Market Equilibration - Demand And Supply Essay
Demand and supply
Demand is the amount of goods that households are willing and able to buy at a particular price in a given period of time holding other variables constant (Mankiw, 2011). Change in price of a commodity lead to change in quantity demanded. For example, if the price of basic commodity such as sugar rise, the quantity demanded will reduce. The law of demand states that there is an inverse relationship between demand and supply. Therefore, demand curve slopes downward. Change in price lead to a movement along demand curve. Determinants of demand are the factors which influence the amount of quantity demanded of a particular product. Changes in determinants of demand lead to shift in demand curve. For example if the price of gas rise, the quantity demanded of Rolls Royce would decline because this model of car consume a lot of gas. The determinants of demand are:
Price – If the price of a commodity increases, the demand for that commodity reduces. For example, if cooking oil increases in price the quantity demanded will reduce. This change causes a movement along demand curve.
Income – Increase in income lead to increase in consumption. People will tend to make impulse buying. Change in income lead to a shift of demand curve.
Tastes and preferences – For example, if people have high taste and preference for Woolworth clothes, the demand for Woolworth clothes will raise and the demand for other cloth designers reduce. This change leads to a shift of demand curve.
Expectations – For example, if consumers expect high prices for wheat in the future, the demand for wheat products will increase because people want to buy more of that product now. Change in expectations lead to shift in demand curve.
Price of related goods and substitutes – For example, if the price of tea rise, consumers will shift to buying coffee. Hence the demand for tea will reduce and the demand for coffee increase. Changes in price of related goods and substitutes lead to shift in demand curve.
Figure 1: Movement along demand curve
Figure 1 shows a movement along demand curve. Increase in sugar price leads to decrease in quantity demanded for sugar.
Figure 2: Shift of demand curve
Figure 2 shows a change in tastes and preferences of good A. If consumers have more taste and preferences for Woolworth clothes, B, the demand for commodity A and B will shift from demand A to demand B.
Supply is the amount of goods that suppliers are willing and able to supply at a given price in a given period of time holding other variables constant. Increase in price lead to increase in supply of a commodity (Mankiw, 2011). The law of supply states that there is a positive relationship between quantity supplied and price. For example, if the price of corn rises, more quantity of corn will be supplied. A change in price causes a movement along the supply curve. Determinants of supply are the factors which influence how much quantity to supply. Determinants of supply lead to shift in supply curve. The determinants of supply are:
Production cost – If high costs of production are incurred, less will be supplied. For example if the price of wages and input factors is high, less will be produced. Change in production cost lead to shift in supply curve.
Technology – Change in technology lead to change in supply. For example, improved technology makes production easier therefore suppliers will be motivated to produce more. It leads to shift in supply curve.
Expectations – If suppliers expect the price of certain commodity to rise, say Toyota cars, they will produce more of that car model. This leads to a shift in supply curve.
Figure 3: Movement along supply curve
Figure 3 shows movement along supply curve. Increase in price in sugar lead to more sugar production.
Figure 4: Shift of supply curve
A change in either technology, cost of production, expectations or number of suppliers causes the supply curve to shift from supply curve A to supply curve B.
Surplus and Shortage
Surplus arises when more quantity is supplied than demanded.
Figure 5: Surplus
Figure 4 shows that the amount of sugar supplied, QS, is more than the amount of sugar demanded, QD.
Shortage arises when quantity demanded exceed quantity supplied.
Figure 6: Shortage
Figure 6 shows that quantity of sugar demanded, QD, is more than quantity of sugar supplied, QS.
Market efficiency theory
This is a theory in security market that states that all information about price is known by all the participants in the market (Marshall, 2013). Any change in price becomes available to the users therefore there is no one person who can control a market. This theory supports knowledge of information in a perfect market and rules out information asymmetry. Information asymmetry arises when one party to a transaction, usually the seller has more information than the other party, usually the buyer. This theory applies in equity and bond markets. Each person can trade to maximize his returns through information which is easily accessible. This theory is used in equity and bond market while trading.
Mankiw, N. G. (2011). Principles of economics. Mason, Ohio: Thomson South-Western.
Marshall, A. (2013). Principles of economics.
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