|
law of supply and demand
the claim that the price of any good adjusts to bring the quantity supplied and the quantity
demanded for that good into balance
Prices as Signals
If the government announced that there was going to be a cull of beef cattle because of some
disease, if workers at major copper mines go on strike, the chances are that the price of beef and
copper would rise. Markets are subject to change and changes in the factors that affect supply and
demand other than price cause a shift in the curve and bring about disequilibrium. The many buyers
and sellers in a market all make independent decisions which act as forces for changes in price. Why
do buyers and sellers react when prices change? The reason is that price acts as a signal to both
buyers and sellers.
Economists have conducted extensive research into the nature and determinants of both demand
and supply. It is useful to have a little bit of background knowledge on this to help understand markets
more effectively. The main function of price in a free market is to act as a signal to both buyers and
sellers. For buyers, price tells them something about what they have to give up (usually an amount of
money) to acquire the benefits that having the good will confer on them. These benefits are referred
to as the utility or satisfaction derived from consumption. If an individual is willing to pay
€10 to go
and watch a movie then economists will assume that the value of the benefits gained from watching
the movie is worth that amount of money to the individual. But what does this mean? How much is
€10 worth? Economists would answer this question by saying that if an individual is willing to give
up
€10 to watch a movie then the value of the benefits gained (the utility) must be greater than the
next best alternative that the
€10 could have been spent on. Principles 1 and 2 of the Ten Principles
of Economics states that people face trade-offs and that the cost of something is what you have to
give up to acquire it. This is fundamental to the law of demand. At higher prices, the sacrifice being
along the demand curve. Equally, some sellers in the market respond to the falling price by redu-
cing the amount they are willing to offer for sale (a movement along the supply curve). Prices
continue to fall until the market reaches a new equilibrium. The effect on price and the amount
bought and sold depends on whether the demand curve or supply curve shifted in the first place
(or whether both shifted). This is why analysis of markets is referred to as comparative statics
because we are comparing one initial static equilibrium with another once market forces have
worked their way through.
If the shift in demand or supply that causes the equilibrium to be disturbed creates a shortage in
the market, buyers’ and sellers’ behaviour again ‘forces’ price to change to bring the market back
into equilibrium. A shortage or situation of excess demand occurs where the quantity of the good
demanded exceeds the quantity supplied at the going price; buyers are unable to buy all they want
at that price. With too many buyers chasing too few goods, sellers can respond to the shortage by
raising their prices without losing sales. As the price rises, some buyers will drop out of the market
and quantity demanded falls (a movement along the demand curve). Rising prices encourage some
farmers to offer more milk for sale as it is now more profitable for them to do so and the quantity
supplied rises. Once again this process will continue until the market once again moves toward
the equilibrium.
Thus, the activities of the many buyers and sellers ‘automatically’ push the market price towards the
equilibrium price. Individual buyers and sellers don’t consciously realize they are acting as forces for change
in the market when they make their decisions but the collective act of all the many buyers and sellers does
push markets towards equilibrium. This phenomenon is so pervasive that it is called the
Do'stlaringiz bilan baham: | 
