Excess Demand and Supply - Coursework Example

Demand and Supply Analysis Demand refers to the buyer's willingness and ability to purchase goods while supply refers to the seller's willingness and ability to provide goods at different price levels (Dolan & Lindsey, 44). According to Paul Gregory, the law of demand states that there is an inverse relationship between the price of a good and the quantity demanded. So, if the price falls, quantity demanded will rise and if the price rises demand for that certain good will decrease. However, the case is different if we put supply in the picture. Market equilibrium exists when the quantity supplied is equal to the quantity demanded at a given price ("Excess Demand and Supply"). The diagram below shows the supply and demand curve for good X and the equilibrium price and quantity. Figure 1.Equilibrium 80 S 70 60 Price of Good X 50 40 30 20 10 D 0 1 2 3 4 5 6 7 Quantity of Good X In diagram above, the quantity of supply and demand are equal at price 50. If the supply and demand curve won't move, the market price of Good X will not change. If the demand for good X will increase, the demand curve will shift to the right or will exhibit an outward shift. Figure 2. Increase in demand 80 S 70 60 Price of Good X 50 40 30 20 D2 10 D1 0 1 2 3 4 5 6 7 Quantity of Good X An increase in demand will cause a movement along the supply curve which will result to the rise of equilibrium quantity and price. With the new demand curve, supply and demand of good X equals to 5 at price 60. Price and quantity both increased. This means that an increase in the demand of good X made firms in the market to sell good X at a higher price. However, an increase in supply will show another different result. This is shown in Figure 3. Figure 3. Increase in demand and supply S2 80 S 70 60 Price of Good X 50 40 30 20 D2 10 D1 0 1 2 3 4 5 6 7 Quantity of Good X With the new demand and supply curve, D2 and S2, the quantity of good X decreased to about 3.75 units while the price increased by about 78 units. This just proves the law of demand that as the price of good X increases, the quantity demanded decreases. There are a lot of reasons that can cause an increase in demand and supply. Increase in demand can be caused by increase in the consumer's income or wealth, rise in the price of substitutes, fall in the interest rate, and fall in the price of complements. An increase in supply, on the other hand, can be caused by cheaper cost of production, government subsidies, improvement in production technology, and the entry of new suppliers to the market ("AS Markets and Market Systems"). On the other hand, a decrease in supply has a different effect. This is shown in the figure below. Figure 4. Decrease in supply 80 S 70 S2 60 Price of Good X 50 40 30 20 10 D1 0 1 2 3 4 5 6 7 Quantity of Good X If the demand curve will remain the same and the supply curve shifts downward, the price of good X will decrease to 40 units while the quantity of good X will increase to approximately 4.75. Again, this conforms to the law of demand. Decrease in the price of good X resulted to an increase in the demand for it. This means that more people will be willing to consume good X because of its lower price. However, the picture will not be the same if the demand curve increases and the supply curve decreases. This is shown in Figure 5. Figure 5. Decrease in supply and increase in demand 80 S1 70 S2 60 Price of Good X 50 40 30 20 D2 10 D1 0 1 2 3 4 5 6 7 Quantity of Good X As you can see, there is a decrease in supply and increase in demand. This resulted to a decrease in price form 50 to approximately 42 units and an increase in the quantity of good X from 4 units to about 5.25 units. The result is different when demand remained constant in the previous graph. A decrease in supply that goes with an increase in demand tends to lower prices and increase the quantity demanded of goods. Works Cited Riley, Geoff. "AS Markets and Market Systems", Tutor2u, September 2006. 29 November 2008. "Excess Demand and Supply", Open-Site, 27 November 2008. Dolan, Edwin and David Lindsey. Economics. 6th ed. Orlando: The Dryden Press, 1991. Gregory, Paul. Essentials of Economics. 6th ed. New York: Addison Wesley, 2005. Read More