Explanation of the Law of Supply and Demand
Question:
How the Law of Demand and Supply Affects Market System Operations in any Economy.
The law of supply and demand is a theory that explains the relationship between supply of resources and the demand for the same resources as well. The theory is key to explaining how the availability of a particular item or product and the desire to own a certain item affects the price of the item. The law of supply and demand has been one of the most basic economic laws as it acts as a tie for all other economic laws. In the market operations, the goal is always to attain equilibrium and so there is always a pull and push in prices until the equilibrium also referred to as market-clearing price, is reached. At this price, the producer is able to sell all the goods that he or she had targeted and the buyer is purchase all the goods that he or she had targeted for as well. This situation mostly works for established brands as upcoming business enterprises tend to face difficulties in sales if they set a high price for any new products. This situation can be quite costly for the producer if he overstocks on the goods and they end up being stored away in the warehouses. This situation forces the price of the items to be lowered and raised until a perfect price is identified (Adam, 2009).
In the supply world especially for a single business enterprise, there are so many contributing factors that include production capacity, production costs from labor to materials, number of competitors that directly affect the business and how the competitors affect the supply of items. There are other factors that affect indirectly among them being availability of material, weather, and reliability of the supply chains (Ehrbar, 2008).
Demand is majorly affected by the quality of a product or item and other not so distant factors such as the substitutes and counterfeits of the products. Other factors include, the amount and extent of advertising done, and shift in process for complimentary products. For example, if the spare parts for cars like Mercedes Benz go down, then there will be more demand placed in for the cars especially in other countries other than the country hosting the production company (Ehrbar, 2008).
In economic activities analysis, the law of demand and supply hardly applies to process as well, it can also contribute to other economic activities such as unemployment, and stock investment. This is due to the fact that if there is a huge demand for products, then there is need for many suppliers and that means a lot of employment opportunities. Howver, if the supply is low, there is the occurrence of a retrenchment happening or lowering of wages to cope with the current economic status. Similarly, there is a likeliness to invest in stock purchases for various companies when there is good demands and supply for products (Ehrbar, 2008).
There is the common understanding that as the price for a product rises, so does the quantity of a product and is the price falls, so does the product demand. This is usually the main goal for producers as they would love to achieve maximum profits for a products, however, the consumers dictate the demand and in most situations, when a product price rises, there are lesser demand for the products. Most buyers tend to purchase products with lesser prices than the higher ones if the availability of variety is available. Similarly, if the consumers had liberty to purchase all products at cheap prices, then there would be less supply of products from the producers and thus, the producers fluctuate the prices in order to attain profits from their goods (Adam, 2009).
Factors Affecting Supply and Demand
The law of supply and demand dictates how market prices for products are determined universally and it also helps in shaping decisions centered towards consumption and production. This makes the basis to the economic system of any nation. This theory is sometimes seen as untrue as in the case of labor, when the wages rise, then the supply of goods and services get reduced as wages are input of labor. Being that labor is one of the biggest determinants in success of supply and demand, the increase in wages will result to decrease in supplies. Demand is not an independent factor as it solely depends on consumption of goods and services that are provided by through supply. Demand is facilitated through trades where there is an exchange of items like money for goods and services (CFI, 2018).
A demand gives money through the supply of goods and or services where the labor cost is subsidized and the consumer side is able to utilize the labor and thus making the demand process always dependent on the labor cost from the supply side. This means that when there is reduction of labor cost on the supply side, then there is also reduction on the money used to place in demands. Though demands and supplies are independent variables, they interrelate and in a symbiotic relationship where they depend on each other. Therefore, as initially thought, the law of demand and supply doesn’t exist as a free system but a closed system (Dowell, 2018).
A country’s government plays significant roles in through national boundaries in terms of common currencies. A common currency creates a fair market for demand and supply of goods. Similarly, there are common regulations that dictate trade and a fixed base of individuals that the system models. The constants that the environments create enable the model to produce valid results that are free of irregularities (Dowell, 2018).
Any government like the Australian government, if there is a shortage of skills in terms of labor. Then employers need to raise the wages in order to attract individuals to the job opportunities for employment. If there is a surplus of goods in a warehouse, then the process will fall according to the law of supply and demand. If labor on the supply side is taken out, and replaced with cheaper labor from different sources, then there is much of demand from the demand side and thus the price of goods and services drop in order to accommodate the loses. Should the demand continue falling and falls to zero, then the economy will collapse due to lack of a point of equilibrium (Kirzner, 2000).
More to that, taking out labor out of the closed system, makes the law of supply and demand null and void on a smaller scale but is still approved in a large stream like the world. It is therefore erroneous and somewhat an economic fallacy when labor markets are considered in the theory as they operate on different systems when compared to the other variables. The variable tends to be inoperative as a different government means different laws and standard of living and thus there is still a stable criteria for assessing economic competition. This means that when considering the law of demand and supply, the variables to be considered are consumers, and goods and services in a closed system. This is free of exports and imports in the foreign exchange program. The economists place major focus in the market results than rather in influencing of prices which is determined through an economic model (Kirzner, 2000).
While there are so many other factors, the major factors to promote successful supplies and demand is the market where the trade takes place. It’s driven by the sentiment. The law of supply and demand is suitable for the market economy as it protects the private property. At the same time, monetary policies in for a country are affected by the law of demand and supply right to adjustments of interests rates. When the interests are low, then more people are able to borrow money which directly influences increase of supply as there is more money that is available in the economy. This enables employment opportunities, increased economic activity and asset prices tailwind. When the interests increase, then people retain their money in the banks and away from the economy and take use of the risk-free rate of return which results in decrease of economic activity and dampens asset prices (Dowell, 2018).
The Federal Reserve which is responsible for banking of money and distribution, stimulates an economy by increasing avail of money supply so as to stop deflation, boost asset prices and increase employment. Similarly, it reduces inflation pressures through raising interest rates and decreasing the money supplies. This is one of the key initial steps that the reserve takes in order to manage a near situation of recession. During recession, it decreases rates and raises them when the economy is overheating. When the interests are lowered there is an increase in money supply even though the number of assets remain constant as the demand for the same increases which results in high prices for acquisition of assets. The dollar circulation decreases and the pressure on prices lower for acquisition of the assets and the law of supply and demand (Ehrbar, 2008).
Conclusion
The environment also affects the trading and prices. This is made possible for situation where there is lack of supply of goods and services but a high demand. In such an environment, prices can be influenced to suit the supplier. There is more to the market than just demand and supply in terms of prices, there is also the preference of assets, production capacity, prediction costs and competition. Even with all the variables, the ultimate key component of the power of choice. At the end of the day owners are free to produce, sell and purchase services or and goods in a free but yet competitive market.
References
Adam, G. (2009). Economic Theory – Supply and Demand. Science20, 1.
CFI. (2018). What is a Market Economy? Corporate Financial Institute (CFI), 1.
Dowell, D. (2018). How Supply and Demand Impacts Decisions in Business. Chron, 1.
Ehrbar, A. (2008). Supply. Library of Economics Liberty, 1.
Hayes, A. (2018). Economics Basics: Supply and Demand B. Investopedia, 1.
Kirzner, M. I. (2000). The Law of Supply and Demand. Foundation for Economic Education, 1.
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