The market is an amazing instrument, it enables people who have never met and who know nothing about each other to interact and do business. Supply & demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy.
Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship.
Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The connection between price and how much of a good or service is supplied to the market is known as the supply relationship.
In this report we will see analyze the factors that causes the demand and supply curve to shift and what causes movements along both these curves. Both the supply curve and the demand curve can experience movements and shifts cause by price and other external factors that will be discussed below.
The Demand Curve
The above figure shows the demand relationship with the help of the demand curve. We can see that at point A when the price is highest at P1 quantity demanded is lowest at Q1. As price decreases from P1 to P2 and P3, the quantity demanded increases to Q2 and Q3 respectively as shown at the point B and C. The graph illustrates the demand relationship that explains that as P increases the demand at points (A, B and C) in the market decreases hence the Q decreases. This demonstrates a downward slope. We know that, the quantity demanded of a good usually is a strong function of its price. Demand is illustrated by the demand curve and the demand schedule. The term quantity demanded refers to a point on a demand curve. (OSullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall)
Movement along the demand curve:
A movement along a demand curve is defined as a change in the quantity demanded due to changes in the price of a good will result in a movement along the demand curve. For instance, a fall in the price of apples from P1 to P2 causes an increase in the quantity demanded from Q1 to Q2. http://www.bized.co.uk/virtual/vla/theories
In other words, a movement occurs when a change in the quantity demanded is caused only by a change in price, and vice versa.
Difference between movement or shifts along the demand curve
Changes in demand for a commodity can be shown through the demand curve in two ways namely:
-Movement along the demand curve.
-Shifts of the demand curve.
The change in the demand of a commodity due to change in its price leads to moving the demand curve upward or downward depending upon the change in price. When the price rises, the demand falls. And when the price falls the demand for that commodity rises leading to movement in the demand curve. Shift in the demand curve is the result of the price remaining constant but the demand changing due to several other factors such as, change in fashion, income, and population, etc. (Krugman, Paul, and Wells, Robin. Microeconomics. Worth Publishers, New York. 2005.)
Shifts in the demand curve:
A shift of the demand curve is referred to as a change in demand due any factor other than price. A demand curve will shift if any of these occurs:
Change in the price of other goods (complements and substitutes); leading to increase / decrease of real income.
Change in the income level.
Change in consumers taste and preferences.
Change in expectations.
Each of these factors tends the demand curve to shift downwards to the left or upwards to the right. While downward shift signifies decrease in demand, an upward shift of the demand curve shows an increase in the demand. For example, if there is a positive news report about FMCG products, the quantity demanded at each price may increase, as demonstrated by the demand curve shifting to the right. There are many factors may influence the demand for a product, and changes in one or more of those factors may cause a shift in the demand curve. ?
An outward (rightward) shift in demand increases both equilibrium price and quantity.
As shown in the demand curve if any of these changes factors changes, the demand curve will shift to D2 from D1 and accordingly the price and quantity demanded will change. Movements along a demand curve is the result of increase or decrease of the price of the good, while the demand curve shifts when any demand determinant other than price changes.
Factors that causes the demand curve to shift
Various factors affect the quantity demanded by a consumer of a good or service. A number of factors may influence the demand for a product. The key determinants of demand are as follows: -( Parkin, Powell, Matthews (2008) Economics, Pearson Education Limited, 7th Edition)
Price of the good:
This is the most important determinant of demand. The relationship between price of the good and quantity demanded is generally inverse as we will see later while studying law of demand.
Price of related goods:
If the price of a substitute goes down than the quantity demanded of the good also goes down and vice versa.
If the price of gasoline goes up the quantity demanded of automobiles will go down. An increase in the price of a complement reduces demand. Thus the prices of complements have an inverse relationship with the demand of a good.
Higher the income of the consumer the more will be quantity demanded of the good. The only exception to this will be inferior goods whose demand decreases with an increase in income level.
Individual taste and preferences:
A preference for a particular good may affect the consumers choice and he / she may continue to demand the same even in rising prices scenario. Expectations about future prices & income: If the consumer expects prices to rise in future he / she may continue to demand higher quantities even in a rising price scenario and vice versa.
Supply is the quantity of a good or service sold or willingness to sell for consumption by the producer for a price at a given point of time.
Law of supply
The law of supply staes that the quantity of a good offered or willing to offer by the producer/owners for sale increase with the increase in the market price of the good and falls if the market price decreases, all other things remaining unchanged?An increase in price will increase the incentive to supply which means that supply curves will slope upwards from left to right. Supply curves can be curves or straight lines?Consider the supply of labour as shown in the figure below.
The above supply curve shows the hours per week at job by the labour on the X axis and hourly wages on the Y axis. As we can see that as the hourly wages increases the hours spent on job also increases. Thus the supply curve is a left to right upward sloping curve
Movement along and shifts in supply curve
Changes in the determinants of the supply cause movement along the supply curve or shifts in the supply curve. ?We will discuss these two phenomenons in detail as below: Movement along the supply curve
Movement along the supply curve happens due to change in the price of the good and resulting change in the quantity demanded at that price. ?For instance, an increase in the price of the good from P1 to P2 in the figure below results in an increase of quantity supplied of the good from Q1 to Q2. This movement from point A to point B on the supply curve S due to change in price of the good all other factors of supply remaining unchanged is called movement along the supply curve. http://faculty.winthrop.edu/stonebrakerr/book/demand_and_supply.htm
Shifts in the supply curve
Shift in the supply curve is also sometimes referred as a change in supply.
This happens due to changes in factors of supply other than that of price of the good?For example, if the price of a factor of a related good increases the supply curve shifts. Similarly changes in technology and government tools like tax and subsidy tends to shift supply curve.?
The supply curve can shift to the right or left as shown in the figure below. A shift towards the right i.e. from S1 to S2 curve denotes an increase in supply of the good at all levels of prices. Similarly a shift in the supply curve from S1 to S3 denotes a decrease in supply of the good at all levels of prices?As seen in the figure above a rightward shift in the supply curve from S1 to S2 increases supply from Q1 to Q2 while the price of the good remains same at P1. Similarly a leftward shift from S1 to S3 decreases supply from Q1 to Q3 whilst the price remaining unchanged at P1?A shift in supply will occur if either of the following changes:
the (opportunity) cost of resources needed to produce the good
the technology available to produce the good.
Either factor could cause the supply curve to shift to the left (a decrease in supply) or to the right (an increase in supply). http://ocw.mit.edu/courses/economics/14-01-principles-of-microeconomics-fall-2007/lecture-notes/14_01_lec02.pdf Factors that causes the supply curve to shift
Quantity supplied of a good/ service is affected by various factors. Several key factors affecting supply are discussed as below: http://www.pitt.edu/~mgahagan/Definitions/SupplyandDemand.pdf
Price of the product:
Since the producer always aims for maximizing his returns/profit, so the quantity supplied changes with increase or decrease I the price of the good.
Advanced technology can yield more quantity and at lesser costs. This may result in the producer to be willing to supply more quantity of the goods
Resource supplies and production costs:
Changes in production costs like wage costs; raw material cost and energy costs might impact the producers production and eventually the supply. An increase in such cost might result in lesser quantities produced and thus lesser quantities supplied and vice versa Tax or subsidy:
Since the producer aims to minimize costs and expand profit, an increase in tax will increase the total cost, thereby decreasing the supply. Similarly a subsidy might incentivize the producer to supply more of that goods in order to maximize his profits. Tax and subsidy are two important tools used by central government to control supplies of certain goods. For example an increase in tax can be used to reduce the supply of cigarettes, while and increase in subsidy can be used to increase the supply of fertilizers
Expectations of prices in future:
An expectation that the prices of goods will fall in future might lead to lessen the production by the producer and thereby decrease the supply and vice-versa.
Price of other goods:
A producer might have several options to produce. Since the money to invest is limited with the producer he would decide to produce the good that offers him the maximum profit. Thus if the producer is currently producing good A and the price of good B increases than he might switch to producing good B as this would result in better returns for him.
Number of producers in the market:
This is a very important factor or determinant of supply. If there are large number of producers or sellers in the market willing to sell goods than the supply of good will increase and vice versa
As shown above, the movement along the demand curve and the supply curve is directly related to any change in price. A rise in price will cause quantity demanded to fall but on the other hand quantity supplied will increase. The shift along the demand curve and the supply curve on the contrary does not depend on the price of the product only but on many other external factors that would cause the both curve to shift either to the left or to the right with the shift to the right being more profitable for the firm producing the product or offering the service.
Parkin, Powell, Matthews (2008) Economics, Pearson Education Limited, 7th Edition
OSullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall
Krugman, Paul, and Wells, Robin. Microeconomics. Worth Publishers, New York. 2005.