Application of demand and supply to Markets
Leave things up to the market. The market will sort if out. It’s what the market wants. You can’t buck the market. These are typical saying about the market and emphasise the power of market forces. The point is that our lives are affected by massively by markets. Market forces affect the prices of the things we buy and the incomes we earn. Even governments find it difficult to control many key markets. Governments find it difficult to control many key markets. Government might not like it when stock market prices plummet or when oil prices soar, but there is precious little they can do about it. In many ways a market is like a democracy. People, by choosing to buy goods, are voting for them to be produced. Firms finding ‘a market’ for their products are happy to oblige and produce them. The way it works is simple. If people want more of a product, they buy more and thereby cast their votes in favour of more being produced. The resulting shortage drives up the price, which gives firms the incentive to produce more of the product. In other words, firms are doing what consumers want-not because of any love for consumers, or because they are being told to produce more by the government-but because it is in their own self-interest. They supply more because the higher prices ha made it profitable to do so. This is a threshold concept because to understand market forces- the forces of demand and supply-is to go straight to the heart of a market economy and understand what makes it tick. And in the process, prices are the key. It is changes in price that balance demand and supply. If demand exceeds supply, price will rise. This will choke off some of the demand and encourage more supply until demand equals supply-until an equilibrium has been reached. If supply exceeds demand, price will fall. This will discourage firms from supplying so much and encourage consumers to buy more, until once more, and equilibrium has been reached. In the process, markets act like an ‘invisible hand’- a term coined by famous economist Adam Smith. Market prices guide both producers to respond to consumer demand and consumers to respond to changes in produce supply. In many circumstances, markets bring outcomes that people want. As we have seen, if consumers want more, then market forces will lead to more being produced. Sometimes, however, market forces can bring adverse effects. It is important at this stage, however, to recognise that markets are rarely perfect. Markets failures n from pollution to the domination of our lives by big business, are very real. The type of equilibrium we will be examining is known as partial equilibrium. It is partial because what we are doing is examining just one tiny bit of the economy at a time: just one market for eggs because we are assuming that price is the only thing that changes to balance demand and supply: that all the other determinants of both demand and supply are held constant. If another determinant of demand or supply does change, there would then be a new partial equilibrium as price adjusts and both demanders and suppliers respond. For example, if a health scare connected with egg consumption causes the demand for eggs to fall, the resulting surplus will lead to a fall in the equilibrium price and quantity.
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