Marshallian Demand and Supply Theory - Assignment Example

 Marshallian Demand and Supply Theory Alfred Marshall was one of the pioneers of economics and much of the present day economic principles have their basis in his ideas and thoughts. It is important here to note that the Marshallian’s theory enabled economics models to come on to the scene in terms of diagrammatic versions. However, under this model, “Alfred Marshall took the price on the vertical axis and quantity demanded on the horizontal axis” (Rittenberg, pp. 469-478, 2008). Marshallian model of supply and demand tries to present those choices that the customers would make in each price and wealth situation. Very much similar to the modern supply and demand functions, it shows the choices of the customer in terms on his demand over a range of prices. Moreover, in the case of supply, it would show the quantity supplied, for a range of prices. Quite understandably, over demand would increase as the prices keeps on increasing since these share a negative relation with each other. However, supply, on the other hand, would have a positive relation with the price; therefore, the supply curve would be an upward or positively sloped curve (Taylor & Weerapana, pp. 126-128, 2007). Moreover, there are two very important assumptions for the Marshallian model as well. Firstly, that the supply and demand, is in no way, interdependent but act freely. Secondly, that supply is limited and finite, and the basic principle of economics must hold true that there are scare resources (Henderson, pp. 124-128, 2009). In addition, this model perfectly solves the utility maximization problem as well. Since consumers get a range of choices, sets of prices and the quantity supplied and demanded on them, they can choose the set, which satisfies them the most (Pindyck & Rubinfeld, pp. 148-149, 2001). Unlike, the Hicksian model, Marshallian model of supply and demand also accommodates the income and substitution effects. In the study of microeconomics, the Hicksain model is referred as the compensated demand function since its idea rests on fixed utility. However, the Marshallian model of supply and demand has received the name of uncompensated demand function, since, as mentioned earlier, that it offers the option of utility maximization (Rittenberg, pp. 469-478, 2008). Importance of Demand Elasticity to Management Quite clearly, the laws of demand and supply are helpful in predicting the direction of changes in price and quantity, whether it would increase or decrease, in response to various shifts in demand and supply. However, for organizations, entrepreneurs and managers, it is not enough to know that whether the prices will fall or rise and whether they would witness an increase or decrease in the quantity demand. It is also important to have an ample knowledge of “how much” this change would be (Adil, pp. 359-367, 2006). Consider this case. Tsunami caused much destruction to the coastal areas of India in the year 2004. Statistics show that most of the people affected lived on agriculture. However, the tsunami caused enough destruction to wash away all the crops. This caused immense shortage of wheat, sugarcane, and rice in the markets of coastal areas. The people who were able to save their crops, quite understandably, were selling it for higher prices. People either decreased or altogether stopped consuming these crops. Government needed to respond quickly by providing relief to these people. It is clear that their buying power had decreased and the government had to provide them with these food crops on decreased prices. However, the fundamental question was of “how much” price decrease was needed here to match the buying power? Moreover, the question was regarding “how much” of crops were needed in those areas (Baumol & Blinder, pp. 69-74, 2008). Quite clearly, while studying the changes in price and quantity demanded, it becomes crucial to determine to extent of change and responsiveness of quantity demanded to price and vice versa. This above-mentioned concept is elasticity (Krugman, Wells & Kelly, pp. 32-35, 2008). The graphs presented above are two types of forms of elasticity of demand. The first one on the left is an example of relatively inelastic demand. However, the one of the left demonstrates highly elastic demand. Let us first discuss the latter. Quite understandably, highly elastic demand refers the fact that demand is highly responsive to any minor changes in price. Even a slight cut in price would be able to attract huge number of buyers; however, a slight increase would make the seller lose many customers too. Usually many substitutes are available for these products. Moreover, the buyer has the power to delay the purchase of that product. In addition, the product is not one of the basic needs for the buyer (Pindyck & Rubinfeld, pp. 148-149, 2001). Given all these conditions, these types of product would have an extremely elastic demand curve. Consider the prices of chips, sweets, mayonnaise, soft drinks, shampoos, and other products with many competitors. If the price of any of these products rises, people would go for the substitutes, other brands, or other products. For example, if the price of Pepsi increases, people would look for Coke. Even if the price of all the soft drinks increase then people are likely to look for water, juices, and other drinks to satisfy their thirst. Moreover, if a buyer were not able to purchase these products, quite clearly, it would not make a huge difference in his life (Pindyck & Rubinfeld, pp. 148-149, 2001). On the other hand, there are products whose purchase cannot be delayed. Life saving drugs, food, electricity, fuel, milk, diapers, antibiotics and others; these products do not have much substitutes available and even if the price rises, they buyer have no choice but to meet that price and buy it (Rittenberg, pp. 469-478, 2008). As shown in the graph on the left, a decrease in price fails to increase the number of buyers by a great amount. If the price of antibiotics or milk decreases by 50 percent, unlike sale of clothing, people would not stand in queue for buying it. They would only buy it when needed (Adil, pp. 359-367, 2006). Therefore, it is imperative for the managers to determine that whether their product is has an elastic demand or an inelastic demand. In case of the former, managers can try price cuts, sales, competitive strategies and cost leadership to attract new customers. However, it would be a disaster to try cost leadership strategies for products having an inelastic demand. Nevertheless, for products that have inelastic demand, managers may try differentiation strategies, trying to position their product as “much more for a little more” proposition. People do not look at price that closely while buying life saving drugs. However, they are more considered about the product performance and effectiveness (Krugman, Wells & Kelly, pp. 32-35, 2008). Relationship between Price and Quantity Demanded One of the most basic theories and concepts of microeconomics tells us that price and quantity share an inversely proportional relationship. Since the demand curve is negatively sloped, any increase in price would decrease quantity demanded. It is common sense that people decrease their consumptions when they find out that they will have to pay more. However, this theory or law of Alfred Marshall, one of the greatest economists of all time, has been challenged at several levels considering the behaviors of Giffen goods, conspicuous consumption goods, and goods that have perfectly inelastic demand (Krugman, Wells & Kelly, pp. 32-35, 2008). It was in the nineteenth century that Sir Robert Giffen came onto the scene as the first person to refute this law of demand. He observed that when wheat was imported on higher prices for bread, which was sold on higher prices, the people of Britain, working class specifically, increased their consumption of bread. However, there are three pre-requisites to Giffen goods; firstly, the good should be extreme inferior good (Mankiw, pp. 55-59, 1998). Secondly, the total consumption of that good must be taking a considerable portion of household expenses. Thirdly and lastly, there should be any close substitutes for the same. What really happened is that when the English people realized that they would no more be having their bread, they decided to decrease the consumption of other food items like meat and others. Those people realized that even with that increase in price, break remained the only inferior good that they could consume as much as they wanted (Forgang & Einolf, pp. 378-379, 2006). The second case is of conspicuous consumption goods as identified by Thortein Veblen. He identified that people do not consume some products for their intrinsic qualities but due to the fact that they appeared as status symbol to them. Therefore, as the price of that rises, the ability of the product to appear as a better status symbol also rises (Krugman, Wells & Kelly, pp. 32-35, 2008). Expensive diamonds are an example for the same. Rich people buy expensive diamonds because it is a status symbol for them, however, a serious decrease in the price would force the previous customers to stop their purchase of diamonds since it would no longer remain a status symbol. Rolex, BMW, Mercedes are some other examples of the same (Adil, pp. 359-367, 2006). One may also argue here that if the prices of these products witness are huge decline then may lower income class customers would jump onto the scene to purchase these products. Then again, it is important here to note that these lower income class people only want these products because they see the rich people using these products. Quite understandably, the top classes are the trendsetters. Once the stop using a product, eventually, the lower class consumers would also follow their footsteps (Forgang & Einolf, pp. 378-379, 2006). Lastly, there are certain products, which have a perfectly inelastic curve, at least in theory. An example could be of gasoline in 1980s. When much of European and American population were going for the purchase of automobiles, they realized that they just cannot leave their cars due to the risking gasoline prices and they kept on purchasing gasoline. For increase in prices, there was no decrease in the quantity demanded (Taylor & Weerapana, pp. 126-128, 2007). References Adil, Janeen R. 2006. Supply and Demand. Capstone Press. Baumol, William J., & Blinder, Alan S. 2008. Microeconomics: Principles and Policy. Cengage Learning. Forgang, William G., & Einolf, Karl W. 2006. Management economics: an accelerated approach. M.E. Sharpe. Henderson, Hubert D. 2009. Supply and Demand. BiblioBazaar, LLC. Krugman, Paul, Wells, Robin, & Kelly, Elizabeth. 2008. Microeconomics. Worth Publishers. Mankiw, N. Gregory. 1998. Microeconomics. Elsevier. Pindyck, Robert S., & Rubinfeld, Daniel L. 2001. Microeconomics. Prentice Hall. Rittenberg, Libby. 2008. Principles of Microeconomics. Flat World Knowledge. Taylor, John B., & Weerapana, Akila. 2007. Principles of Microeconomics. Cengage Learning. Read More