Understanding Supply and Demand in Market Economies
Supply and Demand
Supply and Demand: These are the forces that make market economies work, determining the quantity (Q) of each commodity produced and its selling price. It’s about the behavior of individuals as they interact in markets.
Price
Price: The price of a good represents its exchange value in terms of money; that is, the number of currency units required in exchange for one unit of the good. Price provides information and incentives.
Market
Market: A group of buyers and sellers of a good or service. It encompasses every social institution in which goods, services, and factors of production are traded freely.
Demand
Quantity Demanded (Qdda): The quantity of goods that buyers are willing and able to purchase.
Factors Influencing Individual Demand
- Price: Qdda is negatively related to price.
- Income: A reduction in income generally means less to spend overall.
- Taste: This is the most obvious determinant.
- Expectations: Our expectations about the future can influence our current demand for a good or service.
Law of Demand: States that, keeping everything else constant, the quantity demanded of a good falls when its price rises.
Supply
Quantity Supplied (Qoff): The quantity of a good that sellers are willing and able to sell.
Factors Determining Individual Supply
- Price: The quantity supplied increases when the price rises and decreases when the price is low. This positive relationship is fundamental.
- Prices of Factors: The supply of a good is negatively related to the price of the factors used to produce it (less is offered when the factor price rises).
- Technology: By reducing manufacturing costs, technology increases supply.
- Expectations: Seller expectations impact supply.
Law of Supply: States that, *ceteris paribus* (all else being equal), the quantity supplied of a good increases when its price rises.
Supply and Demand Together
Equilibrium: The condition where supply and demand are equal.
- Equilibrium Price: The price that balances supply and demand.
- Equilibrium Quantity: The quantity supplied and demanded when the price has been adjusted to balance supply and demand.
At the equilibrium price, the quantity of the good that buyers are willing and able to buy is exactly equal to the amount that sellers are willing and able to sell.
Elasticity
Elasticity: A measure of how much the quantity demanded or quantity supplied responds to changes in one of its determinants.
Price Elasticity of Demand
Price Elasticity of Demand: A measure of the degree to which the quantity demanded of a good responds to a change in its price.
Price Elasticity of Supply
Price Elasticity of Supply: A measure of the degree to which the quantity supplied of a good responds to a change in its own price, *ceteris paribus*.
Minimum Wage
Minimum Wage: The lowest wage that can legally be paid to an employee.
- Advantages: Ensures a minimum income for those working.
- Disadvantages: Can cause a reduction in labor demand, leading to unemployment.
Political Question: The trade-off between low wages and unemployment is a key political consideration.
Taxes
Taxes: The government imposes taxes for several reasons:
- To Raise Government Revenue: For public spending (infrastructure, education, health, social programs, etc.).
- To Discourage/Encourage Certain Behaviors:
The incidence of taxes refers to how the tax burden is distributed among market participants. It may fall primarily on the producer, the consumer, or both. A tax creates a shift in the natural market equilibrium: buyers pay more, and sellers receive less, regardless of who is formally responsible for paying the tax.