source : Investopedia, 2008) Law of Supply This theory states that the higher the price of the product, the higher would be the supply (Ashwatappa, 2004).This theory on the other side explains that when the supply decreases the demand falls. This relationship is described by the graph below. When the price of a particular product is on hype irrespective of other factors, this would mean that the producer is able to manage profitability in all realms of the particular business, right from sourcing to the sale to its end producer. This automatically prompts the continued production and thus the supply of the produce. In this context it becomes quite evident that when the price increases supply also increases accordingly. It is this market theory that that basically plays as the determinant in the dominance that a particular product makes in the market. Thus in the context of this theory, the reason for a product still making ample supply in the market despite its premium price becomes very clear. (Source : Investopedia, 2008) Equilibrium between Supply, Demand & Price The interaction between the Law of Demand and the Law of Supply and their correlation with the price becomes quite vital in regulating an optimal economic environment. While analyzing an economic scenario, an equilibrium point between all these four factors is necessary. It is at this equilibrium point, the optimum level of price, supply and demand occurs. This point is important as it determines an ideal quantum of supply of a product at an optimal price so that it fetches optimal demand. On practical grounds, this theory becomes of much importance, as it serves as a determinant in planning a business. In simple worlds, this point would mean an optimum price at which the supply and demand also stays optimum. If the price goes up the supply would obviously go up but this would have a negative impact on the demand. Taking a vice versa situation in which the price is lower than the equilibrium point, the demand may increase but the supply would go down. The market effectiveness of any product would be determined by the fact that the supply is maintained truly according to the demand. This supply-demand balance should also ensure an optimal price for the product. Thus it is important to maintain the equilibrium point between supply, demand and price so that the growth rate is sustainable. (Source : Investopedia, 2008) A contemporary example of Supply Demand Theory A contemporary example that can be used to explain the discussed theory is the credit crunch in the UK housing industry. The International Monetary Fund has described this credit crunch crisis as the largest financial shock since the Great Depression (Sreward H, 2008). The lack of availability of funds has caused serious effects in the housing market in the United Kingdom. The post recessive period observed critical economic outcomes in the housing industry of United Kingdom. In comparison with the previous year, the house prices were 7.4 percent lower in October 2008. (DCLG, 2008). The prices fell 2.2 percent in December 2008. (Alberichi E, 2009). British Land and Land Securities, which are UK’s biggest, listed real estate investment firms, traded 4.7 percent and 3.7 percent lower respectively on that particular day (Reuters, 2009). These all statistics confirm that there had been fall in the prices of houses. In this context the demand is the desire of people to purchase houses. The supply is the availability of houses in UK’s real estate market. The correlation between price and the quantum of goods or service supply to the market is known as the supply relationship (Investopedia, 2008). This relationship makes price the reflection of supply and demand. In the market scenario of UK real estate, this relationship is quite evident. The impact on the price of the properties was the combined effect of the demand for the houses and the market supply. There are a number of channels through which the reduction in house prices affect the demand. One among them is the effects of the price reduction on the house hold. It makes a feel to the consumers that they are less wealthy and subsequently they consume less. (Cameron G, 2005). The demand is highly dependent on the disposable income of the buyers which is the actual disposable money which the customers can afford to spend and invest in the market after paying taxes. (Barnes, R 2008). This income was generated by the consumers of UK’s housing market mainly through credit sourcing. When the availability of credit was highly restricted in the recession period, the spending capacity of the consumers reduced abruptly. This literally meant that the demand for the houses went low. The law of Demand states that when all the other factors in the market remain constant, the price of the product would be inversely proportional to the demand. On the other hand, the law of supply states that when the price is high the supply would be proportionally high. An interaction of the Supply Demand theory can be very well observed in the case of the housing market of the United Kingdom. The credit crunch has caused the demand for real estate properties to shrink. The reduction in price is here however affected by complex relationships of other factors. This would cause the reduction in supply, which in this context is literally the growth of real estate industry. In general it is considered that the national production is highly affected by the demand for the products and services. So would be the dependence of the growth of the real estate industry on the market demand. The sources of demand can be the direct consumers, the government in terms of its spending capacity and also international trade and economic relations. However demand can cause a market performance impact with reference to the quantum of disposable income of the people. This indicator very much depends on the salary or the income the citizens of the nation receive. However disposable income is directly related with other economic indicators and so is other indicators interlinked with each other. As the credit flow almost stopped as a result of the crisis the quantum of the disposable income available with the people reduced to a considerable extend. It is quite obvious that thus the spending capacity of the people would reduce causing a huge gap in the demand. Supply would directly depend on the market demand and the price. In the case of real estate, supply would refer to the availability of more housing properties for sale in the market. With reference to the lower demand caused by the crisis, the supply in the real estate market, which literally means its growth, would be hindered to a considerable extent. References Alberichi E, 2009, Credit Crunch Hits UK House Market, ABC News, viewed 6 March, 2009, http://www.abc.net.au/news/stories/2009/01/03/2458477.htm Ashwatappa, K. Basic economic theories, Tata McGraw-Hill: NewDelhi, 2004 Barnes, R 2008, Economic Indicators: Overview, Investopedia, viewed 08 January, 2009< http://www.investopedia.com/university/releases/> Cameron G, 2005, The UK Housing Market : Economic Review, Department of Economics, University of Oxford, viewed 6 March, 2009,, < http://hicks.nuff.ox.ac.uk/users/cameron/papers/ukhousingmarket.pdf Department for Communities and Local Government, 2009, £18 million deal approved to buy further new homes for affordable housing, Department for Communities and Local Government viewed 6 March, 2009,, http://www.communities.gov.uk/news/corporate/1113423 Investopedia, 2008, Economics Basics: Demand and Supply, Investopedia, viewed 6 March, 2009,, Sreward H, 2008, “IMF says US crisis is largest financial shock since Great Depression, The Guardian, viewed 6 March, 2009, economics3.asp Read More