Demand refers to the desire and ability of a consumer to buy a specific product or service. Supply, on the other hand, is the quantity of goods that suppliers can provide for a certain market (Turvey 20). There is an inseparable relationship between supply and demand. The aim of this term paper is to scrutinize in depth the above principal factors of a market.
The difference between demand and quantity demanded.
Demand is the willingness of a consumer to buy or consume a certain amount of goods or services. The willingness to buy or consume the goods or services should be coupled by the ability of the consumer to buy the products. Demand is recorded on a table (demand schedule), which, then, enables one to plot it on a graph, giving rise to a demand curve. (Ahlersten 12). The demand curve is usually downward sloping. This satisfies the law of demand, which states that the higher the price increases, the lesser a product’s demand. Demand is mostly a relationship between price and quantity demanded with all other factors held constant. However, the other factors also come into play, as they determine the position of the curve of the graph (Turvey 22).
Quantity demanded indicates the amount of goods or services that can be demanded in a market for a given period. The total quantity demanded in a market depends on the price of that particular good or service. Market equilibrium does not determine the quantity demanded. One can get the amount of a goods demanded by picking any point of a supply curve. It represents a specific random point on the supply curve (Hoover 17).
Why the typical demand curve has a negative slope
A demand curve is generally depicted as negatively sloped. This brings out the relationship between the price and quantity demand. This demonstrates the law of demand. The law states that a higher a price would result to lower quantity demand of a product. The vice versa is also true. The negative slope also depicts the income and substitution effects. A fall in the price of a commodity means that consumers will tend to substitute expensive goods with the cheaper ones. The consumer’s ability to buy more of the good, whose price has fallen, will increase. This is due to the increased purchasing power brought about by the price fall (Ahlersten 12).
The difference between supply and quantity supplied.
Supply refers to the amount of a product that suppliers or producers of a market are willing and able to offer or sell at a stated price, assuming that all other factors remain constant. Supply quantities, depicted on a supply schedule, enables us to draw a supply curve. A supply schedule is a table, showing how much of a good firms supply at the various prices. Quantity supplied at various prices is plotted, on a graph, to yield the supply curve. The supply curve depicts the relationship between various prices and the quantities of goods that firms are willing to sell at those prices (Turvey 63).
Quantity supplied refers to the amount of goods, supplied to a market at a specific or given price. It refers to a position on a supply curve. The quantity supplied is usually independent of the market equilibrium.
Movement along a curve and a shift in a curve
Movement along a curve depicts the change in quantity of goods, due to change in price. The change is on the same curve, hence, causing it to be named a ‘movement along’. A change in price, with all other factors held constant, causes a movement along a curve. Below is an example of a movement along the demand curve (Hoover 19).
In the above demand curve, the change in price form p1 to p2 causes a change of quantity from q1 to q2. This causes a change in the original prices and quantity. The new point is B, having moved from A.
On the other hand, shift in a curve, represents the total movement of the curve in consideration to a new position on the graph. There will be new quantities and prices on the new curve. Other factors, excluding price, are the causes of a shift in a curve (Turvey 24).
In the figure above, DD represents the original demand before any changes occurred in the market. An increase in the total demand causes the curve to shift to a new position. This is from position DD to D2D2. The quantity demanded at the price of p1 changes or increases from q1 to q2. The vice versa depicts a fall in demand, whereby there is a shift from D2D2 to DD.
Conditions and/or circumstances that shift demand curves.
All other factors, excluding price, cause a shift in a curve. Some of the factors, causing a shift in the demand curve, include the following.
Change in the disposable income of the consumer.
When the income of a consumer rises, the demand curve for normal goods will shift outwards. This is only true for normal goods. For inferior goods, the curve will shift inwards as the consumer will tend to go for more superior substitutes of the inferior goods. The consumer will go for better goods as an increase in income will increase his or her purchasing power (Ahlersten 13).
A rise in the price of a commodity will cause a fall in its demand. Substitutes will appeal to the consumer, in terms of money value, hence, an increase in demand for them. This will cause the demand curve of the goods to shift to the left, and that of the substitute will shift to the right. For complementary goods, a total decrease in demand will lead to a decrease in the other. Complementary goods are those goods, consumed with others. A shift in the demand curve of a complementary good causes a shift in the demand curve of the other good (Turvey 20).
A change in the population size and structure will cause a shift in the demand. An increase in the number of people, consuming a certain product, will cause a rise in its demand. This will lead to a shift in the total demand curve as more of the commodity will be consumed at the original price.
An expectation of a price change, by consumers, will cause the demand of the commodity to change. The consumers will buy more at the current price so as to cushion themselves against a price increase in future. The same is also true in case of an expected shortage by the consumers. This increase in demand causes the demand to shift outwards to the right. The vice versa is also true (Turvey 19).
Changes in the tastes and preferences of a consumer
Taste and preferences have to do with what the consumer likes or wants to consume. Tastes and preferences are assumed to be fixed in the short-run. The assumption is necessary to allow for the derivation of the market demand curve. In the long run, tastes and preferences of a consumer are bound to change. The demand of a product will change if the taste and preferences of a consumer change. This will lead to the shift in the demand curve inwards, caused by the non-change in price. The vice versa is also true for the consumer liking a certain product.
Elaborate on the conditions and/or circumstances that shift supply curves.
A shift in the supply curve is brought about by changes in factors other than the price of the commodity (Ahlersten 14). Some of the factors include the ones discussed below.
The level of technology affects the amount of goods, supplied in the economy. The emergence of a new technology that aid in the production of more goods at the same cost shifts the supply curve. The amount of goods produced will increase with cost still remaining the same (Turvey 15).
Cost of inputs
A change in the cost of inputs will cause a shift in the supply curve of a commodity. An increase in prices will leave the producer able to produce lesser than before. This reduces the total amount to be supplied. A reduction in the cost of inputs will have the opposite effect.
The supply of seasonal goods increases as we approach the mentioned season. An example is the supply of Christmas cards. The supply of the cards increases at the onset of Christmas and reduce significantly after the festivities. The increase in supply will shift the supply curve outwards and a reduction will shift it inwards (Ahlersten 52).
Taxes and subsidies
A tax subsidy is whereby a government enforces selective tax legislation. This reduces the production cost of a firm. This increases the supply and, hence, shifts the demand curve outward. A tax imposition will have the opposite effect (Jochumzen 27).
An anticipated increase in the demand of a product will cause the producers to increase the good’s production. This will increase the supply and cause a shift in the supply curve.
Skills of employees
A change in the skills of employees increases the supply of goods. Supply increases due to the ability of employees to produce more goods, using the same cost. This increases the supply of the goods and causes a shift in the supply curve (Turvey 41).
Income effect and substitution effect
Income effect refers to the change in the amount demanded, of a commodity, after a change in the purchasing power (real income) of a consumer with the relative prices, remaining the same. While substitution effect refers to a change in the amount demanded, of a commodity, after a change in prices with the purchasing power of the consumer remaining the same.
How and why the substitution and income effects dictate the inverse relationship between price and quantity demanded.
The assumption is that the consumer is a rational human being, wishing to maximize utility. An increase in the price of goods will cause the consumer to demand less of the goods. He or she will substitute the expensive goods for the cheaper goods. An increase in a good’s price will cause its quantity demanded to fall. A fall in price will, then, have the opposite effect (Ahlersten 41).
The budget line shifts from B1 to B2 after an increase in the price of X. The consumer changes his or her consumption bundle from point A to point B. The total effect of a price change is depicted by the movement form A to B. The substitution effect and income effects cause the consumption of X to go down from X1 to X2. X is more expensive in relation to Y (B2 is steeper than B1), leading to a substitution effect. The real income in this case has reduced, leading to an income effect of the price. Product B lies on a lower indifference curve than A. Total effect is represented by the addition of the substitution effect to the income effect. B3 is parallel to B2 as it represents a higher price for X. The curve, which must be tangent to the original indifference curve U1, is represented by point C. The point shows the amount of X a consumer will buy in case the price of X increased. In this case, the consumer’s income has been adjusted. The adjustment allows him or her to consume the original bundle. Substitution effect (B to C) is represented by movement from point A to C. Income effect is represented by subtracting the substitution effect (A to C) from the total effect (A to B). The shift in the budget line (from B3 to B4), proves that X are normal goods. This is because the consumption of X goes down from X3 to X2 (Turvey 117).
Why the income and substitution effects move in opposite directions for inferior goods
An inferior good, is a good that a purchaser consumes, due to his or her inability to buy substitutes. Substitutes, in this case, are more expensive than the inferior good of the same product. The consumer will opt not to buy more of the good; in case its price falls. He will, thus, have foregone the use of the income effect. The consumer will, then, opt to use substitution effect by consuming a substitute of the good (Turvey 118).
How the relative magnitudes of the income effect and substitution effect result in upward sloping demand curves for Giffen goods
Giffen goods refer to products whose demand increase as their prices rise. The good is an inferior good, and it does not have any close substitutes. An increase in price of one commodity will lead to the consumer, decreasing the demand of the cheaper good. The substitution will enable the consumer to be able to buy the commodity whose price has shot up. Generally, the substitution effect is lesser than the negative income effect. The net effect of this will result in the fall of price of the commodity and a resulting fall in demanded quantity (Ahlersten 45)
The supply curves of labor and savings have steep positive slopes; we often assume they are vertical.
For labor, the consumer has to choose whether to work or consume leisure. Labor, in this case, stands for the number of hours a person is willing to work. The relationship between work and leisure is negative. The labor supply curve is vertical, as it has to depict this relationship. If one wants to have more leisure, then, they have to work for fewer hours. On the other hand, if the wages increase, the cost of leisure increases. This is because the opportunity cost for not working is the amount of wage you do not get. The individual will be tempted by the substitution (negative) effect to work more. Income effect occurs due to the increase in wage, causing a rise in the whole wage income. In this case, the income effect will tempt the individual to consume more leisure (Jochumzen 36).
Savings is affected by the level of interest rate in the economy. The higher the interest rate, the more an individual is willing to save. The more an individual saves, the lesser the individual will consume. The consumer will opt to substitute consumption for savings, if the rate of interest rises. A graph of savings against interest rate will produce a vertically sloping savings curve. The level of disposable income also affects the amount of savings. An increase in income propels an individual to save more (Turvey 92).
In conclusion, demand and supply are the major factors of a market. Both, demand and supply, determine the interaction between consumers and suppliers. Price is the major determinant of the factors as it determines the level of the two in the market. Factors, affecting demand and supply, apart from price, only determine their position on a graph. The changes in prices of the various goods in a market determine the amount of a commodity that a purchaser can consume. The price change causes both substitution and income effect to the consumer. The consumer will, then, choose whether to utilize the income or the substitution effect. The two effects income and substitution cut across various areas of an individual’s life. This is portrayed in the labor market and savings’ curve. The consumer has to apply the two effects to determine his or her personal consumption in the labor market, in case of a change in wages. In a market, the suppliers of goods and services have to incur a certain cost. All expenses for the production of a good add up to give us total cost. The differentiation of the total cost will give us the marginal cost (cost of producing an extra unit). The marginal cost curve of a firm, in the short run, a period, where one factor of producing a product is fixed, is the supply curve. Demand and supply are, therefore, the most important factors of a market (Ahlersten 93).