Supply and Demand in Economics - Term Paper Example

Supply and Demand SUPPLY AND DEMAND Supply and demand in economics is a basic concept. Supply and demand can be considered as the backbone of the economy of the market. The amount which the market has to offer is called the supply. It means how much the suppliers can supply when the buyers pay a certain price. Supply relationship is the relation between the amount of goods provided and the price at which it is provided. Demand is the amount of a product or service which is wanted by the buyers. The amount in demand is the quantity of a certain product or service which people want to purchase at a particular cost. Demand relationship is the association between the amount demanded and the price it is demanded at. Supply and demand are expressed in terms of the price (J. R. Adil, 2006). The force which distributes the resources is triggered by the correlation of supply and demand. The theories involved in market economy suggest that the supply and demand theory can distribute the resources in a highly efficient manner. To see how that happens we will study closely the laws of supply and demand. A. The Law of Demand According to the “Law of Demand”, considering all the other factors to remain constant, the price of a good is inversely proportional to its demand. If the price of a good is increased than less people would want it and if the prices are decreased then more people will want to buy the good. With the increase in price of a good or service, there is an increase in the opportunity cost of the purchase of that particular good or service and that is why less people buy that good. This will result in people not buying goods which will cause them to abstain from using goods which are more valuable to them. As shown in the graph below, the curve is a downward slope. The curve of demand has three points on it which are A, B and C on it. On the curve, the relationship between price (P) and quantity (Q) is being directly represented at each point. So the quantity and price at point A will be Q1 and P1 respectively, and so on. The inverse relation between the price and quantity demanded is evident from the curve. At A the price is higher therefore the demand is lower whereas at C, the demand is higher and the price is lower (Economics Basics: Supply and Demand, 2003). B. Law of Supply  The law of supply exhibits those quantities which are sold at fixed prices similar to that in the “Law of Demand”, but the slope in the law of supply is upward. This means that the price and the amount supplied are directly proportional to each other. Higher the price higher will be the supply. More is supplied when the price is higher because it generates more revenue. The curve of demand has three points on it which are A, B and C on it. On the curve, the relationship between price (P) and quantity (Q) is being directly represented at each point. So the quantity and price at point A will be Q1 and P1 respectively, and so on. The direct relation between price and quantity supplied is evident from the curve (Economics Basics: Supply and Demand, 2003). Time and Supply: The supply relationship is a component of time. The factor of time is crucial to supply as the reaction to the changes in prices and demand should be quick, but they are always not very quick. Therefore it should be determined if the change in price caused by changes in demand is permanent or not. C. Supply and Demand Relationship  Following is an example illustrating how supply and demand can affect the price of good. Consider your favorite band releasing a special edition CD for $25. The company is aware that if the price exceeds $25 then there will be no demand for it. Therefore only 5 CDs were released because if the suppliers produced more CDs then the opportunity cost will be too high for them. If those 5 CDs are in demand by 10 buyers, then the price of the CD will increase in accordance with the demand relationship. This would result in an increase in supply. On the other hand, if 15 CDs are manufactured and they are still being demanded by 10 people then the price will not be increased and the price may even fall as there will be no demand after 10 people buys the CD. The people who considered $25 too much for the CD will avail the CD at a lower cost (Economics Basics: Supply and Demand, 2003). D. Equilibrium When demand and supply are the same i.e. at the point where their functions cross each other, then there is said to be equilibrium in the economy. When the economy is at equilibrium, the distribution of good is as efficient as it could be the quantity of the goods which are in demand are exactly the same as the quantity being supplied. Thus every individual, country or firm is content with the state of its economy. At a given price, every good produced is being sold by suppliers and being bought by consumers. It is evident from the chart that the point where the demand and supply curves cross over each other is the point of equilibrium and there is no wastefulness in the allocation of goods. At equilibrium, the price is denoted by P* and quantity is denoted by Q* and are they are called price and quantity of equilibrium respectively. However, equilibrium can only be achieved theoretically and not in the real market so there is a constant change in prices relative to change in supply and demand (Economics Basics: Supply and Demand, 2003). E. Disequilibrium  When the price is not P* and quantity is not Q*, then the economy is in a state of disequilibrium. 1. Excess Supply There will be a waste of goods when allocated if the price of the goods is high and there will be a surplus in supply. Q2 indicates the quantity that the manufacturers want to supply at price P1. However, at the same price, consumers want to an amount which is lesser than Q2, Q1. There is an excess of production and much less consumption as Q1 is less than Q2. The manufacturers want to gain profit by producing more goods, but the consumers will not want to buy the goods as the price is out of their reach. 2. Demand in Excess If the equilibrium price exceeds the actual price, it gives rise to excess demand. More consumers are attracted towards the good because of its low price whereas the production of the good is not enough to fulfill the demand. The amount of goods which are demanded at price P1 is Q2. However, the quantity that the manufacturers are willing to produce is Q1. Therefore, there is an excess in demand of the good as the production of that good is not meeting the demand, and there is a competition among the buyers to get the good. This results in an increase in supply as the manufacturers see that their good is in demand, and the price nears its equilibrium point (Economics Basics: Supply and Demand, 2003). F. Movement and Shifts 1. Movements A change which occurs along a curve is called a movement. Movements signify a change on the curve of demand in price as well as the quantity being demanded. The meaning of a movement is that there is no change in the demand relationship. That means that the movement will be caused when the price will change which will lead to a change in demand accordingly. Consequently, a movement will take place when the price of the amount demanded will change and vice versa. Movements in the curve of supply result in the supply relationship remaining constant just like in movement on the curve of demand. That signifies that movement will be caused when the price changes which will result the supply changing accordingly. For that reason, the reason causing a movement is when the price of the quantity supplied changes and vice versa 2. Shifts Shifts in the curve of supply takes place when there is a change in the amount of goods supplied or in demand when there is no change in the price of that good. For example, if a bottle of water of a particular brand is for $5 and its demand increases from Q1 to Q2 then the shift will be in the demand of water bottles. If a shift in the demand curve occurs, it means that there is some change in the original demand relationship and that the change is not caused by price, but some other factor. This shift may result if for example, other brands stop supplying bottled water. Shift in Demand of Bottled Water On the contrary, if the bottle of water cost $5 and the amount of bottles supplied decreases from Q1 to Q2, then the shift would take place in the supply. A shift in the supply curve would also mean that it has been caused by a factor which is not the price of the bottle of water. The factor may be a natural calamity which caused a shortage of stores and the company will have no other option than to supply less (Economics Basics: Supply and Demand, 2003). REFERENCES: Adil, J. R. (2006). Supply and demand. Mankato, Minn.: Capstone Press. Economics Basics: Supply and Demand | Investopedia. (n.d.). Investopedia - Educating the world about finance.(2003) Retrieved March 29, 2013, from http://www.investopedia.com/university/economics/economics3.asp Read More