How Are Expected Future Prices in a Competitive Market Often Affected by Current Demand and Supply - Assignment Example

Name: Professor: Institution: Course: Date: Competitive Markets A competitive market refers to a market that comprise of many sellers and buyers in that no single seller or buyer can be able to influence or control the price or any other aspect. There is efficient allocation of resources in a competitive market. Efficiency in this market is attained because competition among the buyers forces them to pay the demand price while competition among the sellers forces them to price their products at a minimum supply price. The diagram below represents a typical competitive market that has attained market equilibrium (Investopedia, 2012). The demand curve is market D and the supply curve is labeled S. the price p0 is derived from interaction of demand and supply curve. This market price is highly dependent on these crucial components of markets. Exchange of commodities occurs when the sellers and buyers agree on the price. When the exchange occurs, the equilibrium price p0 and q0 .Competition among the buyers pushes the price to the maximum price on the demand curve while competition among the sellers pushes the supply price of the products and services down on the supply curve. With competition from both sellers and buyers, the price of the market is simultaneously on the supply and demand curve (Investopedia, 2012). How current demand affects future prices of goods and services in a competitive market From the diagram above, if the price goes below p0 the quantity demand will be greater than what the suppliers can supply. In this case, the customers will be anxious to buy the product or service while the suppliers will be unwilling to supply the product or service while result to a shortage of the product or services. So as to cope with the shortage, the customers will have to pay a higher price for the product or service while suppliers will demand a higher price for their product so as to make the product available in the market. The end result is prices will rise to from p2 to p1 (Parkin, Powell&Matthews ,2002). This is as illustrated below Consequently, when the prices rise to p2, the quantity demanded will fall from Q2 to Q1 and the market will be in surplus as quantity demanded will be lower than quantity supplied. Suppliers will be forced to lower the prices from p1 and back to the equilibrium. However, if the prices go below p2 to p3, the customers will be willing to buy more and hence the quantity demanded will increase from Q2 to Q3. As illustrated above, the changes in the quantity supplied and quantity of demand will affect the prices of goods in the future. If the current demand is higher than the quantity supplied, the prices of the commodity will increase in future and if the current demand for the product is lower than that the quantity supplied, the future prices of the goods will be lower as consumers will be willing to purchase more (Parkin, Powell&Matthews, 2002). How current demand affects future prices of goods and services in a competitive market The law of supply describes the quantity that is going to be sold at a particular price. The law of supply states that provide other factors remain constant, as the prices of the commodity increases, the quantity supplied will also increase. This means that there is a positive relationship between the quantity supplied and the price of a commodity. Manufactures and producers purchase resources and turn them into goods and services and therefore producers incur costs when they purchase resources. All producers or manufacturing firms are in business to make a profit and for this reason, they supply products at a price higher than the cost of production to make sure that they make a profit. Initially, the price is at the equilibrium P2. As the price of the product increases to P3, the suppliers will find it more profitable to supply it and the quantity demanded will increase from q2 to q3.This is as illustrated in the diagram below. When the price of the commodity decreases from p2 top1, the suppliers will find the commodity less profitable to produce and therefore, the quantity demanded will reduce from q2 to q1. From the analysis above, it is clear that the current price will determine the quantity that suppliers are willing to supply. If the current price is high, the suppliers will be willing to supply more. However, due to the high supply, the future prices will be pushed downwards due to excess supply (Perloff,2008). How government policy affect the future prices of goods and services Taxation Taxes refer to a compulsory payment to the government. Introduction of taxes by the government will reduce the supply and demand of the products and push the market equilibrium to a price higher than the tax it was without the tax and the quantity lower than it was without the tax. The government requires that the seller or the buyer be responsible for payment of the tax. Tax incidence refers to the way in which tax burden is shared between the buyers and the sellers. Suppose the government decides to impose tax of $1 per gallon on all the milk producers (Wall&Griffiths, 2008) . From the illustration above, originally, the price of the milk was $2 per gallon. However after a $1 tax, the supply curve shifts to the left and the consumers now have to pay $2.60 for a gallon of milk. The milk producers will receive $1.60 for each gallon after tax. Therefore, $0.60 of the tax is paid by the consumers while $ 0.40 is paid for by the milk producers. The deadweight loss due to taxation occurs since there are fewer beneficial exchanges between sellers and buyers. From the illustration above, it is clear that the taxation will affect demand and supply and consequently affect future prices (Wall&Griffiths, 2008) .. Subsidies Subsidy is another one of the government policies that affect the demand and supply of goods and hence the future prices of goods. Subsidies are seen as a negative tax. The government gives money to the producers to encourage them to supply that product. This in turn reduces the cost of production. They shift the supply curve to the right by the amount of the subsidy given. If other factors remain constant, the final price of the product will reduce. Before the subsidy, the price was at p1. After subsidies by the government, the suppliers were willing to supply more corn and the prices reduced from p1 to pe (Wall&Griffiths, 2008). Elasticity of supply Elasticity of supply is the suppliers’ responsiveness to changes in price to the quantity they are willing to supply. The major determinant of the degree of elasticity is the amount of time that it takes to produce a commodity. If the suppliers respond to changes rapidly the supply is relatively elastic and if it takes the supplier a considerable long time to supply the commodities, then supply is relatively inelastic. Take an example of wine and corn tortillas. Corn tortillas are easier to manufacture and its raw materials are easily available. If the price of corn tortilla was to increase, the suppliers would not experience any problem meeting the increased supply need. However, if the wine price increases, then the wine makers would have a difficulty responding to this change as vines take a long time to ripen. Therefore, the more elastic commodity is, the more the likelihood of price increases (Investopedia, 2012). Elasticity of demand This refers to the degree of responsiveness of quantity demanded as a result of changes in prices. If a change in prices causes a relatively big change in quantity demanded, then the commodity is said to be relative elastic while if changes in the price of a commodity causes a small change in the quantity demanded, the commodity is said to be relatively inelastic. For the products which are relatively elastic, the future prices are not likely to change much while those commodities which are relatively inelastic, the future prices are likely to change (Investopedia, 2012). Price of substitute goods In relation to demand, Substitute commodity is a commodity that gives the same need or want as another product. While in relation to supply, substitute goods refer to commodities that use similar resources for production. Each and every day, consumers are faced with the decision to buy one commodity or another. Each commodity serves the same basic function and therefore the customers have to purchase one of them but not both. Take an example of the need for food, a consumer may decide to take fried chicken or pizza. The need for transportation can be met by using a motorcycle or using a vehicle. A change in the price of a substitute good will obviously affect the demand of a product and cause a shift in the demand curve. An increase in the price of a substitute good will result to an increase in demand of a product as consumers move shift from the substitute goods to your product. On the other hand, if the prices of the substitute goods decrease, the demand of a product will go down as the consumer shift to the substitute goods(Wall&Griffiths, 2008) . This is as illustrated below. References Investopedia, (2012) Economics Basics: Demand and Supply Retrieved on 23rd May 2012 from http://www.investopedia.com/university/economics/economics3.asp#axzz1vg6Jfy9u Parkin M, Powell M, Matthews K (2002). Economics, Harlow: Addison-Wesley. Perloff J (2008). Microeconomics Theory & Applications with Calculus.Pearson. Wall S, Griffiths A (2008). Economics for Business and Management, Financial Times Prentice Hall. Read More