economics

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The relationship between supply and demand

As an economic model of price determination in a market, the relationship between supply and demand is a topic being discussed for a long time. We may think of demand as a force which tends to increase the price of a good, and also that supply as a force which tends to reduce the price.

According to the microeconomics theory, the price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D).It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.

When the two forces balance one another, the result will be that the price neither rise nor fall, but stay stable. This is the analogy that leads us to think of the stable or natural price in a particular market. It is called the “equilibrium” price. As we know, iPhone now has attracted great attention and become a heated topic. Here, we take it for example: if every consumer wants and can afford an iPhone, and APPLE Company is willing to provide each of them one iPhone, the demand and supply is in “equilibrium” status.

In addition to the theory above, is there any relation among supply demand and the market? How to measure the relation? Is there anything else to measure the functions of supply and demand in market? Or they have some links when influencing the market? There are three theses concerning this topic for further discussion.

The first thesis I have chosen is <Supply/Demand Estimation Model Helps Understand Markets> written by David Huffman. The author insists that supply and demand is measurable. (Another thesis I introduce below is the opposite: <Why Supply and Demand Are Hard to Measure>) He tries to resort to retail Market Place to addresses these questions because he thinks the database of Retail Market Place can provide a direct comparison between retail sales and consumer spending by industry and it can therefore measures the gap between supply and demand. In his thesis, he holds the view that there are two ways - by supply or demand to measure activity in a retail market. The article is mainly divided into three parts to probe into this topic: Market Supply (Retail Sales); Market Demand (Retail Potential); The Leakage/Surplus Factor (Supply and Demand). One point must be emphasized is that “Leakage” in an area represents a condition where a market's supply is less than the demand. For such factors, it seems that to measure the market by using supply and demand as a tool is doable and useful.

There is another thesis <How Supply and Demand Determine Commodities Market Prices> by an anonymous author also discusses the relation of supply, demand and market. Ordinarily, there always exist different price levels where individual buyers and sellers are satisfied so that the sum total will create a market or equilibrium price. But in reality, there will be some exceptions, because a market price is not a fair price to all participants in the marketplace. Not only when there is no increase in the quantity of product demanded, but also when there is a shift in demand due to changing consumer preferences will influence the market price and reach a new equilibrium. So does the reaction to the short run or long run changes. The charts below are separately describing change in equilibrium price and shift in demand.

In most regions, iPhone is not only a cell phone but more than an apparatus of making telephone calls and writing text messages. iPhone has been a symbol of some “players”, and people distinguish their identity from using iPhone: They have a keen sense of popularity; They enjoy being a member of their circle and they like communicating with real friends or net friends; They eagerly break the tradition and desire something new… Though the price of iPhone is high enough to restrain most consumers, many people choose iPhone for proving themselves different. Such relation of supply and demand decides that iPhone occupies in the High End of the market. If the price of iPhone decreases, on one hand, it will surely attract more consumers, but on the other hand, many previous buyers will quit because iPhone is no longer “unique” and “rare”.

But in the article <Why Supply and Demand Are Hard to Measure> written by JUSTIN WOLFERS in 2009, the author argues that supply and demand are difficult to measure. At the very beginning of the article, the author raises the question of Catherine Rampell, “Does lowering the price of broadband increase its use”, which brings a research and a series of data and diagram trying to figure out the demand curve.

However, the reality is always beyond the theory only in the textbook. Sometimes to our surprise, the result is different though the source of data is the same. The author gives an example to illustrate it: a supply-obsessed economist were interested in asking “Does increasing use of broadband raise its price?” so that he might examine data on broadband prices and adoption rates. He expects to see more broadband correlated with higher prices because the supply curve is upward sloping but undoubtedly the result will be opposite for a demand-obsessed economist.

As we know, there are many types of factors taking effect. On one hand, the determinants of supply include production costs, the technology of production, the price of related goods, firm's expectations about future prices, number of suppliers, etc. On the other hand, the determinants of demand comprise income, tastes and preferences, prices of related goods and services, expectations and number of Buyers. What’s more, it is believed that factoring in of Marketing also has something to do with the curves because marketing drives demand in some way.

In a wide variety of historic and current examples, we find more and more evidence that with shifts in demand or in supply causing changes in price and quantity, we can explain changes in quantities as well as prices as the equilibrium of supply and demand. The changes in price and quantity are coordinated in many ways that can be not only understood but also predicted, at the premise that we understand the theory of supply and demand. As the topic of the article, the author thinks that the factors influencing the equilibrium are far more complicated so “Supply and Demand Are Hard to Measure”. To some extent, that is because prices and quantities are determined by both supply and demand.

The author has a new idea that nationality has influence and it indeed makes a difference. It is pointed out that prices and quantities differ across countries, which breaks the traditional theory of “If both curves were the same in every country, broadband prices and use would be the same in every country.” Some people may even argue that income skews the opportunity cost of broadband ownership.

It seems strange that iPhone sells extraordinarily well Mainland China. Maybe you will surprise that in such a developing Asian country, though a small portion of people can lead a tremendous change. It’s true, and it’s certain that China has been the greatest purchasing power only after the USA on luxury goods, let along iPhone.

Consequently, what makes supply and demand hard to measure is the reality: the world is indeed a mixture of both cases. The author owes this to an identification problem, with a bit sense of humor, which arises precisely because prices and quantities are determined by both blades of the supply and demand scissors.

The example of iPhone indeed proves that demand and supply are hard to measure. Many people bought iPhone not because they need it but for other reasons. Some bought for keeping up with the latest trend, some bought because other people recommended, some bought for showing off, and some bought for having a try… Here comes the consequence of over demand. What’s more, if the APPLE Company restricts the supply so that iPhones seem scarce to consumers, many people will squeeze and swarm forward to get simply one iPhone, even late at night before its release. Some luxury companies also promote their articles in “limited edition” and as a result supply and demand is unequal.

We can bring the same example to every day life. If we compare the price of water to the price of diamonds, there is a dramatic difference. The price of water is very cheap and we use it everyday, not only for drinking, but also for washing cars, watering plants, and for flushing the toilets. Most importantly water is crucial for our life. Diamonds on the other hand, has no significant influence to our lives other than showing off. Diamonds are for sure luxury products, but its components are simply “carbon”. If we assume that the price of water is extremely expensive, would we still use water to wash our cars or flushing the toilets? If the price of diamonds are as cheap as water, will people still ware it on their fingers or as an engagement gift? It all comes down to the theory of scarcity. Water is cheap simply because its easy to get and the world has sufficient of it, diamonds are expensive because it takes millions of years to form and its hard to find.

Generally, there is still something worth digesting after reading and some problems remain unsolved. With much doubt, some readers raised a list of questions. For instance, supply and demand curves must be linear? If supply and demand curves shift around in different geographical regions, or in different periods of time, then shall we get to assume that economic equilibrium is well-defined? Whether the author assumes the shifts occur because of how preferences are distributed or because preferences change, it seems that there’s no guarantee that exchanges are approaching an efficient allocation of resources… The three theses above have a sequence from concrete to abstract. In fact, in the marketplace, it is rarely possible for supply and demand to go the path we have designed. On one hand, supply and demand can be used to describe and measure the market, but on the other hand, for the factors are numerous, the curve is a result of price and quantity as well as a combination of demand and supply, and surely these reasons make the relationship of supply and demand hard to measure.


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