Importance Of Supply And Demand Essay

Question:

Discuss about the Importance of Supply and Demand.

Answer:

Introduction

Supply and Demand are two of the most important feature of any market. Demand is simply the amount the people are interested or willing to buy at the price prevailing in the market. In other words, demand is determined by the buyers and the way that all the buyers respond to changes. Supply is the number of units that buyers are willing to supply at the prevailing price. Changes in supply is determined by the way the quantity produced will differ in the face of changes in price. Market equilibrium occurs at the point where the quantity demanded in the market is equal to the quantity supplied in the market. Any changes in price driven endogenously (with the framework of supply and demand) or exogenously (outside the framework of supply and demand) will have an impact on either the quantity demanded or the quantity supplied. However, this concept can be most conveniently explained with the help of an example. Hence, for the purpose of this paper, the commodity that has been chosen in order to show the changes in demand and supply will have an effect on its price is coffee (Varangis, 2014). Before getting to the supply and demand it would be interesting to define the good. Coffee is consumed by virtually everyone in society and, therefore, to that extent it is a necessity. It is important to bear in mind that the utility that is served by coffee can also be served by tea, green tea, or other forms of tea. Hence, both tea and coffee are perfect substitutes. Along with this there are a number of other factors which influences the supply and demand for coffee which will be covered in the next section. It is essential to keep in mind that the supply and demand are influenced by a number of factors. All those factors are influential in determining the supply and demand. The market equilibrium responds to all the changes in the market for coffee. Hence, change in other factors also lead to shift in market equilibrium which will lead to a shift in either demand or supply or both. Hence, the achieving a state of market equilibrium is a dynamic process which depends on a range of factors which will be analyzed in the next section (Tian, 2013).

Analysis of Supply and Demand – A Case Study of Coffee

As mentioned, the initial assumption made regarding the nature of good is that it is a necessity. Hence, the simple and basic rules of demand will apply here – which is that a rise in demand will be triggered by a fall in price. Similarly, a rise in price will lead to a fall in demand. The effect on the supply curve for a rise in price will be opposite to that of the demand. A rise in price will entice producers to produce more and will lead to a rise in quantity supplied. Therefore, the traditional rules for supply and demand are applicable here, as can be noted from the explanation (Thomas and Maurice, 2008).

For the analysis to follow it is important to make the distinction between increase in quantity demanded and increase in demand. Increase in demand will mean the complete shift of the demand curve either to the left or the right. On the other hand, quantity demanded means the quantity demanded and supplied has changed due to change in the prices. However, there are other external factors which also play a role in fixing the market equilibrium. Analyzing all the factors will be an important part of the exercise that will undertake in order to understand the dynamics of the market equilibrium (Pearson, 2010). There are a number of factors which does play a role in determining the both the level of quantity demanded as well as quantity supplied at the level. More insightful understanding of the dynamics can only come with knowing the factors that influences either the demand or the supply (Mankiw, 2009).

In the coming paragraphs we will first briefly analyze the way in which the market functions. In other words, the diagrammatic presentation along with relevant explanations will be presented in ways in which the changes in supply and demand has on the equilibrium. For instance, how the change in supply and demand does influences the market. The way in which the price and quantity will react will be an important function of the exercise to follow and it will help us to know the dynamics of the changes. After that, we will look at some of the factors which plays a crucial in impacting the supply and demand. The reasons that either demand or supply responds to those factors will also be explained. It is essential to highlight that demand and supply are constantly based on these factors and it is these factors which influences the way in equilibrium changes from one position to the next. The change in the equilibrium from one position to the next is driven by changes demand curve or supply or both the curves (Birchall, 2016).

We will first explain the basic mechanics of the supply and demand. The price that prevails at the intersection of the two curves will be an important part of this discussion. The diagram given below shows the equilibrium price and quantity that prevails in the coffee market. At a price of 5 dollars the quantity demanded and quantity supplied is equal to 10. Therefore, the market equilibrium is given by the point E. This point is the point where the quantity supplied is equal to quantity supplied. In simple terms, when the producers are willing to supply a quantity of 10 whereas the consumers are willing to buy 10 units of the coffee the price that will prevail in the market is 5. This is the standard supply and demand situation that prevails in the market for any good (Gordon, 2005).

If the market moves out of equilibrium then it would throw up scenarios where shortage or surplus would exist. For example, we will assume that, due to some reason, the price of the coffee has fallen to 3 dollars. The fall in the price of coffee could take place due to many reasons. It could, for example, take place because of fall in the price of tea. However, it will be interesting to analyze the fall in the price of the coffee market has on the quantity supplied and quantity demanded (Gravelle, 2007).


We can see that the fall in price of the coffee has drastic implications for situation of supply and demand. At this lower price, the quantity demanded will be 12. The inverse relationship means that a fall in price has increased the quantity demanded. Whereas the quantity that will be supplied at this price will be 8. Therefore, the market is in disequilibrium. Simply stated, the market is out of the equilibrium. In this case, due to the fact the quantity demanded is greater than quantity supplied therefore, it means that the situation of shortage prevails (Confrey, 2012). The quantity supplied at a price of 3 dollars is not able to fulfil the amount that is being demanded in the market. The total shortage in absolute that prevails in the market is 4. Hence, to make up for this shortage, either of the two things have to happen. The first is that either the supply has to increase. Second, the demand has to decrease. The reasonable outcome, under this situation, will be a fall in demand. It is unlikely that the supply will go up at this lower unless some sort of government support is provided by the government. Therefore, this is a situation of the shortage. The alternative situation will be a situation when surplus would prevail in the market. The figure for that has been given below after which the explanation will be gives for the same (Reynolds, 2005).

The above figure shows a situation which is completely opposite to the one which prevailed in the last section. In this figure, it can be easily noticed that at a price of 10 dollars the quantity that is demanded is 8 whereas the quantity that is supplied is 12. Hence, at this price, the quantity supplied is more than the quantity demanded. This is precisely why there is a situation of surplus in the market (Plank, 2009).

At this stage it is essential to point out that in the market of coffee that we have analyzed applied to all the market. Whether a situation of surplus or shortage prevails the market itself will be in a position to come back to come back to equilibrium. In other words, the market has the capacity to be self-correcting, that is, it has all the ability to be able to correct all the misbalance that prevails in the market in terms of supply and demand. At this stage, it is interesting to look at the factors that leads to changes in the price for coffee. The price that prevails in the market is also as a result of equilibrium that prevails in other and the nature of the good. The substitute of coffee is tea. Therefore, if the price of tea falls then it is likely for consumers that consume to shift some of their consumption from coffee to tea. This is nature because the lower price of tea will entice consumers of coffee to shift their consumption. Essentially, this is because both the goods seem to satisfy the same type of utility. As a result, there is no problem for the consumers to switch their consumption from one good to the other (Townsend, 1995).

The other factor that could also influence the market for coffee is the price of the sugar. Sugar is an important ingredient in the preparation of coffee. It essentially the consumption of coffee as sugar is done together and not in isolation. Therefore, it has to be said that changes in the price of sugar will have an impact on the consumption of coffee (Davis, 2015). For instance, an increase in the price of coffee makes the consumption costly. Hence, an increase in the price of coffee will lead to a decrease in consumption of coffee. Therefore, change in the price of sugar also has an impact on the consumption of coffee. In the same way, the decrease in price of sugar will lead to an increase in the consumption of coffee (Wesley, 2009).


The other factors that will influence the market of the coffee production and consumption is the change in the taste and preference of the consumer. For instance, if a medical effects of coffee are discovered then the people will like to increase their consumption for coffee over other forms of eatables (Roberts, 2005). The preference of coffee will go up among the consumer which means more people will consumer coffee. Over a period of time, the demand for the coffee will increase as people will increase their consumption. The effect of the increased demand will be on the demand curve which will shift to the right. In other words, it means that people are willing to consumer increased quantity of coffee at the same price. Therefore, the shift in demand will have an effect on the equilibrium. The change in the equilibrium have been shown in the diagram below (Wexler, 2012).

It is clearly visible from the diagram that the increased demand for coffee will lead not only to an increase in quantity consumed but also to increase in price. Therefore, both the price and quantity supplied and quantity consumed has gone. In this case, for the price to come back to its original equilibrium it is essential for the firms to increase the supply. The supply has to increase by the same amount as the increase in demand for the price to come back at the same equilibrium. Hence, as can be seen, the interplay of supply and demand are driven by different factors which determine the price. The other factor that also plays a role is the income of the consumer. It is important to understand that the demand of the consumer comes from the income as well. If the income of the consumer goes up then the demand will also be impacted. Hence, if the income or the expected income is scheduled to go up then the consumer will increase its spending in the market. The increased spending will also mean that buying additional coffee in the market. This will lead to a shift in the demand curve for money to the right. Hence, the increase in income will lead to a shift in demand curve to the right which will also have an impact on the price and the quantity consumer or supplied. The increase in income will lead to demand curve shifting to the right. The resultant increase of this shift will be an increase in both quantity demanded and quantity supplied. Hence, as quantity demanded will increase will mean that people are willing to buy additional units of coffee. However, the increased demand does not mean that the supply also has increased. Therefore, the effect of it will be an increase in prices (Burkey, 2008).

Conclusion

We have clearly seen that the demand and supply can be influenced by a number of factors. Hence, the determination of the market equilibrium takes place due to a range of factors all of which are very important from the point of view of ascertaining the equilibrium in the market. It is essential to also know that the market equilibrium is not a static concept but changes all the times as per the changes in the other real factors affecting both the consumer and the suppliers. Therefore, the market equilibrium also evolves over a period of time to come to settle at a point. There are a number of factors that are very important and also influences the market and therefore their understanding is of utmost importance (Turvey, 2007). Hence, it is very well understand that the supply and demand are related concepts and operate jointly in the market to determine the price. Further, the market has all the features to be able to correct any disequilibrium that prevails. Any disequilibirium that prevails in terms of excess supply and excess demand can be exploited by the economic agent swiftly to be able to come back at the equilibrium.

Lastly, the concept of supply of demand is one of the most important is microeconomics. An intimate knowledge of how each of the two operates is the basic building block to a more complex models in the microeconomics. The concepts of supply and demand are, to a very large extent, also used in macroeconomics. Hence, to this extent, it is essential to know that understanding how each one of them is really important if one wants to have a thorough understanding how some of other rather important concepts in the field evolve (Bhat and Rau, 2008).

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