Price And Output Determination Economics Essay

This assignment will explain supply and demand and how both are key variables that impact price with examples from everyday life.

Firstly to explain that price is derived by the interaction of supply and demand. The market price is dependent upon both of these components. The market is where an arrangement between buyers and sellers to buy or sell goods or services will occur and can agree on a price. When an exchange occurs, the agreed price is called the equilibrium price.

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2. Demand

“Demand in economics has three characteristics, desire to have a good, willingness to pay for that good and the ability to pay for that good. In absence of any of these three characteristics there is no demand” Gupta G.S (2006).

Demand is based on consumers and is the relationship between the price that is charged and the amount of that product that will be bought at that price. The quantity demanded is the amount of a product people are willing to buy at a particular given price.

3. The Law of Demand states that when the price of a product increases then less will be demanded. When the price of a product is decreased then more will be demanded. The reason quantity demanded is a key variable to price is we must assume people have a limited amount of income. With other things being equal the higher the price of a product the smaller the amount that can be purchased and vice versa.

Most products have substitutes such as Tesco tea is a substitute to Lyons tea. If the price of Lyons tea rises relative to the price of Tesco brand, customers will buy less Lyons tea and more of the Tesco substitute.

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The relationship between price and the amount of product people want can be illustrated on a demand schedule and a demand curve.

4. Demand Schedule illustrated in table 1.1 shows the quantities demanded at each different price other things being equal. We can see as price is reduced demand increases. This demand schedule can then be illustrated by drawing a demand curve which graphs the relationship between the quantity demanded of a product and its price.

Table 1.1 Demand schedule

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Price of Video Game (Euro)

Quantity Demanded of Video Game Per Day

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5. A Demand curve shows how price influences the quantity demanded by plotting price on the vertical axis and quantity demanded on the horizontal axis. As price goes down demand will increase. We can see this from the demand curve illustrated in graph 1.2. that the demand curve slopes downward from left to right indicating as price falls demand increases, for instance if the price of a video game is at 5 Euro there is a quantity demand for 5, however when the price is lowered to 1 Euro the quantity demand increases to 25.

Graph .2 Demand curve

6. Shift in a demand occurs when a good’s quantity demanded changes even though the price remains the same. The shift can increase or decrease depending on a number of factors such as:

When income increases customers will buy more goods and vice versa.

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If the price of substitute goods decreases customers will switch to that product and vice versa.

If price of a complement product decreases the demand for both will rise, i.e. if the price of DVD players decreases the demand for the DVD player and DVD’s will increases and vice versa.

Change in taste influences demand. If customers are in favour of a product demand goes up, when they change against a product demand goes down.

Advertising or the lack of advertising can effect demand

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Population change also has an effect but usually long term.

Graph 2.1 illustrates a shift in demand where that if a consumer’s income increases from 200 Euro to 250 Euro a week, one of the conditions of demand has changed. With the increased income the consumer is willing and able to buy more video games. This leads to the demand for video games per day increasing with no change of price.

Graph 2.1. Shift in demand curve.

http://t2.gstatic.com/images?q=tbn:ANd9GcRRvA8vEjzK48wT3i-XEU4bt-X2k691CLCBIopjodywnatU6xY_Jw

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http://www.netmba.com/econ/micro/demand/curve/

7. A perverse demand curve is when a price rises, demand rises and when price falls demand falls. This is the opposite of a demand curve (figure 1.2). There are two main reasons this may happen.

Giffen goods, named after the economist who discovered the phenomenon was based on the observation that the poor of Victorian London bought less bread when it was cheap. The reason being when the price of an inferior good falls the customer has more income available to buy higher quality goods.

Exclusive goods, is when there is a greater appeal for exclusivity for some consumers and as the price increases so does demand. Examples of exclusive goods are certain types of jewellery and cosmetics.

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8. Supply

Is “a fundamental economic concept that describes the total amount of a specific good or service that is available to consumers” (www.investopedia.com)

Supply is based on manufactures and can be defined as the total amount of goods available for purchase which along with demand is one of two key variables that impact price. The higher the price of a good the greater the quantity that will be supplied other things being equal. There are five determinants of quantity supplied,

The price of the commodity is cost of production plus profit. We expect the higher the price, the more profitable it will be to make thus increasing supply.

If the price of other commodities increase. The production of the commodity whose price that does not increase will make it less attractive than before. Therefore we expect the supply of a commodity will fall as the price of other commodities rise.

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Price of factors of production is an important influence on price. If the cost to produce a product increases the profit margin will be reduced. For that reason if the cost of labour increases this will cause a reduction in supply. However if there is a decrease in cost of labour a larger quantity can be profitably supplied.

The goals of firms. Producers might want to decide to keep the price high to restrict demand keeping profits high, a good example of this is the sale of I-phones. They may also decide to sell as much as possible, even if it costs them some profit in doing so.

The state of technology can aid a producer in minimising his cost of production and increasing efficiency. Mass production is therefore possible with technology, reducing the cost to make a unit.

9. The law of supply states that all other things equal, as the price of a good rises its quantity supplied will rise. This results in producers willing to offer more products for sale on the market at higher prices by increasing production as a way of increasing profits.

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Table 3.1 illustrates a supply schedule showing the different quantities of video game consoles that producers are willing and able to supply at different prices over a given time period.

Table 3.1. Supply schedule.

Price of video game console (Euro)

Quantity supplied per day

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10. A supply curve illustrated in graph 3.2 is a graph that shows the relationship between the price of a good and the quantity supplied.

Price is plotted on the vertical axis and quantity supplied is plotted horizontal axis. The supply curve is upward sloping from left to right reflecting the law of supply. We can see that as the price increases the quantity supplied also increases.

Graph 3.2 supply curve.

http://www.netmba.com/images/econ/micro/supply/curve/supplycurve.gif

http://www.netmba.com/econ/micro/supply/curve/

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11. A shift in a supply curve is when there is a change in supply for a reason other than a change in price.

Graph 4.1. illustrates that the supply curve has shifted to the right. This means that more is supplied at the same price.

The major causes of a rise in supply shifting the supply curve to the right are:

improvements in technology

reduced price of raw materials

reduced production costs

reduced labour costs.

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The supply curve can also shift to the left showing a fall in supply. This means less will be supplied at the same price.

The major causes for this are:

a switch in production to a more lucrative option

increase in price of raw materials

a decline in demand for the product

increases in the cost of production.

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Graph 4.1 Shift in a supply curve

http://www.netmba.com/images/econ/micro/supply/curve/supplyshift.gif

http://www.netmba.com/econ/micro/supply/curve/

12. Price and output determination. The price of a good regulates the quantities demanded and supplied. By combining the supply and demand curves we can show how the actual price of a good and the quantities bought and sold are determined.

13. Equilibrium is where the demand and supply curves intersect showing the point where the quantity demanded equals the quantity supplied. By looking at graph 5.1 where the demand curve crosses the supply curve in the centre is known as the equilibrium. The equilibrium price is referred to as the market clearing price as there is no surplus or shortage.

Surplus occurs when quantity supplied exceeds quantity demanded. Shortage occurs when quantity demanded exceeds quantity supplied.

The equilibrium price will remain unchanged once the demand and supply curves remain unchanged. If either the demand or supply shifts, it will result in a new equilibrium price. Such as if console games are one Euro each, consumer demand can exceed supply. This leads to a shortage of console games in the market. Shortages will to force up the price and consumers contend to buy the product. When prices increase to a point where consumers will not buy the product or buy substitute product, demand decreases. This creates a surplus. To reduce surplus the price goes down and consumers start buying again maintaining equilibrium.

Graph 5.1. Supply and demand curves intersecting

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http://www.netmba.com/images/econ/micro/supply-demand/supplydemand.gif

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14. Conclusion

Supply and demand is considered a fundamental basis of economics. They are key variables of price and output in different markets. They are an essential part of a free market economy that will respond to changes to overcome shortages and surplus and maintain an equilibrium price and help keep the market stable.

Sullivan, Arthur; Steven M. Sheffrin (2003). Economics, principles in action. New Jersey Pearson Prentice Hall.

Gupta G.S (2006) Managerial Economics, Tata Mc Graw-Hill, New Delhi 101 p17

http://www.netmba.com/econ/micro/demand/curve/

http://www.investopedia.com/terms/s/supply.asp#axzz2Jy1zly8F

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