Market Equilibrium Process, Essay Example

The law of demand says that everything else equal, the demand of a commodity has an inverse relationship with the price of the commodity. When the price of a commodity increases, its demand decreases and vice versa (Investopedia). There are various factors that determine the level of demand. These factors are consumer preferences, number of buyers, consumer incomes, prices of complementary and substitute goods, and consumer expectations (National Council on Economic Education).

Changes in consumer preferences that are positive lead to an increase in demand while negative changes result in declining demand. Similarly, as the number of buyers increase, so does the demand for the commodity and vice versa. The demand of a commodity is also positively correlated to the consumers’ income levels. As far as complementary goods are concerned, the price of the complementary good and the demand for the commodity under consideration are inversely related and the price of the substitute good and the demand for the commodity under consideration are positively related. The last determinant is consumer expectations. If the consumers expect the price to rise in the future, they will buy more of the commodity now and if they expect future prices to drop, they will delay their purchases.

Toyota has recently reported that the demand for its Prius model has been increasing due to rising gas prices. This makes sense because Prius with its hybrid technology is a substitute to traditional cars that only run on gas. Since the cost of owning a traditional vehicle that only runs on gas has been rising, the demand for a substitute which is Prius in this case, has also been rising. This means price will also rise from P1 to P2 due to a shift in demand curve.

The law of supply has a positive relationship with price. When the price of a commodity goes up, suppliers increase their supply to maximize their profit opportunities but declining price results in lower supply of the commodity. The factors that determine the quantity of supply are input prices, change in technology, taxes and subsidies, price of other goods, producer expectations, and change in the number of suppliers (National Council on Economic Education). An increase in input prices increase the cost of production and has an adverse impact on the supply of the commodity. Technologies usually lead to greater efficiencies and increased productivity as well as an increase in the supply of the commodity. Taxes raise cost of production where as subsidies lower cost of production. Thus, taxes reduce and subsidies increase the supply of the commodity. If prices of other commodities go up, suppliers lower the supply of existing commodity and switch to the one yielding higher returns in the market. Thus, an increase in price of another good will lower the supply of the existing one and vice versa. If a supplier expects prices to go up in the future he will delay his sales to the future to take advantage of higher profit opportunities. But if the supplier expects the price to drop, he will be inclined to sell more now. Similarly, the overall market supply is also positively related to the number of suppliers in the industry. It is not surprising that the crisis in Middle East such as in Libya (Alden, 2011) threatened to increase oil prices because of suppliers expectations that prices will rise in the future.

The amount of commodities actually sold as well as the price charged is determined by the market equilibrium which is a point at which the quantity supplied equals quantity demanded, resulting in an equilibrium price. Whenever quantity supplied and quantity demanded are different, market forces act and bring them back to the equilibrium level (EconWeb). If quantity demanded is more than the quantity supplied, there is upward pressure on the price as more consumers compete for limited quantities and the only way a supplier can address the shortage is by raising the price. If quantity supplied is more than the quantity demanded, the suppliers are left with excess inventory and in order to clear the inventory, they lower the price. As price declines, demand rises and price is determined at the level where the quantity supplied equals the quantity demanded. This phenomenon is called efficient markets theory because the collective actions of all the buyers and sellers help achieve equilibrium quantity and price and any disturbances are immediately corrected.

References

EconWeb. (n.d.). Equilibrium: Determination of Price and Quantity. Retrieved April 15, 2012, from http://www.econweb.com/MacroWelcome/sandd/notes.html#3

Investopedia. (n.d.). Law of Demand. Retrieved April 15, 2012, from http://www.investopedia.com/terms/l/lawofdemand.asp

National Council on Economic Education. (n.d.). Determinants of Demand. Retrieved April 15, 2012, from http://docs.google.com/viewera=v&q=cache:nvKISYZdMMkJ:www.councilforeconed.org/resources/lessons/ap_resources/APMicroeconomicsVisualsUnit2.ppt+determinants+of+demand&hl=en&gl=us&pid=bl&srcid=ADGEESglRJ7n5wjN9u9IxUg4E8pTegb7jjw2dTqrSMdX2E-9KjzTqRD-Ozhk