The invisible hand and economic progress



During the global economic recession, every industry has been undergoing slump in its revenue or output at a different level. This economic crisis has also affected the market system in a negative way; the role of supply and demand seems out of balance. As a consequence, if the consumer's income level falls, people will begin to refuse to purchase things they do not need in order to save money, making a phenomenon in which the quantity supplied is greater than the quantity demanded. In other words, the problem of overcapacity and lack of effective demand will occur as a result of this crisis. In this situation, most factories will be forced to sharply cut back their production as a business decision, which will inevitably lead an enormous waste of production. Consequently, the rate of unemployment increases, and the majority of companies have to close down with their heavy debt.

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From an economic perspective, the concept of supply and demand is an essential and useful tool for managerial decision-making. A business organization, prior to make a business decision, in order to get optimization point and prevent profit loss from overcapacity, needs to fully understand the market system it operates in, for example, how much of its product need to be produced and supply to match up with the demand and decide how much of its product to produce. As Harvey (2007 p45 ) states, "an enterprise's business strategy defines measurements for total output by first judging demand for its product, and then allocating its limited supply of resources to maximize production levels and increase its profitability". This is simple principle of supply and demand. The question of how do principle of supply and demand work in organization will be analyzed.

The aim of this paper is focused on the question of how do the supply and demand affects the business decision making. This paper has been divided into several parts to draw this question. Initially, the theory of supply and demand will be explained with some examples. Additionally, through diverse respects from invisible hand, mixed economic and economic power to evaluate how supply and demand interacts with each other in those situations. Finally, in order to explain how business strategy affects by principle of supply and demand, two organizations in difference industries will be examined in the section of empirical evidences.


Supply and Demand.

It is relatively important to understand the interaction force of supply and demand before making business decision. In free-market economics, there are two opposite forces supply and demand that make market economics work. As noted by Bruce (2009); the normally interpretation of supply and demand refers to the behavior of sellers and buyers. Also, demand is related to wants while supply is limited, relating to resource. The amount of any goods or services that people are able to sell and willing to sell is the quantity supplied. Similarly, the quantity demanded is defined as the amount of goods that buyers are willing and able to purchase. The interaction of the force of supply and demand affects different products prices. In the words of Harvey (2007), the price of any good is mainly responded to how supply of particular product or service is related to its demand. Also, Sloman (2000) claimed that the functions of prices in a free market play an essential role in transmitting information from sellers to buyers and evoking a response.

It is apparent that the general relationship between prices and quantity demanded is negatively. By convention, when the price of goods rises the quantity demanded for this goods will decrease. Bruce (2009) states, this is the law of demand. For example, in the case of the smoking problem there are two ways that government could attempt to reduce the quantity of smoking demanded. One is to raise the price of cigarette. Alternatively, to shift the demand curve through public service advertising on cigarette packages or television to reduce the quantity of cigarettes demanded at any given price. Once again, the theory of price system is positively related to the quantity supplied for goods or services. As the price of goods rises the quantity supplied of goods will also rise because the high price makes business more profitable and then encourages suppliers to produce more-------this is the law of supply. Meanwhile, others factors affecting supply and demand in many way. In terms of demand it will also be determined by price of the good, income, the price of the substitutes, customer's tastes and expectation for further. While, supply is determined by input prices, the price of the goods, technology, expectations. Where the curves of supply and demand intersect, this point is defined as the equilibrium price that could be employed and adjusted to balance supply and demand when the phenomenon of excess of supply and demand exists in the markets; Mankiw (1998) explained which could be considered as the law of supply and demand.

Invisible hand
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In free market economics, due to the fact that there is no government control, all decisions are made by individual enterprise. Individual firm decides what goods to produce and how many this goods need to be produced more that all depend on the interactions of supply and demand in the market. Gillespie (2007) pointed out that the market is a "invisible hand" that advocates a free market economic system, everyone is allowed freely access to the market in which people enable to act as a role of buyer or seller to purchase or sell goods or service at the given price. In free-market economies, where the invisible hand was shaped by combining with principle of supply and demand. That is to say that, the interaction of supply and demand in free market could be frequently defined as the "invisible hand" which adjusts the market and forms the market price of goods or services. According to Bruce (2009), the invisible hand is regarded as a natural tool to adjust the price of products in free market. In other words, the relationship between supply and demand is determined by the market price of particular goods. Supposed that the price of potato in market is quite high that encourages producer to hire more land to grow more potato in order to gain more profit. Hence, the quantity supplied of the potato will increase. Assuming that the quantity demanded remains unchanged that causes a phenomenon of the excess of supply over demand. At this stage, the suppliers have to cut their price down or reduction in their output for keeping balance between supply and demand. As Randall (2001) states, the invisible hand contributes to market to allocate resources efficiently; the most significant feature of invisible hand is the ability to allow the market place to be self-regulating.

Nevertheless, due to the changes in market trends under the negative influence of economic crises, the invisible hand sometimes does not work. The theory of invisible hand in a Capitalist country, for example, since a serious blow from economic crises, the market mechanism has been influenced to a large extent and leads to people begin to realize that the invisible hand almost lost its unique ability of controlling this market. Moreover, Mankiw (1998) doubt that the effect of invisible hand is even less able to ensure that economic prosperity fairly allocates resources. The indivisible hand cannot ensure that everyone will be treated equally, such as to have adequate health care and ability to pay for an expensive house. Therefore, in order to achieve stable and rapid growth in economic, government intervention is required.

The mixed economics

The real world is one of the mixed economic. The definition of the mixed economics is explained by Gillespie (2007); a mixed economy is set in the middle of free market economy and command economy. That means that in mixed economics, where half business decisions are carried out by private firms through the market and the rest of the decisions are made by the government. As stated above a healthy market economics should involve some degree of government intervention that can be used to achieve the goals that have not been perfectly achieved by market. In mixed economics, government intervention affects business decision and management in various ways. Lipsey (2007) indicates that governments are more likely to adjust the present market by levying taxes or directly controlling the price of products even controlling the pattern of production and consumption to balance supply- demand in the market. From an economics perspective, the government intervention is regarded as "visible hand". As noted by Sloman (2007), it is necessary to introduce a visible hand to make up defects of the invisible hand in the mixed economic. Normally, the analysis of supply and demand is a useful tool that could be employed to exam the effects of government. On the other hand, Wessels (2006) argues that government intervention in mixed economics may be result in shortages and surpluses by fixing prices out of equilibrium point. If the price is fixed below the equilibrium price that causes demand exceed supply, if the price is fixed above the equilibrium price that results in waste of resource, in other words, supply exceeds demand. Under this situation, business decision making will be limited on some extent and whether firms need to increase in output of this product or not is determined by the government's price.

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The definition of monopoly is a market structure where there is only one company that produces goods or service in this industry. In practice, Bruce (2009) points out; "pure monopoly" is rarely found in real life. However, one firm may be able to dominate the amount of supply of goods and then charges higher prices to earn higher profits. Under the condition of monopoly, the high profit occurs where Margin Revenue is equal with Margin Cost. To take advantage of its economic power, the aim of monopoly firm is to gain maximization profit so that its more likely to control the supply of goods to the market for its personal interest because these is a sole producer.

See Figure 1, supply curve has been shifted from S1 to S2; meaning supply of this product in the market is less than before. When demand for this product remains unchanged, the price will rise from P to Pm. Harvey (2007) states; monopoly firm has ability to have a substantial influence on market price which will be able to form of an enormous market power. Furthermore, if monopoly firm produces the product is necessary without a close substitute, and then the demand for products is inelastic. Therefore, the greater the inelasticity of demand, the greater a higher price will be set by monopolist. So as to say that, business decision making of monopoly firm is based on the point of profit max, when demand for product remains unchanged, firm will cut back the amount in supply of this product for gaining as much as profit. Monopoly influences the healthy market in a negative way in which monopoly firm intends to adopt various measures to maintain its high profit and favorable situation of the market by merging corporation and assets. As criticized by Mankiw (1998), there is a one of market failure, made by market power-monopoly, in which monopoly firm will produce less than the socially efficient out. Therefore, using government policy to adjust and regulate monopoly behavior is inevitable. Nevertheless, the merits of monopoly could not be ignored totally. By contrast the perfectly competition market, the monopoly firm has a proper production plan that will not cause excess supply and waste resource. In addition, Sloman (2000) indicated, the monopoly firm may be able to achieve economies of scale and avoid producing duplicate.

The problem of principles of optimization

In the market, customers always intend to spend less money to obtain more benefit from what they purchased. The utility maximization is a problem that customer will encounter. Similarly, the decision of firms incline to use less resource to produce more product for gaining as much as profit from products they supplied. However, it is inevitable that the opposition of forces contributes to conflict of interest in the market. For a firm, the rule of profit-maximizing is MR=MC. In addition the output of product could be applied and controlled to adjust its profit. When MR is above MC that means firm can obtain profit by expanding production. Conversely, suppose that MC is greater than MR, meaning the high cost diminish its reward and then cut back its amount of output to remain its profit.

Empirical evidences

The empirical evidence of the principle of supply and demand impinge on the business decision making will be provided by introducing two examples which occur in two different industries. The first attempted to understand how business decision of real estate agency is made under the negative influence of economic crisis. The second is focused on Oil Company to investigate how business decision could be made is responded to the interaction force of supply and demand.

In 2008, as the explosion of credit crisis in USA, the global economic has influenced the whole world economic. The incomes of consumers have reduced on a large extent. As a result, the real estate market has led to a slowdown. The report of of Windwalker Real Estate (2008) reveals that the cumulative sale volumes for all poverties have dropped by 37% to 214 from 339. In other words, the quantity demanded for house is less than before, while the quantity supplied remains unchanged, which leads the vacancy rate grows. With that, the price of houses falls. Hence, for the purpose of keeping more profit the Windwalker Real Estate decided to reduce supply in order to rise in price of house.

Personally, there is no denied that the decision of cutting down in supply of the houses may be able to increase in price of house because house is a special product that everyone has a chance to buy it in the lives. However, according to the Sloman (2007), when the consumer's incomes fall, there will be a large falls in consumer's demands that less will be spent than before. Due to the fact that the demander's paying ability has been considered as a critical factor to form the effective demand. Therefore, under this situation, buyers tend to consider more before acting. What is more is that the potential buyers will not immediately purchase the house, if they believe that the house price will fall again and causes them to wait. If they believe this fall will not last long time, they will purchase it immediately to benefit from the fall in price. It was stated by Wessels (2006), if the people think that the expectation of future price are going to rise, they are likely to buy more before the price does go up, and a belief that price will fall that causes them to wait. In this example, this is illustrated in Figure 2, S1 intersect with D1 where is equilibrium price P1, However, due to the recession in real estate, the demand curve D1 has been shifted from right to left D2; so that, equilibrium price has moved from P1 to P2, during this time, supplier want to rise price of house by cutting down the supply. The S1 has shift to S2, and the price has risen from P2 to P3. Suppose that buyers expect that the price of house will increase continually that encourages them to buy immediately, demand curve will shift from D2 to D3 and equilibrium price has risen to the place of P1. The price of house rises successfully. As noted by Lipsey (2007), a reduction in supply is signaled by a rise in price.

This example is given by Mankiw (1998 p105). In the 1970 members of the organization of Petroleum Exporting Countries (OPEC) is one of largest monopoly organization, providing people with oil in the world. They have power to influence the price of oil in the oil market. By using their dominance, they decided to raise the world price of oil in order to reach the point of optimization to gain profit and revenue maximization. During the same time, the amount of oil they supplied has been reduced on a large extent. However, the demand for oil supply remains stable in short run. From 1973 to 1974, the price of oil rose more than 50%. After several years, they did not stop to raise the price of oil until 1985 the price of oil is difficult to maintain a high price and then was back to where it began.

From this monopoly example, it is apparent illustrates that the price of oil would not always keep high, even if the oil company has power to shape the price of oil. Additionally, the differences of supply and demand were found between in the short run and long run. In the short run, the supply for oil take quite long time to produce and also oil cannot be changed so frequently that means the supply for oil is inelastic. Moreover, most drivers have got used to pay a high price for oil so that they could not response quickly to a high price. Therefore, demand for oil remains inelastic. Due to the short run, the curves of supply and demand are far steep. As the supply of oil reduce and demand for oil keep stable. See Figure 3 shows, the supply curve will shift from right S1 to left S2, the price of oil rise at a large extent from P1 to P2. Compared with the long run, firms realized that the high price oil contributes to substantial profit. By using this long period, they have begun to further increase oil exploration and output. However, consumers have realized that the high affects their expense in their life and decide to buy a new efficient car as instead or choose another transportation tools. As Figure 4 shows, in the long run, the amount of oil supply has been reduced from S1 to S2 that causes the price of oil has a slightly increase from P1 to P2. Thus, business decision of reducing in supply in OPEC proved that they obtained less profit in the long run than in short run. As states by Gillespie (2007), the response of falling in supply is determined by the time horizon.


From what have been discussed above the following conclusion can be drawn from the present work in different aspects. Initially, in free market economy, all decisions are made by individual or firms who tend to seek to maximize their utility or profit from what they purchased and sold. Also, during the same time, people pursue their interests that are able to promote the interests of society. In addition, the price mechanism in a free market plays a role as an invisible hand to adjust demand and supply into balance. Therefore, a rise in product's price will rise in supply of this product; Firms will increase the amount of production of this product. On the contrary, a fall in price of this product causes less profitable and firms decide to cut back supply of this product or exit this industry. By contrast, the mixed economics involves government interventions as a visible hand in a free market to work with invisible hand to prevent from market failure. Hence, half decisions making of firms are intervened under the government control. However, the argument from Wessels (2006) against that government participate in market by fixing price of the product may be cause shortage or surplus. If the price is fixed below the equilibrium price that causes demand exceed supply, if the price is fixed above the equilibrium price that results in waste of resource, in other words, supply exceed demand. Under this situation, business decision making will be limited on some extent and whether firms need to increase in output of this product or not is determined by the government's price. The final section of empirical evidence suggests that the relationship between supply and demand is not only affected by market price, but also is affected by other factors such as customer's income, customer's expectation and time dimension etc.

In general, the free-market economy cannot be separated from the principle of supply and demand. In other words, the principle of supply and demand is natural tool that leads to market work efficiently. Also, the mode of supply and demand influences business decision in a way in which firms should able to fully understand the current situation of the market by analyzing the interaction force of supply and demand. Afterward, making decisions of how much product and what product should increase the amount of supply to match up the demand for this product in order to gain more profit and benefit.


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