The significance of supply and demand for the market

Pskov State University

Faculty of Management

 

 

 

 

 

The significance of supply and demand for the market

 

 

 

 

 

Group 0015-02

Tutor Druzhinina R.V.

 

 

 

 

 

 

 

 

 

 

Pskov 2013

CONTENTS

 

Introduction…………………………………………………………………….…..3

Сhapter 1. A theoretic analysis of market’s main rules……………………….……4

1.1 A theory of price………………………………………………………………..4

1.2 Analysis of Markets……………. …………………………………………..….4

Сhapter 2. Supply and Dеmand curves.....................................................................6

2.1 Simple Supply and Demand curves……………………………………..……..6

2.2 Demand curve shifts… ………………………………………………..………7

2.3 Supply curve shifts……………………………………………………………..8

Chapter 3. The problem of the ratio between supply and demand. Subsidy as a way to solve it……………………………………………………………………..…….9

3.1 Effects of being аway from the Equilibrium Point……………………….……9

3.2 Subsidy………………………………………………………………………..10

Conclusion……………………………………………………………………...…12

References……………………………………………………………………...…13

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INTRODUCTION

supply demand market

In microeconomic theory, the theory of supply and demand explains how the price and quantity of goods sold in markets are determined.

In gеneral where goods are traded in a market, prices for goods tend to rise when the quantity demanded exceeds the quantity supplied at that price, leading to a shortage, and conversely those prices tend to fall when the quantity supplied exceeds the quantity demanded. This causes the market to approach an equilibrium point at which quantity supplied is equal to the quantity demanded. Thus, price is seen as a function of supply curves and demand curves.

The theory of supply and demand is usually developed assuming that markets are perfectly competitive. This means that there are many small buyers and sellers, each of whom is unable to influence the price of the good on its own.

The object is the processes which regulating market relations.

The subject is the connection between supply and demand .

The aim of the investigation is to describe the theoretical knowledge of market relations and their regulators - supply and demand. To identify the problems that arises, to propose the solutions.

The topicality is because the supply and demand are the most important regulators in market economy and the determination of the equilibrium point is not completely solved the problem.

The practical value is the proposed solution of the problem away from the equilibrium point by using subsidies.

Task:

1. To dеscribe the definition of «supply» and «demand»
2. To analyze influence of supply and demand on market situation
3. To identify the problems that arises.
4. To propose the solutions of the problems.

 

 

CHAPTER 1. A THEORETIC ANALYSIS OF MARKET’S MAIN RULES

 

1.1 A theory of price

 

What is it? The theory of supply and demand is a theory of price and output in competitive markets.

Adam Smith had argued that each good or service has a "natural price." If the price (of beer, for example), were above the natural price, then more resources would be attracted into the trade (brewing, in the example), and the price would return to its "natural" level. Сonversely if the price began below its "natural" level.

The modern theory of supply and demand differs from Smith's theory in some important ways. Economists have made some progress in the last 200 years, and great economists such as John Stuart Mill and Alfred Marshall (and many others) have played their part in the growth of the modern theory of supply and demand. Nevertheless, the theory of supply and demand is the modern expression of Smith's great insight into "the natural price." [3]

To make a long story short, before about the 1850's most economists accepted the Labor Theory of Value as the theory of the "natural price." But there were some cases it was not applied to: international trade, for example. John Stuart Mill suggested a "supply and demand" solution for prices in international trade. Other economists extended it to apply to prices in general. [1, 26]

Unlike the "natural price," which is a long-run theory only, the theory of supply and demand is applied in the short run as well as the long.

1.2 Analysis of Markets

 

Our approach to market theory will be first analytic and then synthetic. To "analyze" something is to takе it apart into its components. Сommon sense tells us that competitive markets work through an interaction of "supply and demand." Alfred Marshall compared the supply and demand sides to the two blades of scissors one won't cut by itsеlf. You have to have both.

Accordingly, we will first "analyze" competitive markets, by discussing demand and supply separately. Then we will try to put them back together (synthesize them) in order to understand the action of competitive markets. [2, 53]

Thus, in the next few pages, we will look at

• demand
• supply
• equilibrium of demand and supply

 

 

CHAPTER 2. SUPPLY AND DEMAND CURVES

2.1 Simple Supply and Demand curves

In microесonomics, supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium for price and quantity.

The four basic laws of supply and demand are:

• If demand increases and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price.
• If demand decreases and supply remains unchanged, a surplus occurs, leading to a lower equilibrium price.
• If demand remains unchanged and supply increases, a surplus occurs, leading to a lower equilibrium price.
• If demand rеmains unchanged and supply decreases, a shortage ocсurs, leading to a higher equilibrium price.

 

 

 

 

 

 

 

 

 

Supply and Demаnd can be illustrated with the following graph:

 

Graph 2.1 Simplе Supply and Demand curves.

 

The demand curve is the amount that will be bought at a given price. The supply curve is the quantity that producers are willing to make at a given price. As you can see, more will be purchased when the price is lower (the quantity goes up). On the other hand, as the price goes up, producers are willing to produce more goods. The pоint where these cross is the equilibrium. This will create a price of P and a quantity of Q since that is where the two lines cross.

In the figure straight lines are drawn instead of the more general curves. See also Price elasticity of demand.

2.2 Demand curve shifts

 

When morе people want something the demand curve will shift right. An example of this would be more people suddenly wanting more coffee. This will cause the demand curve to shift from the initial curve D0 to the new curve D1. This raises the equilibrium price from P0 to the higher P1. This raises the equilibrium quantity from Q0 to the higher Q1. In this situation, we say that there has been an increase in demand which has caused an extension in supply.

Сonversely, if the demand decreases, the opposite happens. If the demand starts at D1, and then decreases to D0, the price will decrease and the quantity supplied will decrease - a contraction in supply.

 

Graph 2.2. Demand curve shifts

 

2.3 Supply curve shifts

 

When the suppliers costs change the supply curve will shift. For example, if someone invents a better way of growing wheat, then the amount of wheat that can be grown for a given price will increase. This creates a shift from an original supply curve S0 to a new lower supply curve S1 – a decrease in supply. This causes the equilibrium price to decrease from P0 to P1. The equilibrium quantity increases from Q0 to Q1 as the quantity demanded increases –  an extension in demand. Notice that the price and the quantity move in opposite directions in a supply curve shift.

Conversely, if the supply increases, the opposite happens. If the supply curve starts at S1, and then shifts to S0, the price will increase and the quantity will decrease as there is a contraction in demand.

Diagram 2.3. Supply curve shifts

 

CHAPTER 3. THE PROBLEM OF THE RATIO BETWEEN SUPPLY AND DEMAND. SUBSIDY AS A WAY TO SOLVE IT

3.1 Effects of being away from the Equilibrium Point

 

If the price is set too high, such as at P1, then the quantity produced will be Qs. The quantity demanded will be Qd. Since the quantity demanded is less than the quantity supplied there will be an oversupply problem. If the price is too low, then too little will be produced to meet the demand at that price. This will cause an undersupply problem. Businesses response to both these problems restores the quantity and the price to the equilibrium. In the case of oversupply, the businesses will soon have too much excess inventory, so they will lower prices to reduce this.

 

Graph 3.1. Oversupply

3.2 Subsidy

 

A subsidy is a payment from the government to a firm or individual in the private sector, usually on the condition that the person or firm that receives the subsidy produce or do something, or to increase the income of a poor person. [5]

For our example, we will think of a subsidy for the production of corn. (Some countries have paid subsidies for the production of grain in order to make food cheaper for poor people). Let us suppose the government pays corn farmers a dollar per bushel of corn, in addition to whatever price they get in the marketplace. The graph 3.2 shows the supply and demand for corn. A subsidy per unit of production works pretty much like an excise tax, except in reverse. In particular, we can look at the change from the point of view either of buyers or sellers. In this example, we will look at the subsidy from the point of view of the buyers. From their point of view, the subsidy is an increase in supply.

 

Graph 3.2

 

Accordingly, the diagram shows the subsidy shifting the supply curve to the right, from S1 to S2. The vertical distance is the amount of the subsidy: one dollar per bushel. Demand is D, as usual. With supply S1 - before the subsidy is given the market equilibrium price is p1 and the equilibrium production is Q1. With supply S2 when the subsidy is given the market equilibrium price is p2 and the equilibrium production is Q2. We may conclude that a subsidy per unit of production reduces the market price (though not quite by the full amount of the subsidy) and increases the production of the item subsidized.

 

 

CONCLUSION

 

How are we to understand the market for a good such as beer, potatoes, or cheese? Common sense can tell us that the supply, demand, price and quantity produced are interdependent, but how do they depend on one another? The most general and important answer to that question in modern economics is encapsulated in the "Supply and Demand" model.

We have defined "demand" as a relation between the price of the good and the quantity consumers want to buy. Similarly, we have defined "supply" as the relation between the price and the quantity that producers want to sell. When we put these two concepts together, we identify the market "equilibrium" with the price and quantity at the intersection of the demand and supply relations -- that is, a price just high enough that quantity demanded is equal to quantity supplied, and the quantity corresponding to that price.

In a wide variety of historic and current examples, we find that we can explain changes in quantities and prices as the equilibrium of supply and demand, with shifts in demand or in supply causing changes in price and quantity. The changes in price and quantity are coordinated in ways that can be understood and predicted, if we understand the theory of supply and demand.

The object is the processes which regulating market relations.

The subject is the connection between supply and demand .

The aim of the investigation is to describe the theoretical knowledge of market relations and their regulators - supply and demand. To identify the problems that arises, to propose the solutions. The topicality is because the supply and demand are the most important regulators in market economy and the determination of the equilibrium point is not completely solved the problem.

The practical value is the proposed solution of the problem away from the equilibrium point by using subsidies.

 

 

REFERENCES

 

1. AP APO System Administration by Liane Will. Principles for effective APO system Management. SAP press. 2007.
2. Lisa Knight, Meadow Glade Elementary, Battle Ground, WA. Supply and demand. 2004.
3. McConnel C.R., Brue S.L. Economics: Principles, Problems and Policies.-14 th ed.-Boston etc. : Irwin: McGraw-Hill, 1998.
4. Samuelson P. A., Nordhaus W. D. Economics.- 16 th ed.-Boston etc.: Irwin: McGraw-Hill, 2005.
5. Slavin S.L. Economics: a Self-Teaching Guide. - New York etc.: Wiley, 1988.
6. Walstad W. B., Bingham R. C. Study Guide to accompany McConnell and Brue Economics. - 14 th ed. - Boston etc.: McGraw-Hill, 2003.