Market Forces: Demand and Supply Supply and demand are economic forces that determine the amount

of a product that is produced and its price. The supply of a product is the amount of it that businesses are willing and able to offer for sale at alternative prices. Generally, the higher the price is, the greater the amount supplied will be. Similarly, the demand for a product is the amount of it that users can and would like to buy at alternative prices. Demand also depends on the price, but in the opposite way. Usually, the quantity demanded is lower at high prices than at low ones. Because the amount that producers actually sell must be the same as the amount that users actually buy, the only price at which everyone can be satisfied is the one for which supply equals demand. This is called the equilibrium price. The supply and demand diagram shows how these economic forces operate. Using the market for onions as an example, the supply curve SS' shows the number of pounds produced each month at every possible market price. Higher prices encourage farmers to produce more onions, and low prices discourage production. Consumers' reactions are shown by the demand curve DD', which shows how many pounds of onions customers want to buy each month at every possible price. At low prices, they want many onions. At high prices, the customers use other vegetables. Supply and demand curves cross at a certain price (20 cents a pound in the example). When this is the market price, suppliers will offer just the quantity that users wish to buy. At any higher price, farmers will produce more onions than consumers are willing to buy, and competition among farmers will force the price down. At prices lower than equilibrium, purchasers will demand more onions than are available, and the scarcity of onions will drive the price up. Suppose the price of onion is Rs. 5 per kg. We will use lot of onions in our vegetables and/or in salads because it is very cheap. This over consumption by most of people will lead to increase in demand of onions. (We can fairly assume that supply is constant because farmers generally grow onions on a limited land every year.) Thus, sellers, who supply onions, will benefit from this constant supply and increase in demand by increasing the price in the market. So he will charge Rs. 10 for one kg of onion. Over a period of time, people would use less onion in vegetables or stop adding onions in salads because it has become expensive (also monthly budget of families is generally fixed). Thus, the demand for onions would fall in the market. The sellers would be forced to lower the price again.

Demand and Supply Curves

D1

S1

P D2 S2

P* D1 S1 0 Q* GRAPH I Q 0 GRAPH II P** S2 Q** Q D2

Determinants of demand 1. Price of substitutes 2. Income 3. Preference (tastes) 4. Number of buyers 5. Expectation of future price Price of substitutes Two goods are said to be substitutes if they satisfy similar needs or desires and one can be replaced with the other without compromising on the needs. Umbrella and Rain coats are substitutes. The price of one and the demand for the other are directly related. As the price of rain coats rises, the demand for umbrellas increases. Income As a person's income rises, he or she can buy more goods at a given price at any particular time. But the ability to buy more goods does not necessarily imply the willingness to do so. If the demand for a good rises as income rises, then that good is called a normal good. Also, the demand for a normal good falls as income falls. The demand for a normal good and income are directly related. Suppose a person's income increases and she buys fewer bikes. This time bikes are an inferior good because as income rises more people would like to buy cars than bikes. The demand for an inferior good falls as income rises and rises as income falls. The demand for an inferior good and income are inversely related. Preference People's preference affects the amount of a good they are willing to buy at a particular price. A change in preferences in favor of a good shifts the demand curve rightward. A change in preferences away from the good shifts the demand curve leftward. Number of buyers

The demand for a good in a particular market is related to the number of buyers in the area. The more buyers, the higher demand, while the fewer buyers, the lower the demand. Expectations of future price Buyers who expect the price of a good to be higher next month may buy the good nowthus increasing the current demand for that particular good. Buyers who expect the price of a good to be lower next month may wait until next month to buy the good-thus decreasing the current demand for the good. Population Demand also depends on the size and the age structure of the population. Others remaining the same, the larger (smaller) the population, higher (lower) is the demand for all goods. For example India and China have created so much demand for goods and services because of its massive population Supply Suppose the price of onion is Rs. 25 per kg in the market while the cost of production is only Rs 5 per kg. This will encourage and attract a number of farmers to cultivate onions in their farm and reap huge profit. This will lead to excess supply in the market over a period of time. Assuming that the demand remains constant in this period, farmers would be forced to lower the price in order to sell all their onions and offload their produce. Thus prices of onion in the market will drop, say to Rs. 10 per kg. Now, new farmers will not be attracted towards producing onions because of lower profits. Remember, the drop and rise in prices due to demand and supply does not happen overnight. This may take from few weeks to few months to happen. Determinants of Supply 1. Price of relevant resources 2. Technology 3. Number of sellers 4. Expectation of future price 5. Taxes and subsidies 6. Government restrictions

Prices of relevant resources Resources are needed to produce goods. For example- Steel is needed to produce Cars. If the price of steels falls, it becomes less costly to produce cars, and hence, the supply of cars increases.

Technology Technology leads to innovation and effective way of producing goods. Generally, innovations in technology lead to reduction in cost of production. If there is an advance in technology, the quantity supplied of a good at each price increases. This is because the lower costs increase profitability and therefore provide producers with an incentive to produce more. Number of sellers If more sellers begin producing a particular good, perhaps because of high profits, the price of that good come down after some time. Expectations of Future Price If the price of a good is expected to be higher in the future, producers may hold back some of the product today. Then, they will have more to sell at the higher future price. Thus, if expected future price is high, sellers will hold back products and sell it in future, reducing the supply. Taxes and subsidies Some taxes increase per-unit costs or cost of production. Suppose a manufacture has to pay tax of Rs. 100 per good, the manufacturer would sell fewer goods at each price. Subsidies have the opposite effect. If the government subsidize the production of one good, the quantity supplied of the good would be greater at each price. Government Restrictions Sometimes government acts to reduce supply. Recently, government banned the export of pulses and rice to control domestic price. An export quota or restriction on export of goods increases the supply of products in domestic market. Thus, prices came down within a short period. Equilibrium Equilibrium is a situation in which supply and demand has been brought into balance. Equilibrium price is the relative price at which the quantity demanded equals the quantity supplied. Equilibrium quantity is the amount bought and sold at the equilibrium price. If the price is above equilibrium, then quantity supplied exceeds quantity demanded and surplus will occur. That will force suppliers to lower prices in order to clear their stocks. As price falls, producers will cut back production and consumers will purchase more until surplus disappear. If the price is below equilibrium, then quantity demanded exceeds quantity supplied and a shortage will occur. This shortage will encourage buyers to increase the price to make

more profits. An increase in price will convince firms to expand output and discourage consumption until the new equilibrium is established.