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The Fundamental Theory Of Supply And Demand Economics Essay

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Published: Mon, 5 Dec 2016

The theory of supply and demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy. The supply and demand model describes how prices vary as a result of a balance between product availability and consumer demand.

Since contemporary economies rely on the market forces of supply and demand instead of government forces to distribute goods and services there must be a method for determining who gets the products that are produced. This is where supply and demand begin to work. By themselves the laws of supply and demand give us basic information, but when working together they are the key to distribution in a market economy.

It is not enough for a buyer to want or desire an item. He or she must show the ability to pay and then the willingness to pay. So, demand is comprised of three things:

Desire;

Ability to pay;

Willingness to pay.

What factors alter a consumer’s desire, willingness and ability to pay for products? Some factors include consumers’ income and tastes, the prices and availability of related products like substitutes or complementary goods, and the item’s usefulness.

Substitutes are goods that satisfy similar needs and which are normally consumed in place of each other. As the price of one substitute declines, demand for the other substitute will decrease. Butter and margarine are close substitutes. If the price of butter goes up, then people will tend to substitute margarine for butter.

Complementary goods are those that are normally consumed together (e.g., DVD players and DVD movies). An increase in the price of a product will diminish demand for its complement while a decrease in the price of a product will increase demand for its complement.

Think of the item’s usefulness this way. It is a hot summer day and you are gasping for a drink*. You come across a lemonade stand and gulp down a glass*. It tasted great so you want another. This second glass is marginal utility meaning an extra satisfaction a consumer gets by purchasing one more unit of a product. But now you reach for a third glass. Suddenly your stomach is bloated and you are feeling sick. That’s diminishing marginal utility! The law of diminishing marginal utility says that the more units one buys the less eager one is to buy more.

In economics, demand is people’s desire, willingness and ability to purchase particular amounts of goods or services at certain prices in a given period of time. To the economists consumers make rational choices about how much to buy and how to spend their income on the products that will give them the greatest satisfaction at the least cost. So, demand describes the behavior of buyers.

The law of demand states that the higher the price of a product, the fewer people will demand that product, that is, demand for a product varies inversely with its price, all other factors remaining equal*. Factors other than a good’s price which affect the amount consumers are willing to buy are called the non-price determinants of demand. The law of demand expresses the relationship between prices and the quantity of goods and services that would be purchased at each and every price. In other words, the higher the price of a product, the lower the quantity demanded.

Economists like to look at things graphically. A demand schedule is a table showing the number of units of a product that would be purchased at various prices during a given period of time. The information presented in a graphic form is called a demand curve. It shows an inverse relationship between the price and the quantity demanded. The demand curve represents the quantities of a product or service which consumers are willing and able to buy at various prices, all non-price factors being equal. The demand curve slopes downward from left to right based on the law of demand. Or to put it another way, a demand curve shows that the quantity demanded is greater at a lower price and lower at a higher price.

The advantage of the curve is that it enables economists to see the relation between price and quantity demanded and to calculate approximately what the demand would be for those prices falling in between the prices that are in the demand schedule. Each point along the curve represents a different price-quantity combination.

Demand schedule for cut jeans

Price

The quantity demanded

$400

200

$350

500

$300

800

$225

1200

$175

1600

$100

2400

$50

3000

Increased demand can be represented on the graph as the curve being shifted to the right, because at each price, a greater quantity is demanded. An example of this would be more people suddenly wanting more cut jeans. On the other hand, if the demand decreases, the opposite happens. Decreased demand can be represented on the graph as the curve being shifted to the left, because at each price the quantity demanded is less. It means that fewer people want to buy cut jeans.

The key point is to distinguish between demand and the quantity demanded.

Demand refers to how much of a product or service is desired by buyers.

The quantity demanded is the amount of a product that people are willing to buy at a certain price.

The difference is subtle but important. If the demand of ice cream goes up in summer it is because consumptive demand has truly increased, clearly it is hot. In this case the business can most likely raise prices without suffering a cut in sales. This is a change in the quantity demanded. In winter the business incurs a sales fall at the same price. The only way out of increasing sales is to reduce the price. As a result of a price cut the increased sales of ice cream means that consumer demand has artificially been manipulated. In reality, actual demand is low but extra efforts have to be made to increase sales. This leads to a change in demand.

Economists distinguish two different ways that the quantity of purchases of a product can change.

According to the law of demand a change in price leads to a movement along the original demand curve and results in a change in the quantity demanded, that is, more will be purchased but only at a lower price.

When one of the non-price factors changes (e.g., a change in income) there will be a change in demand. This change causes a shift of the demand curve either outward or inward in response to a change in a condition other than the good’s price. It means that more or less will be purchased at the same price.

All of the non-price determinants (changes in the size of the market, income for the average consumer, population size, the prices and availability of related goods, consumer preferences) are directly related to consumers. In other words, at any given price, consumers will be willing and able to purchase either more or less.

Let’s take a look at an effect a change in consumer preferences or desire for a particular product leads to. On the one hand, if a product like cut jeans becomes the latest fashion fad, demand at any given price will be increased and the demand curve shifts out. On the other hand, if there is a decline in the size of the market or a product becomes unfashionable then the demand curve shifts in. Thus, the only thing that can change the quantity demanded is a change in the market price, all other things remaining the same. While a change in demand results from changes of any of the non-price determinants, the good’s price being equal.

To understand better the theory of supply and demand it is necessary to know how much buyers and sellers respond to price changes. This responsiveness is called elasticity.

Elasticity varies among products because some products may be more essential to the consumer. A good or service is considered to be highly elastic if a slight change in price leads to a sharp change in the quantity demanded. A price increase of a product or service that isn’t considered a necessity will discourage more consumers to buy the product or service. On the other hand, an inelastic good or service is one in which changes in price bring about only modest changes in the quantity demanded, if any at all. Products that are necessities are more insensitive to price changes because consumers will continue buying these products despite a price rise. It is known as the price elasticity of demand.

In economics, the price elasticity of demand is an elasticity that measures the nature and degree of the relationship between changes in the quantity demanded of a commodity and changes in its price.

One typical application of the concept of elasticity is to consider what happens to consumer demand for a product when prices increase. As the price of a product rises, consumers will usually demand less of that product, perhaps by consuming less, substituting another product for it, and so on. The greater the extent to which demand falls as price rises, the greater the price elasticity of demand is.

Demand is called elastic if a small change in price has a relatively large effect on the quantity demanded.

The number and quality of substitutes for a product are the basic influence on price elasticity of demand. If the prices of substitutes remain the same, a rise in the product’s price will discourage consumers from buying this product. On the other hand, if there is a price cut in the product, consumers will substitute other items for this product. Thus, the demand for this product tends to be elastic. In general, demand is elastic for non-essential commodities (visits to theatres or concerts, holidays, parties, etc.)

However, there are some goods that consumers cannot consume less of, and cannot find substitutes for even if prices rise. Some goods and services that are necessities, relatively inexpensive and difficult to find substitutes are said to have inelastic demand. To put it another way, a change in price results in a relatively small effect on the quantity demanded.

The elasticity of demand also deals with the effect of a price change on the seller’s total revenue, that is the amount paid by the buyers and received by the sellers of products. When the price elasticity of demand for a product is elastic, the percentage change in quantity is greater than the percentage change in price. Hence*, when the price is raised, the total revenue of producers falls, and the total revenue of producers rises, when the price is decreased. When the price elasticity of demand for a product is inelastic, the percentage change in quantity is smaller than the percentage change in price. Therefore, when the price is raised, the total revenue of producers rises and the total revenue of producers decreases, when there is a good’s price fall.

COMMENTS:

to gasp for a drink – помирати вÑ-д спраги;

to gulp down a glass – жадÑ-бно/квапливо проковтнути напÑ-й;

all other factors remaining equal – за умов, що усÑ- Ñ-ншÑ- фактори залишаються незмÑ-нними;

hence – отже, звÑ-дси, в результатÑ-.

Exercise 1. Read, translate into Ukrainian in writing and memorize the following economic terms and concepts.

Complementary goods: the two goods tend to be consumed or used together in relatively fixed or standardized proportions.

____________________________________________________________________________________________________________________________________________________________________________

Demand curve: the graphical representation of how demand for something varies in relation to its price.

_________________________________________________________________________________________________________________________________

Demand schedule: a table showing the quantities of a product that would be purchased at various prices at a given time.

____________________________________________________________________________________________________________________________________________________________________________

Demand: the level of a consumer’s willingness, ability and desire or need that exist for particular goods or services.

_________________________________________________________________________________________________________________________________

Diminishing marginal utility: each successive increase in consumption of a product or service provides less additional enjoyment or usefulness than the previous one.

_______________________________________________________________________________________________________________________________________________________________________________________________________________________

Elastic demand: Demand for which a small change in price results in a large change in demand.

_________________________________________________________________________________________________________________________________

Elasticity: An economic concept which is concerned with a shift in either demand for or supply of an economic product as the result of a change in a product’s price.

_______________________________________________________________________________________________________________________________________________________________________________________________________________________

Inelastic demand: Demand for which a large change in price leads to only a small change in demand.

________________________________________________________________________________________________________________________________

Law of demand: the economic law that states that demand for a product varies inversely with its price.

_________________________________________________________________________________________________________________________________

Law of diminishing marginal utility: the economic law that states that for a single consumer the marginal utility of a commodity diminishes for each additional unit of the commodity consumed.

__________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

Marginal utility: the additional satisfaction a consumer gains from consuming one more unit of a good or service.

____________________________________________________________________________________________________________________________________________________________________________

Price elasticity of demand: The degree to which demand for a commodity responds to a change in the price of this commodity.

____________________________________________________________________________________________________________________________________________________________________________

Substitute: a product or service that partly satisfies the need of a consumer that another product or service fulfills.

_________________________________________________________________________________________________________________________________

Utility: an economic term referring to the total satisfaction received from consuming a good or service.

_________________________________________________________________________________________________________________________________

TEXT

Transactions require both buyers and sellers. Thus, demand is only one aspect of decisions about prices and the amounts of goods traded, supply is the other. So, supply is one of the two key determinants of price. The theory of supply explains the mechanisms by which prices and levels of production are set. Unlike demand, supply describes the behavior of sellers.

In economics, supply relates to the quantity of goods or services that a producer or a supplier is willing to bring into the market (пустити в продаж) at a particular price in a given time period, all other things being equal.

The law of supply states that the quantity of a commodity supplied (товар, який постачається) varies directly with its price, all other factors that may determine supply remaining the same. The law of supply expresses the relationship between prices and the quantity of goods and services that sellers would offer for sale (пропонувати на продаж) at each and every price. In other words, the higher the price of a product, the higher the quantity supplied. As the price of a commodity increases relative to price of all other goods, business enterprises switch resources and production from other goods to production of this commodity, increasing the quantity supplied.

Clearly the law of supply is the opposite of the law of demand. Consumers want to pay as little as they can. They will buy more when there is a price decrease in the market. Sellers, on the other hand, want to charge as much as they can. They will be willing to make more and sell more as the price goes up. In this way they can maximize profits. (значно збÑ-льшувати прибутки)

The relationship between price of a product and its quantity supplied is represented in a table called a supply schedule. The supply curve is a graphic representation of the market supply schedule and the law of supply. The supply curve shows a direct relationship (прямо пропорцÑ-йна залежнÑ-сть) between the quantities of products that firms are willing to produce and sell at various prices, all non-price factors (нецÑ-новÑ- фактори) being constant. The supply curve slopes upward from left to right based on the law of supply. Producers supply more at a higher price because selling a larger quantity at a higher price increases their revenue.

Supply schedule for cut jeans

Price

The quantity supplied

$400

3000

$350

2400

$300

1600

$225

1200

$175

800

$100

500

$50

200

The supply curve enables producers to anticipate (давати можливÑ-сть виробникам передбачити) what the supply would be for those prices falling in between the prices that are in the supply schedule. Each point along the curve represents a different price-quantity combination, or to put it another way, a direct correlation between the quantities supplied and price. Like a movement along the demand curve, a movement along the supply curve will occur when a price change leads to a change in the quantity supplied (змÑ-на величини пропозицÑ-Ñ-), that is, more will be offered for sale but only at a higher price or vice versa.

Like a shift in the demand curve, a shift in the supply curve to the right or to the left means that the quantity supplied is affected by a factor other than a product’s price. (фактор Ñ-нший нÑ-ж цÑ-на товару)

People often confuse supply with the quantity supplied. The difference between supply and quantity supplied is that

Supply represents the amounts of items that suppliers are willing and able to offer for sale at different prices at a particular time and place, all non-price determinants being equal.

The quantity supplied refers to the amount of a certain product producers are willing to supply at a certain price (за певною цÑ-ною). A change in the price of the product will cause a change in the quantity supplied.

Price is an important determinant of the quantities supplied. The law of supply states that the amount offered for sale rises, as the price is higher. The quantity of pairs of cut jeans producers are willing to offer for sale rises, since their price is higher primarily because they need to cover the increased costs of production. (покривати збÑ-льшенÑ- виробничÑ- витрати)

Thus, according to the law of supply a change in price leads to a movement along the original supply curve and results in a change in the quantity supplied. On the one hand, an upward movement along the curve (рух уздовж кривоÑ- спрямований угору) represents an increase in the quantity supplied as the price is raised. On the other hand, a downward movement along the curve shows a decrease in the quantity supplied as a result of a price reduction.

When one of the factors other than a product’s price changes (e.g., a change in technology) there will be a change in supply. Economists use the term “supply” to refer to the original supply curve. An increase in supply is reflected by a shift of the supply curve to the right. It means that at the same price, sellers are willing to supply more than they were willing to supply before (вони були готовÑ- постачати ранÑ-ше). A decrease in supply is represented by a shift of the original supply curve to the left. It means that at any given price, producers are willing to supply less than they were willing to supply before.

However, there are things other than price which affect the amounts of goods and services suppliers are able to bring into the market. These things are called the non-price determinants of supply.

As it has been mentioned a change in the quantity supplied caused only by a change in the price of the product. A change in supply is caused by a change in the non-price determinants of supply. Based on a new supply schedule (виходячи з новоÑ- шкали пропозицÑ-Ñ-), the supply curve moves inward or outward since the prices stay the same and only the quantities supplied change.

Non-price determinants of supply are:

Changes in the cost of production. Production costs relate to the labour costs and other costs of doing business (витрати експлуатацÑ-Ñ- пÑ-дприємства) used in production process. The cost of production is probably one of the most important influences on production process. An increase in the costs of any input brings about the lower output, which means that the supply curve will shift inward. Regardless of the price that a firm can charge for its product, price must exceed costs (перевищувати витрати) to make a profit. Thus, the supply decision (Ñ€Ñ-шення щодо пропозицÑ-Ñ-) is a decision in response to changes in the cost of production.

Changes in technology. Changes in technology usually result in improved productivity. Improved technology decreases production costs and therefore increases supply.

Changes in the price of resources needed to produce goods and services. If the price of a resource used to produce the product increases, this will increase the production costs and the producer will no longer be willing to offer the same quantity at the same price. He will want to charge a higher price to cover the higher costs. As a result the supply curve will shift inward.

Changes in the expectations of future prices. Changes in producers’ expectations about the future price can cause a change in the current supply (Ñ-снуюча пропозицÑ-я) of products. If producers anticipate a price rise in the future, they may prefer to store their products today and sell them later. As a result, the current supply of a particular product will decrease. In this case a supply curve will shift to the left. It is necessary to keep in mind that supply is not the quantity available for sale. (кÑ-лькÑ-сть, яка Ñ” в наявностÑ- для продажу)

Changes in the profit opportunities. If a business firm produces more than one product, a change in the price of one product can change the supply of another product. For example, automobile manufacturers can produce both small and large cars. If the price of small cars rises, the producers will produce more small cars to earn higher profits. They will shift the resources of the plant from the production of large cars to the production of small ones. Therefore, the supply of small cars will increase and a supply curve will shift outward. So, profit opportunities encourage producers to produce those goods that have high prices.

Changes in the number of suppliers in the market. Potential producers are producers who can produce a product but don’t do it because of relatively low price. If price of a product rises potential suppliers will switch over production to that product to make more profit. If more producers enter a market, the supply will increase, shifting the supply curve to the right.

Making a summary it is necessary to emphasize that the understanding of concepts of supply and demand provides an explanation of how prices are determined in competitive markets. (конкурентний ринок)

An important concept in understanding supply and demand theories is elasticity. Comprehension of elasticity (розумÑ-ння еластичностÑ-) is useful to understand the response of supply to changes in consumer demand in order to achieve an expected result or avoid unforeseen consequences (уникати непередбачених наслÑ-дкÑ-в). For example, an entrepreneur expecting a price increase might find that* it lowers the profits if demand is highly elastic, as sales would fall sharply. Similarly, a business reckoning on a price cut might find that* it does not increase sales, if demand for the product is inelastic.

In economics, the price elasticity of supply is the degree of proportionality with which the amount of a commodity offered for sale changes in response to a given change in the going price. In other words elasticity of supply is a measure of how much the quantity supplied of a particular product responds to a change in the price of that product.

Elasticity of supply works similar to elasticity of demand. If a change in price results in a large change in the quantity supplied, supply is considered elastic. On the other hand, if a great change in price brings about a small change in the quantity supplied, supply is called inelastic.

Here are the determinants of price elasticity of supply:

the ability of producers to change the amount of goods they produce

time period needed to alter the output.

Elasticity of supply is different in the short run and the long run. The quantity of a product supplied in the short run differs from the amount produced, as manufacturers have stocks of finished products (запаси готовоÑ- продукцÑ-Ñ- ) as well as raw materials which they have to build up or reduce. In the long run quantity supplied and quantity produced are equal but it takes time to adjust supply to current demand and going prices. For example, supply of many goods can be increased over time by allocating alternative resources, investing in an expansion of production capacity, or developing competitive products that can substitute for hot items. Hence, supply is more elastic in the long run than in the short run.

COMMENTS

A different price-quantity combination – Ñ-нша комбÑ-нацÑ-я цÑ-ни та кÑ-лькостÑ-;

an entrepreneur expecting a price increase might find that – пÑ-дприємець, який сподÑ-вається на пÑ-двищення цÑ-ни, мÑ-г би з’ясувати, що;

a business reckoning on a price cut might find that – пÑ-дприємець, який розраховує на зниження цÑ-ни, мÑ-г би з’ясувати, що.

Exercise 1. Read, translate into Ukrainian in written form and memorize the definitions of the following economic terms and concepts.

Elastic supply: Supply for which a percentage change in a product’s price causes a larger percentage change in the quantity supplied.

Еластична пропозицÑ-я: пропозицÑ-я за якоÑ- процентна змÑ-на в цÑ-нÑ- товару призводить до бÑ-льшоÑ- змÑ-ни величини пропозицÑ-Ñ-.

Elasticity of supply: The degree to which supply of a commodity responds to a change in that commodity’s price.

ЕластичнÑ-сть пропозицÑ-Ñ-: положення за яким пропозицÑ-я товару реагує на змÑ-ну цÑ-ни товару.

Inelastic supply: Supply for which a percentage change in a product’s price causes a smaller percentage change in the quantity supplied.

Нееластична пропозицÑ-я: пропозицÑ-я за якоÑ- процентна змÑ-на цÑ-ни товару призводить до меншоÑ- змÑ-ни величини попиту.

Law of supply: the economic law that states as the price of a commodity that producers are willing and able to offer for sale during a particular period of time rises (falls), the quantity of the commodity supplied goes up (decreases), all non-price determinates being equal.

Ð-акон пропозицÑ-Ñ-: економÑ-чний закон, який стверджує, що якщо цÑ-на товару, яку виробники готовÑ- та здатнÑ- пропонувати для продажу за визначений перÑ-од часу, зростає (спадає), кÑ-лькÑ-сть запропонованого товару зростає (скорочується), всÑ- нецÑ-новÑ- визначники залишаються незмÑ-нними.

Quantity supplied: the amount of a product that producers are willing and able to sell at a certain price during a time period, all other factors that may determine supply remaining the same.

Величина пропозицÑ-Ñ-: кÑ-лькÑ-сть товарÑ-в, якÑ- виробники готовÑ- та здатнÑ- продавати за визначеноÑ- цÑ-ни впродовж певного перÑ-оду часу, всÑ- Ñ-ншÑ- фактори, якÑ- можуть визначити пропозицÑ-ÑŽ залишаються незмÑ-нними.

Supply: the total amount of a commodity available for purchase by consumers.

ПропозицÑ-я: сукупна кÑ-лькÑ-сть товарÑ-в доступних для придбання споживачами.

Supply curve: the graphical representation of how supply varies as prices change.

Крива пропозицÑ-Ñ-: графÑ-чне вÑ-дображення того, як пропозицÑ-я змÑ-нюється якщо змÑ-нюються цÑ-ни.

Supply schedule: a table showing the quantities of a product that would be offered for sale at various prices at a given time.

Шкала пропозицÑ-Ñ-: таблиця, що показує кÑ-лькÑ-сть товару, який буде запропонований на продаж за Ñ€Ñ-зноÑ- цÑ-ни впродовж певного часу.


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