The Invisible Hands Of The Market: Supply and Demand

1. Demand

Definition: The quantity of a good or service that consumers are willing and able to buy at a particular price.

Factors Affecting Demand:

• Price: Inverse relationship with demand

• The diagram represents the inverse relationship between demand and price.

•  As demand increases, producers increase the price to gain more revenue(Pe to P1). 

• As demand decreases, prices are lowered in order for producers to gain more revenue(Pe to P2). 

• A point to note is that in this example, supply remains constant and doesn’t change.

• The price change is due to the increase in demand, a change in demand due to change in price is called an extension/contraction in demand. 

• Contraction in demand can be defined as a decrease in demand DUE to an increase in price. 

• Extension in demand is an increase in demand DUE to a decrease in price.

  

• Income: As income changes, spending is also likely to change , the two types of goods that income is spent on can be classified as:

  1.Normal Goods: Demand for goods  increases as income increases.(eg: food,clothing)

  2.Inferior Goods: Demand for goods  decreases as income increases(eg:Toned milk which faces a reduction in demand while full cream milk experiences  an increase in demand)

  
  

• Price of Related Goods:

  1.Substitutes: An increase in the price of one good increases demand for its substitute (eg: tea and coffee).

  2.Complements: An increase in the price of one good decreases demand for its complement (eg:cars and petrol).

  
  

• Consumer Preferences: Changes in tastes or trends can shift demand.

• Population Changes: More people = greater demand.

• Expectations: Expectation of future changes in price can affect the present demand. If consumers expect prices to rise in the long-run, there will be an increase in demand for the products in the short-run.

2. Supply

Definition: The quantity of a good or service that producers are willing and able to sell at a particular price.

Factors Affecting Supply:

• Price:Higher price leads to greater supply; conversely, supply decreases when price decreases. The relationship between price and supply is positive. 

• An increase in supply leads to a surplus which results in a lowered price(S to S1 and Pe to P1).

•  A decrease in price leads to scarcity and increased prices(S to S2 and Pe to P2)

• Expansion in supply is an increase in supply along with price(Pe to P2 and Qe to Q2).

• Contraction in supply is a decrease in supply along with price(Pe to P1 and Qe to Q1)

•  Costs of Production: Increased production costs can lead to a decrease in supply. 

• Technology: Advances in technology can increase supply as more amount of goods can be produced with the same productive potential

• Taxes and Subsidies

  1. Taxes: Indirect taxes are imposed on firms/producers by the government to gain government revenue. It can also be imposed to reduce the supply of the good(Demerit goods)

  2. Subsidies: Subsidies are granted to help an industry or firm by offering an incentive to continue production and not quit the market. 

  
  

• Price of Related Goods: 

  1.Substitute goods-Goods that can be used to fulfil the same purpose(Physical books and e-books)

  2.Complementary goods-A good which is used along with another good(Automobiles and fuel)

  
  

• Expectations: Changes in the supply curve are possible based on what producers expect to happen to price in the future

• Natural Factors: Weather, natural disasters, etc., can influence supply, especially agricultural

3. Equilibrium

Definition: The point where demand equals supply, determines the market price and quantity.

Disequilibrium:

Excess Demand: When the price is below equilibrium, then there are shortages.

Excess Supply: When the price is above equilibrium, then there are surpluses.

4. Price Elasticity

5. Applications

Government Intervention:

Price Ceilings: Maximum price below equilibrium (e.g., rent control).Done by the government to make the product more affordable for the public, imposed on items such as food and medicine

Price Floors: Minimum price above equilibrium (e.g., minimum wage). Ensures producers don’t get exploited.

Market Efficiency: Supply and demand efficiently allocate resources.