Economics- Market forces of Demand and Supply: UPSC/ RAS/ HCS/ UPPSC
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Economics- Market forces of Demand and Supply: UPSC/ RAS/ HCS/ UPPSC
Economics can be defined as the science of logically oriented or rational human beings, with unlimited wants, and limited resources.
The limited resources available with an individual forces him to make a choice among his unlimited wants and choose the one he prioritizes the most.
The study of market forces of demand and supply is one of the most concepts of economics. Its proper analysis is very crucial to understand its concept. We have already covered part 1 of this topic. So before starting with this, thoroughly go through that first.
Here's the link for that: Market forces of Demand and Supply: UPSC/ RAS/ HCS/ UPPSC
Now let us begin with this.
Variables affecting a shift in the supply curve
Expectation:
If a firm expects the price of ice cream to rise in the future, it will put some of its current production into storage and supply less to the market today.
Number of Sellers:
If some sellers are to retire from their business, then the supply in the market would fall.
Input Prices:
The supply of a good is negatively related to the price of the inputs used to make the good.
Technology:
The invention of the mechanized good reduces the amount of labor necessary to produce that good. It decreases the firm's cost and raises the supply of goods.
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Exceptions to law of supply
Expectations regarding future prices:
When the sellers expect the prices to rise in the future then they may withhold the supply of goods.
Farm produce:
These products may not react to changes in prices due to heavy dependence on weather conditions.
Perishable commodities:
Sellers cannot wait for a longer time for commodities having a very short shelf life and supply these in the market even when the prices are not rising.
Out of fashion goods:
Sellers may supply goods that are no longer in demand at low prices.
Economic slowdown:
During the low economic phases the sellers may not have the advantage of high prices and hence during such times goods are sold even when they do not witness a price rise in order to recover their costs.
Change in business:
When the present business is on the verge of closure then the seller may sell the goods at lower prices simply to clear them off.
Immediate requirement of funds:
In situations of the immediate requirement of funds, the seller may supply the goods in the market even at lower prices.
Supply of labor:
Initially, the supply of labor is directly related to the wages but after a certain level, the relation between wages and supply of labor becomes inversely related.
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Supply and demand together
- Wherever the Market Demand curve and Market Supply curve will intersect, when taken together on the same figure, that point is called the Market’s equilibrium.
- The price at this intersection is called the equilibrium price and the quantity is called the equilibrium quantity.
- The equilibrium price is also known as market-clearing price because the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell.
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Surplus of good:
- It is a situation of excess supply.
- Sellers respond to the surplus by cutting their prices. It increases the quantity demanded and decreases the quantity supplied. Prices continue to fall until the market reaches equilibrium.
Shortage of good:
- It is a situation of excess demand.
- Sellers can respond to the shortage by raising their prices without losing sales. As the price rises, the quantity demanded falls, the quantity supplied increases, and the market moves towards equilibrium.
Elasticity of demand
- The price elasticity of demand measures how much the quantity demanded a response to a change in price.
- The elasticity of demand = (Percentage change in quantity demanded) / (percentage change in price)
- It is always negative.
- Demand for a good is said to be elastic if the quantity demanded response substantially to changes in price.
- Demand is said to be inelastic if the quantity demanded response only slightly to changes in the price.
- It measures consumer behavior.
Factors affecting price elasticity of demand
Availability of close substitutes:
- Goods with close substitutes have more elastic demand.
- For eg., a small increase in the price of tea, assuming the price of coffee is held fixed, causes the quantity of tea to be sold to fall by a large amount.
Necessities versus Luxuries:
- Necessities like visiting a doctor have inelastic demand.
- Luxuries like buying a television have elastic demand.
Time Horizon:
- Demand is elastic in the long run.
Elasticity of supply
- The price elasticity of supply measures how much the quantity supplied responds to a change in price.
- The elasticity of supply = (Percentage change in quantity supplied) / (percentage change in price)
- Supply for a good is said to be elastic if the quantity supplied response substantially to changes in price.
- Supply is said to be inelastic if the quantity supplied response only slightly to changes in the price.
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Factors affecting elasticity of supply
- It depends on the flexibility of sellers to change the number of goods they produce. For eg., beachfront land has an inelastic supply whereas manufactured goods have an elastic supply.
- Supply is more elastic in the long run. Over a short period of time, firms cannot easily change the size of their factories to make more or less of a good.
Types of markets
There are 3 types of markets:
- Perfectly Competitive Market
- Monopoly
- Imperfect Markets
Features of Perfectly Competitive Market:
- Multiple buyers and sellers in the market
- The goods offered by the various sellers are largely the same.
- Firms can freely enter or exit the market.
Each buyer and seller takes the price as regulated by the market, hence ‘price taker’.
Monopoly:
- A monopoly such as Microsoft has no close competitors and therefore, can influence the market price of its product. Therefore a monopoly firm is a price maker.
Reasons for monopoly:
- A key source is owned by a single firm.
- The government gives a single firm the exclusive right to produce some goods or services.
- The costs of production make a single producer more efficient than a large number of producers.
Natural monopoly:
- An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.
- Eg., distribution of water
Imperfect markets:
Oligopoly:
- Market with only a few sellers, each offering a product similar or identical to the others.
- Eg., Oil, Pharmaceuticals
Monopolistic:
- Market with many firms selling products that are similar but not identical.
- Eg., Markets for novels, movies, CDs
- They have to incur high advertising costs.
- Each firm has a monopoly over the product it makes.
Engel’s law
- According to Engel’s law, as income rises, the proportion of income spent on food falls, even if absolute expenditure on food rises.
- The income elasticity of demand for food lies between 0 and 1.
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