Demand and Supply in Microeconomic Theory - Assignment Example

Demand and Supply al Affiliation Demand and Supply In a market economy, producers make production decisions and consumersmake plans of consumption based on the changes in the market. The invisible hand, as described by economics, describes the interaction of these individuals in the commodity market and the impact of their decisions in the market and the economy as whole. In this perspective, the interaction of consumers and manufacturer (suppliers) in the chewing gum market determines the quality and quantity of chewing gum produced and price charged for each product. The price system works in the chewing gum market because there is a free choice within the economy market. Through the interaction of these parties in chewing gum market, a consensus price level is achieved, which describe price floor for producers and price ceiling for consumers. This price is known as equilibrium price, which indicate the highest price that consumers are willing to pay for quantity of goods (Ferguson & Gould, 2005, p. 146). It also describes the lowest price that producers are willing to offer their goods to be purchased in the market. Question A Determination of the equilibrium point is imperative because it is a point where buyers and sellers of chewing gum are both happy with the price and quantity of chewing gum (Mas-Colell, et.al 2007, p. 131). An equilibrium price and quantity is found where the supply of and demand for chewing gum are equal. In other words, the interdependent relationship between the demand and supply of chewing gum of buyers and sellers creates a theoretical equilibrium point that describes the average market price and volume of chewing gum relative to that price. Given the demand and supply schedule below, equilibrium price and quantity can be obtain by drawing demand and supply curve on a Cartesian plane. Price Pence Per pack Quantity Demanded (millions of packs A week) Quantity supplied (millions of packs A week) 20 180 60 30 160 80 40 140 100 50 120 120 60 100 140 70 80 160 80 60 180 Figure 1.1 Demand and Supply curve Since the demand curve shows a negative slope and supply curve has a positive slope, then there will be a tip where the two curves inadvertently cross over each other on the supply / demand chart for chewing gums. The market for chewing gums is always in constant influx as the supplies and varying influences and forces affect demands of chewing gums. In fact, the point of intersection between the demand and supply curve from the market equilibrium. Changes in price result in differences between quantity supplied and quantity demanded thereby generating surplus and shortages (Henderson, 2012, p. 90). Equilibrium = supply = demand In the chewing gum market, the equilibrium price and quantity are 50p and 120 quantities of chewing gum respectively. This price represents the value of the product suppliers and producers are willing to accept in exchange of chewing gum. conversely, the value of the product describe the quantity of chewing gum that consumers are willing to buy and the highest amount of chewing gums that producers are willing and able to supply in the market (Layard & Walters, 2008, p. 90). Above or below the equilibrium point creates disequilibrium in the chewing gum market. Question B If the price of chewing gum changes to 70p a pack, the market will not be at equilibrium since this price is higher than the equilibrium price. In this perspective, the price is higher than what consumers are willing to place on chewing gums. Since demand curve have a negative slope, increase in price of chewing gum reduces the amount of income that consumer set aside to buy chewing gums. This change in purchasing power of consumers result in decline in amount of chewing gum demanded. The slope of supply curve is positive meaning that increase in price of chewing gum result in increase in value of benefits that the supplier obtains. In this perspective, suppliers will increase the quantity of chewing gums supplier thereby leading to surplus. Disequilibrium in chewing gum market will be experienced due to excess supply and decline in demand of chewing gums (Kreps, 2010, p. 64). Figure 1.2 Graphical representation of increase in price of chewing gums The disequilibrium in the market for chewing gum is not expected to stay for a long time before the equilibrium is established. In this perspective, for equilibrium to be attained in this kind of situation, prices have to go down from 70p to 50p in order to make it affordable to consumers. However, there is no direct and immediate response between the supply and demand of chewing gum in the market. Delays and indirect response are caused by lag involved in consumption and production time. It may be difficult to attain equilibrium between supply and demand level and consensus price may be difficult to reach (Ferguson & Gould, 2005, p. 290). The simple economic rules that attempt to explain the relationship between prices and demand and supply are not only factual but also lack enough grounds to authenticate the rationale behind the movement. The cobweb model is an economic principle that best explain the movement and relationship of the price of products and the demand and supply level. The cobweb model attempts to explain the movement of the price of chewing gum from 70p to 50p by taking into account time lag when making its predictions on the equilibrium price and quantity. This model demonstrates that the excess supply and high price of chewing gum will exist for a longer time before the price changes gradually to the equilibrium level. Below diagram exemplifies the movement toward the equilibrium levels as demonstrated in cobweb model. Figure 1.3: Cobweb Model Question C The destruction of gum producing factories may have economic effects in the market for chewing gums. To this end, the production of chewing gum decreases, thereby limiting the amount of chewing gums supplied in the market. The demand for chewing gum remains constant while the supply decline by 40 million packs a week thereby creating disequilibrium in the market. Disequilibrium occurs since there is excess demand for chewing gum since the supply decline by 40 million. In addition, the destruction may create inefficiency in the market since the market has not sufficiently met the demands in the market, thereby increasing the demand for other substitute products such as sweets. In addition, the demand for complementary products decreases. Scarcity influences the price of available chewing gums thereby causing further inefficiency and disequilibrium Changes in the supply of chewing gum result in supply to shift accordingly. The supply shift means less or more of chewing gums being available to meet a given demand, thereby affecting the equilibrium price and quantity by shifting the supply curve downwards or upwards. In this perspective, the decline in supply of chewing gum caused by fire leads to the downward shift of the supply curve. This means that there will be less chewing gum available in the market to meet the competing demand. A shift therefore means that the equilibrium point will be determined each week since the decline is consistent and therefore will have to operate without 40 million packs of chewing gum in a week (Mas-Colell, et.al 2007, p. 189). The equilibrium price and quantity will therefore be determined each week. Excess demand of chewing gum influences its price in the market. The law of supply suggests that as the supply decreases the price increases. Price changes cause movement along the supply curve. However, movement along the supply curve will occur after the supply for chewing gums shifts thereby decreasing the supply. Movement along the supply curve generally shows the change of prices because of changes in quantity supplied (Henderson, 2012, p. 189). The destruction of gum factories affected only the amount of chewing gums supplied in the market, ceteris paribus. In this perspective, the demand for chewing gum is not affected since there is no correlation between factory fire and chewing gum’s consumers (Adler & Huffman, 2009, p. 41). Decline in the quantity of chewing gum supplied in the market creates scarcity, which affects prices. Changes of price in the market cause movement along the demand curve. The movement is inconsistent with the law of demand. The law of demand states that as the price of the commodity changes, the willingness and the ability of consumers to purchase this commodity changes but inversely. Decline in the supply of chewing gum causes its price to increase, thereby causing downward movement along the demand curve. In the long run, changes in the quantity of chewing gum in the market cause consumers to adjust to these changes. In retrospect, there is less chewing gum available for consumers to purchase. This causes a shift of demand curve, thereby leading to the generation of a new equilibrium point (Lopez, & Ubide, 2006, p. 51). The equilibrium price and quantity will also be determined after every week. Below is an inverse demand function that exemplifies the position of equilibrium that exists between demand and supply. Figure 1.4 Inverse demand curve showing shift of the supply curve and movement in the demand curve. The initial equilibrium point is given by the point E1 whereby the equilibrium price and quantity is 50p and 120 million of chewing gum respectively. Fire destruction reduces the quantity of chewing gum supplied. The change in the quantity of chewing gum leads to supply curve shifting from supply1 and supply2. This therefore caused excess demand as represented in figure 1.4. Question d Other exogenous factors affect the demand and supply of chewing gum causing either movement and/or shift in the two curves. An increase in the population of the teenage population has an economic effect of increasing the demands of chewing gum in the market. This is because these demographics are major consumers of chewing gums and therefore population increase can be translated to increase of the demands. As the law of demand suggests, when the demand for chewing gum increases, automatically price mounts. Fire in the production of chewing gum as well reduces the supply. Increase in demand and decline of supply of chewing gums causes disequilibrium and competition in the market (Lopez, & Ubide, 2006, p. 142). Competition emerges as individuals strive to obtain scarce commodity. In retrospect, the change in the supply of chewing gum due to fire in the production initially causes a shift to supply curve. It is therefore depicted as a leftward shift of the supply curve. Leftward shift of supply curve shows a decrease in the supply meaning that producers are going to sell less chewing gum at each possible price. The shift alters the market price of the product since producers will set a higher price in order to take advantage of the growing and increasing demands. Movement along the supply curve could have resulted due to change in the value of chewing gum. In this perspective, in the long run shift of supply curve can cause the price of chewing gum to increase, thereby causing movement along the supply curve to set the price at higher value. Population change is a non-price determinant of demand. All non-price determinants cause either the demand curve to shift upward or downward trend depending on the direction and the movement of these factors (Adler & Huffman, 2009, p. 78). An increase in the population of teenagers causes an increase in demand, which is depicted as a rightward shift of the demand curve. In fact, the increase in demand generally means that consumers will purchase more chewing gum at each possible price. Population will therefore lead to shift of the demand curve. Change in the demand curve also result in new equilibrium point. The multiple changes in the chewing gum market increase disequilibrium and inefficiency. Disequilibrium is generated because consumer purchasing power decline because of increase in the price of purchasing chewing gum. Chewing gums available are less than the quantity demand therefore creating artificial scarcity. According to intuitive theory, scarcity is imperative to the willingness to pay which causes an increase in the market value of the product. Efficiency on the other hand occurs because the production systems available are not operating at optimal point to meet the local demands of the product (Kreps, 2010, p. 110). In this perspective, the imbalance occurs, leading to increase in demand of substitute products. Below is a graphical representation of an inverse demand curve demonstrating the multiple effects of the two factors. Figure 1.5 Graphical representation of inverse demand function Increase in population of teenagers and fire in the production line causes the equilibrium to shift from point E1 to E2. The quantity supplied decreases and demand increases. This movement in the market creates a gap that represents ‘excess demand’. In fact, point b represents an excess demand by later consumers while point a is demand increase resulted to increase in teenage population. The price shifts from 50p to 80p. Demand and supply of chewing gum are affected by both the exogenous or non-price determinants and price determinants. These factors create either movement along or shift of the demand/supply curves. Furthermore, the interaction of demand and supply result in equilibrium price and quantity, which dictate the market value of chewing gum and quantity supplied at a given value. References Adler, D. A., & Huffman, T. (2009). Prices go up, prices go down: The laws of supply and demand. New York: F. Watts. Ferguson, C. E., & Gould, J. P. (2005). Microeconomic theory. Homewood, Ill: R.D. Irwin. Henderson, H. D. (2012). Supply and demand. New York: Harcourt, Brace. Jehle, G. A., & Reny, P. J. (2013). Advanced microeconomic theory. Boston: Addison-Wesley. Kreps, D. M. (2010). A course in microeconomic theory. Princeton, N.J: Princeton University Press. Layard, R., & Walters, A. A. (2008). Microeconomic theory. New York: McGraw-Hill. Lopez, J. H., & Ubide, A. J. (2006). Demand, supply. Florence: European University Institute. Mas-Colell, A., Whinston, M. D., & Green, J. R. (2007). Microeconomic theory. New York: Oxford University Press. Read More