The Law of Supply and Demand - Term Paper Example

The Law of Supply and Demand Introduction There are various topics and studies which economists have delved into in the field of microeconomics. Mofatt (2009) defines microeconomics from The Economists Dictionary of Economics as "the study of economics at the level of individual consumers, groups of consumers, or firms... The general concern of microeconomics is the efficient allocation of scarce resources between alternative uses but more specifically it involves the determination of price through the optimizing behavior of economic agents, with consumers maximizing utility and firms maximizing profit." This is basically a study of factors which affect economic decisions of individuals, households and business enterprises in specifically defined markets. In view of these, a relevant topic encompassing economics at the abovementioned level is the law of supply and demand. The factors involved in the concept surrounding supply and demand will be presented and assessed in terms of their effects on the economic market and competition. It is the objective of this essay to determine the underlying theories, concepts and practical applications of the law of supply and demand. Definition of Terms For purposes of explaining and presenting relevant concepts in relation to the law of supply and demand, it is imperative at this point to define terms which are used in this topic. As mentioned earlier, the law of supply and demand in microeconomics takes into consideration economic decisions of individuals, households and business enterprises in specifically defined markets. According to BasicEconomics (2009 par.1), “a market is defined as a group of buyers and sellers of a particular product or service. Competitive markets are markets with many buyers and sellers, so that each has a very small influence on the price. Supply and demand is the most useful model for a competitive market, and shows how buyers (citizens) and sellers (businesses) interact in that market.” The main factor that influences the law of supply and demand is the price of the product or service in consideration. Mofatt (2009) defines demand as “the want or desire to possess a good or service with the necessary goods, services, or financial instruments necessary to make a legal transaction for those goods or services.” Individuals have certain needs, want or desires which influence the demand for a product. Supply, on the other hand, is simply stated as the quantity of products or services available for sale. The law of demand is explained as follows: when prices of a certain product or service increases, all other factors or considerations in status quo, the quantity demanded of that product will decrease. On the other hand, the law of supply states that, as the price of a certain product or service increases, all other factors or considerations in status quo, the quantity of that product or service will increase – as suppliers will produce more to take advantage of earning more. From these definitions, there are constant factors which directly influence demand and supply: price and quantity – all other factors in status quo, or what is frequently referred to in latin as ceteris paribus (holding all other influences constant). Of course, it is not a realistic scenario to hold other influences constant. Therefore, aside from the price as the principal determinant of demand and supply of products, there are other relevant factors which influence these two. There are also economic models which determine the number of quantities to be sold, or produced, given a certain price. Factors that Influence Demand Economists have undertaken studies to determine other factors which influence the demand for certain products or services. These factors are known as income, price of related or competitive products, tastes and preferences, and future expectations. Income, per se, has so many definitions depending on perspectives. Webster’s New World Dictionary (327) defines income as “money, etc., received in a given period, as wages, rent, interest, etc.” Thus, for an employee, income is one’s compensation for work rendered. For a business enterprise, income is the amount that remains after deducting expenses from revenues. For a landlord, income means monthly rental. According to BasicEconomics (2009 par. 3) “as income increases, we are able to buy more of most goods. When demand for a good increases when incomes increase, we call that good a ‘normal good’. When demand for a good decreases when incomes increase, then that good is called an ‘inferior good’.” Price of related or competitive products mean the amount tagged for products of the same category as the one being offered or purchased. BasicEconomics (par. 3) presented concise and clear examples and types of this factor, to wit: “related goods come in two types, the first of which are "substitutes". Substitutes are similar products that can be used as alternatives. Examples of substitute goods are Coke/Pepsi, and butter/margarine. Usually, people substitute away to the less expensive good. Other related products are classified as "complements". Complements are products that are used in conjunction with each other. Examples of complements are pencil/eraser, left/right shoes, and coffee/sugar.” Tastes and preferences are determined by characteristics, traits, and values of the buyers. Expectations, on the other hand, are good determinants of demand because “when you expect the price of a good to go up in the future, you tend to increase your demand today. This is another example of the rule of substitution, since you are substituting away from the expected relatively more expensive future consumption.” (BasicEconomics par. 3) Factors that Influence Supply As previously defined, supply is the quantity of products or services available for sale. The major determinant of this is the cost of production. In turn, production cost is influenced by input prices, technology and future expectations. By input prices, a business entity considers raw materials, labor, and other pertinent considerations that form part of producing the product. Assuming that the prices of these inputs increase, lesser number of products would be produced using the same amount of investment. Therefore, this leads to decreases in supply. “Technology relates to methods of transforming inputs into outputs. Improvements in technology will reduce the costs of production and make sales more profitable so it tends to increase the supply.” (BasicEconomics par. 7) Finally, like in the demand side, future expectations play an important role in determining the movement of supply for goods and services. If prices for the goods they firm has manufactured is low, then the firm would tend to produce less. If it is expected that prices would increase a month from now, the firm would increase production to meet the expected increase in price and to take advantage of increase in profits. Demand and Supply Curves There are economic models which measure the effect of prices on quantities of goods produced by a business enterprise. The demand and supply curves show relationships between prices of the product and respective quantities on a graph or curve. They determine how many of the products would be produced and/or sold given a specific price. An important consideration for measuring demand and supply is to determine the equilibrium price. This is the point where the demand and supply curves intersect – the price where the quantity demanded is exactly met by the quantity supplied. When market forces are destabilized, there are situations that produce excess in demand or supply or deficiency. It is relevant to consider the implications of each to apply the appropriate action and achieve market equilibrium. Conclusion The law of demand and supply may appear simple to economists and observers of market forces. However, as mentioned, there is no such thing as ceteris paribus. Therefore, an efficient buyer or selling should always be vigilant on which specific forces are actively affecting the demand and supply of goods to assist him in his decision making. In these times of financial crisis, the prices of commodities are relevant considerations before actual purchase. Knowledge of this law in microeconomics provides a timely guide to assist decision makers in making simple but efficient transactions. Outline The Law of Supply and Demand Introduction Definition of Terms Factors that Influence Demand Factors that Influence Supply Demand and Supply Curves Conclusion Works Cited Works Cited Mofatt, Mike (2009). Definition of Demand. About.com. Retrieved on April 18, 2009 from < http://economics.about.com/cs/economicsglossary/g/demand.htm> Mofatt, Mike (2009). What is Microeconomics? About.com. Retrieved on April 18, 2009 from BasicEconomics.info. (2009). Supply and Demand. Retrieved on April 18, 2009 from Read More