Saturday, 2 April 2011

Demand and Supply (Microeconomics)

This post will broken down into demand, supply and then demand with supply. Lets go...

Firstly, demand. Demand is the willingness and ability to buy a good at any given price. It is shown by a demand curve on a supply and demand diagram, and it shows the relationship between quantity demanded and price. There are two types of demand, effective demand and notional demand. Effective demand is the willingness and ability to buy a good, whereas notional demand is the desire for a good. The relationship between price and demand is inverse... so the lower the price - the higher the demand. There are many factors that determine the demand of a good, they are:
  • Tastes or preferences - If a good is currently 'in', or the taste for a product increases then demand will increase. If it's out of fashion or the taste for it decreases then demand will decrease.
  • The number of consumers - Simply put, more consumers will generally increase demand... less consumers will decrease demand.
  • The income of consumers - If income increase then demand for superior goods such as Bentleys or TVs increases and vice versa. For inferior goods, such as tesco value food, as income increases demand decreases as consumers move to better quality goods. 
  • Price of related goods - Using phones as an example, if Nokia phones are really expensive then demand for Samsung phones may increase. Opposite will happen if Nokia phones and really cheap. 

Now onto supply. Supply is the quantity of a product that producers are willing to provide at different market prices over a period of time. The relationship between price and supply is fairly obvious, the higher the price - the more producers are willing to supply to the market (higher supply). The determinants of supply are:
  • Production costs - If production costs rise you'd expect a fall in supply, if they fall you'd expect a rise in supply. If its cheaper to make a good, then more will be produced.
  • Size and nature of industry - In a competitive industry, any changes in cost will effect supply, however in a market with only one or two major players, any changes in cost can be passed onto the consumers without having to change supply.
  • Government policy - Governments may change taxes, or introduce legislation restricting supply. Each would have an effect on supply.
  • Natural disaster - Something such as a hurricane may wipe out workers or factories, thus decreasing supply.

When you combine a supply curve and a demand curve onto one diagram, we get presented with a price. The supply and demand diagram is usually set up with price up the y axis and quantity along the x axis. Here is an example...

This is a simple demand and supply diagram, which shows us how prices are determined. The point 'PQ' on the diagram is where the supply curve and the diagram curve meet, meaning the position where both buyers are willing to buy and sellers are willing to sell -  both parties are satisfied. This point is referred to as the market equilibrium price or the clearing price. 

The equilibrium point isn't set in stone and changes as either the demand or supply curve changes. The next image will show this... 

In this new diagram we can see that supply and demand have both changed. Supply has increased, so the curve has shifted to the right from "supply" to "supply 1". Demand has also increased, and thus the curve has shifted to the right from "demand" to "demand 1". The result of this is a new market equilibrium point of 'P-Q1'. What this shows is that any changes in supply or demand will result in a new equilibrium price.

That's all the basics for supply and demand, the next post will be about complimentary and sustitute goods. Thanks for reading!

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