Economics - Supply and Demand

Economics

Introduction

In a free market if supply and demand do not equal, there will be a change in supply and/or demand in order to achieve a market equilibrium and therefore the most efficient allocation of resources. However sometimes market fails to produce the best outcome for society. Therefore, government intervention is necessary. A market is where buyers and sellers exchange products & services. Equilibrium occurs when the supply of goods equals demand. If there is too much demand and not enough quantity or not enough demand and oversupply the market becomes unbalanced.

Disequilibrium occurs when supply does not equal demand. This results in a misallocation of resources such as land, labour, capital and enterprise.

The price of goods plays a crucial role in determining an efficient distribution of resources. Price acts as a signal for shortages and surpluses which help companies respond to changing market conditions. In a market economy, price is determined by demand and supply. According to the law of demand, the quantity of a good demanded falls as the price rises, and vice versa. As to law of supply, it shows that the quantity of a good supplied rises as the market price rises, and falls as the price falls.

In figure 1

[pic 1],

it shows the increase and decrease of demand and the line has been shifted to left or right. The main factors that cause change in demand are change in preference, falls/rises in price of a substitute good and future expectation. Taking PlayStation as an example, if the price of the games is dropped, demand for the PlayStation console would increase as gamers would prefer to buy a console whose games are cheaper so that they can have more games to entertain themselves with and vice versa if the games are expensive, they would probably substitute it with alternative such as Xbox whose games are more affordable leading to a decrease in demand for PlayStation.

As shown in figure 2,

 [pic 2]the increase or decrease in demand directly determines if the supply contracts or expands. If the demands for PlayStation console increase, SONY would rise the supply to maximise profit and if the demand decreases, the supply contracts to avoid oversupplying.

There is a market strategy called seasonal pricing which involves both law of supply and demand. This technique is commonly used by seasonal business such as tourism business including airline and hotels, clothing business. The price of flights and hotels increases massively as more people go on vacations which means there is a rise in demand which leads to rise in supply and price. In the fashion business, the outfit is determined by the season whether it is hot or cold. In summer, demand for long-sleeved or winter items is lower so companies mark down the price of winter items in order to rise the demand by tempting customers with ridiculously low price and there is a need of getting rid of old items and replacing them with new one in order to keep up with the fashion trend.

In reality, the market mechanism does not always produce a socially optimal outcome.

this is called market failure. Market failures can take many forms such as negative externality, oversupply of demerit goods and anti-competitive behaviour by businesses.

An externality is a consequence of an economic activity experienced by unrelated outsiders not involved in the market transaction, or in other words, people who are not buyers or sellers being affected by a production or consumption of a good. An externality can be either positive or negative. Positive externalities occur when consuming a merit good and benefits to the society than your personal benefit. For instance, consuming any kind of education or attending a university not only benefits that particular person and makes them qualified for a certain skill or ability but with their professional skills acquired, they contribute to the society, thus everyone benefits from it. For negative externality, social cost is greater than private cost. The consumption of demerit goods like cigarette and alcohol has negative impacts on the third-party. For example, the consumption of alcohol makes the drinker intoxicated and leads to rise in crime rate and arise other health issues. According to SA health, 58% of victim-reported crime was alcohol related, while 65% of serious assaults were alcohol related in the Adelaide CBD between 2008 and 2009. Another report stated that 5554 deaths 157132 hospitalisations were caused by alcohol which increases the demand for medical care. The free market level of consumption usually disregards the occurrence of externalities and that is the reason government intervenes by introducing different policies, for example imposing taxes, penalising consumer with fine or even banning a certain product. In South Australia, in the legal “dry zone”, it is illegal to carry any opened alcohol and offenders would receive a $165 fine ticket.

It should be emphasized that both kinds of externalities can cause market failure as it is often forgotten by people that positive externality also causes market failure. When positive externalities exist, market generated output is lower than the socially optimal level and marginal social benefits exceed marginal private benefits. When merit goods are under-produced, it is also a type of market failure. To fix this issue, government intervenes by providing subsidies which lowers the private cost and it increases the market generated output

Referring to figure 2 [pic 3] it shows the impacts of government intervention. D1 is the initial demand when the demerit good is sold at the initial price. However, when government increases the cost of the good by taxation, the demand contracts and the equilibrium quantity is decreased. In addition to taxation, positive advertising campaign leads to decreases in demand as the line shifts to the left.

Another common cause of market failure is lack of competition in the market. When a monopoly is creating, they might exploit their market power which builds up barriers to entry for small-sized company leading lack of choices for consumers, lower quality of good and higher prices. And in oligopolies, serval power firms might cooperate with each other to reduce consumer welfare which is referred as collision or we ourselves as customers would call it “ripping off”. The Australian government enforced the competition and consumer act in 2010 aiming to enhance the welfare of Australians by promoting fair trading and competition, and through the provision of consumer protections. It protects small-business from deceptive conduct and anti-competitive behaviour such as price fixing and market sharing agreement. It also protects consumers from being “ripped off” through the law that illegalize misleading information and the ACCC is also obligated to investigate the alleged companies that violate the Consumer and competition act and take action on them.