The Market Forces Of Supply And Demand
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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, here it is important to distinguish between demand and quantity demanded. Demand refers to how much of a product or service is desired by buyers. The quantity demanded, in its turn, is the amount of a product that people are willing to buy at a certain price.
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.
So what factors except of price alter a consumer's desire, willingness and ability to pay for different products? Some factors include consumers' income and tastes, the prices and availability of related products like substitutes or complements (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., cars and tires). An increase in the price of a product will lead to the increase in demand for its complement while a decrease in the price of a product will decrease demand for its complement.
Talking about quantity demanded, there are two ways one of a particular product can change. First, 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. Second, 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.
Economists often look at things graphically. A demand curve 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.
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 a particular product. 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 this product.
The difference between change in demand and quantity demanded 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.
Since any transaction involves both buyers and sellers, 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 and it describes the behavior of sellers.
In economics, 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. A change in the price of the product will cause a change in the quantity supplied.
The law of supply states that the quantity of a commodity supplied 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 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.
Price is an important determinant of the quantity supplied. The law of supply states that the amount offered for sale rises, as the price is higher. The quantity of a certain product producers are willing to offer for sale rises, since their price is higher primarily because they need to cover the increased costs of production.
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 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. 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, 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 labor costs and other costs of doing business 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 to make a profit. Thus, the supply decision 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-ÑÐ½ÑƒÑŽÑ‡Ð° Ð¿Ñ€Ð¾Ð¿Ð¾Ð·Ð¸Ñ†Ñ-Ñ) 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.
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.
In order 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, which 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.
The price elasticity of supply, in its turn, 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 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.
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