Supply+and+Demand

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=**Supply and Demand** -- By Sarah Deville= = =


 * How come hotel rooms and rental appartments on the Mediterranean coast are more expensive during summer?
 * Why is it that gas prices increase substantially when there are conflicts in the Middle East?
 * Why are soccer and football players so well-paid?

After a few economics classes, we probably all know that the answer to the three questions above is because of the fluctuation of supply and demand. If we already know what supply and demand are, how do those two work together in a market? How do they reach the equilibrium? As future managers, how can we use them to predict the changes in product and input prices? This article will help you keep the essential concepts related to supply, demand and equilibrium. The first part is meant to clarify the basic concepts before getting any further, whereas the second part is more technical and focused on the actual computation of equilibrium prices and quantities. The multiple choice will serve as a conclusion and review of the concepts introduced.

**__A summary of the basic concepts__**
Supply and Demand are the driving forces of an economy. Indeed, in a market, some people sell goods -the suppliers- and some others want to buy goods - the buyers. Demand is represented as a downward sloping curve and defined as the quantity of a certain good that buyers are ready to buy at a given price. The higher the price, the least buyers want to buy. The quantity demanded or the price that buyers are ready to pay to get the goods can be found out using a demand equation such as Qd=6-3P, where Qd is the quantity demanded and P the price buyers consider appropriate. A demand curve looks as follows:

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Supply is represented as an upward sloping curve and described as the quantity of goods that suppliers have available for sale at a given price. The higher the price, the more the suppliers want to sell. The quantity supplied or the price at which suppliers agree to sell their goods can be found out using a supply equation such as Qs=6+P, where Qs is the quantity supplied and P the price suppliers consider fair for the selling of their goods. A supply curve looks as follows:

When the quantity demanded by the buyers is the same as the quantity supplied by the sellers, then the market reaches an //equilibrium//. When there is an equilibrium, the price that buyers judge appropriate for a certain good is the same as the price that suppliers judge fair for the goods they provide, and all suppliers will find buyers. On the following graph, we have joined the demand and supply curves so as to create a model. Equilibrium is where the two intersect.

No matter what happens, a market where there is perfect competition will always come to an equilibrium. For example, let's imagine that suppliers have too many DVDs in stock and want to get rid of them. They decide to lower the selling prices. Consumers will then want to buy more of them, since it is a good bargain. The quantity supplied will decrease, and the suppliers will now ask again for more since their goods tend to be rarer on the market. Since prices have increased again, consumers want less of it, and the market gradually reaches an equilibrium again.

__**Now, let's get a little more technical...**__
Since we are done with the reviewing of basic concepts, we will now go one step further in our understanding of a market.

If the market is not in equilibrium, two different patterns can happen. Either the selling price is too high and the consumers do not want to buy goods at this price, which produces a surplus. In that case, Qs>Qd where Qs is the quantity supplied and Qd the quantity demanded. Not enough goods are being sold but since the market regulates itself, the suppliers will have too many goods in stock and decrease their selling price, thus triggering the buying of the goods by buyers, and the coming back to an equilibrium. In the opposite situation, if the selling price is very low and a lot of consumers want to buy the goods, a shortage will happen since the quantity supplied will not be enough in regards with the quantity demanded. In that case, we have now Qd>Qs. There are not enough goods on the market to satisfy every consumer's needs. Having less and less of the goods in stock, the suppliers will want to increase the price of their goods, which will make the quantity demanded decrease. Again, the market will come back to an equilibrium.

To understand fully how equilibrium works, we also need to consider what would happen if demand or supply changed. If there is a change in the price of the good, in the consumers' level of income, in the consumers' personal tastes, in the price of substitute goods or in the price of complementary goods, this will trigger a shift of the demand curve. If demand increases and the demand curve shifts right, there will be an increase in the equilibrium quantity and the equilibrium price, as shown on the following graph:

However, if there is a decrease in demand, the demand curve will shift inward and the equilibrium price and quantity will both decrease.

If there is a change in the cost of production, in technology, in the price of other goods, in the number and size of other suppliers or a change in the weather, there will be a shift in the supply curve. If the curve shifts right, the quantity supplied increases and the equilibrium price will decrease as well.



However, if the supply curve shifts left, the quantity supplied decreases and the equilibrium price will increase.

__So, how can we apply these concepts in the real world?__
Since we are future managers, the theory of supply and demand deserves special attention. Indeed, it allows us to understand how our customers --the demand-- decide to allocate their ressources by buying some specific types of goods and not some others. However, some strong objections have been given against the theory of supply and demand. Indeed, it has been argued that the equilibrium theory was incomplete since it could only be applied to situations of perfect competition, where the products supplied by all suppliers are the same and where the consumer behaves as an homo economicus, that is to say someone who "acts to obtain the highest possible well-being for himself given available information about opportunities and other constraints, both natural and institutional, on his ability to achieve his predetermined goals" (Wikipedia Dictionary). Also, the concept of equilibrium can be seen as something which is hard to rely on, since it is always changing. Still, the model of supply and demand can help us predict how markets behave, even if it us only at a broader scale, and anticipate any shortages or surpluses in our inventories. It helps us get a broader view of what could happen, even if the instability of equilibrium makes the whole model more like some type of approximation instead of an exact theory where results would always be 100% accurate. To go further in our understanding of how supply, demand and equilibrium might be intertwined, price floors and price ceilings are a direct example of how one can infer on supply and demand.

__Did I really get everything? A few multiple choice questions for the road__
Good luck! (Explanations follow)

1. The demand for bananas can be expressed as Qd=5-2P with Qd being the quantity demanded and P the price buyers are ready to pay. If the supply of bananas is stated as Qs=4+P, what is the equilibrium price and equilibrium quantity for bananas in this market?

a. The equilibrium price will be $2 but the equilibrium quantity cannot be determined b. The equilibrium quantity will be 33 and the equilibrium price will be slightly superior to $4 c. The equilibrium quantity will be slightly superior to 4 and the equilibrium price will be $0.33 d. None of the above, an essential piece of information is missing

2. In the same market for bananas, what happens if suppliers decide to sell their bananas at $1?

a. There will be a shortage b. There will be a surplus c. The market will be in equilibrium and the quantity supplied is the quantity demanded. d. None of the above

3. What is the best explanation for the concept of equilibrium ?

a. When the quantity supplied increases, the quantity demanded goes up too and this creates equilibrium b. When demand goes down, supply goes up. Equilibrium is when the two reach a balance c. When buyers want to buy and customers want to sell, the two are agreeing and this creates an equilibrium. d. Equilibrium is when the quantity supplied equals the quantity demanded. They are balanced and there is no specific tendency for prices to go up or down.

4. What are the main arguments against the theory of equilibrium?

a. It is instable b. It only works under perfect competition or if we consider people as homo economicus c. a and b d. None of the above, the theory of equilibrium has not been criticized so far.

5. What is the allocation of resources and how does that relate to equilibrium?

a. The allocation of resources means what you --as a consumer-- decide to do with your money. Depending on how you spend it, your actions as an "homo economicus" are going to infer on the market. b. It means that there are limited resources and that the fear of shortages might influence you to buy more goods. This influences equilibrium prices. c. The allocation of resources have nothing to do with the concept of equilibrium. d. It means that all things held equal, the equilibrium happens when peoples wants and needs are equal and satisfied.


 * Anwers**

1. c) Using the equation Qs=Qd, we get 5-2P=4+P. This gives us 1=3P and then P=1/3. The equilibrium price will be $0.33. As to the quantity, just plug the equilibrium price in either one of the two quantity equations. For example, we can do it using Qd=5-2P such as Qd=5-2(1/3), which gives is 13/3, that is to say 4.33 2. b) If we use P=$4 and plug it into both equations we get: Qs=4+1=5units, and Qd=5-2(1)=2units. Since Qs>Qd, we have a surplus. 3. d) This takes us directly back to the definition given in the paragraph "a summary of the basic concepts". Indeed, equilibrium happens when the quantity supplied equals the quantity demanded. 4. c) As we discussed in the paragraph "how can we apply these concepts in real world", there are limitations to the theory of equilibrium and the main objections to it are that it might be instable and that special conditions are required for equilibrium to be possible, thus limiting the span of application of the theory. 5. a) Again and as discussed in the paragraph "how can we apply these concepts in real world", the behaviour of consumers influences and determine the market. Each person decides what to do with their money and this creates more or less demand for a specific type of product, thus directly influencing its equilibrium price and quantity.

__References__
Bayes, M. (2006), Managerial economics and business strategy. McGraw-Hill, Irwin.

Capul, J. Y. and O. Garnier (2002), Dictionnaire d'économie et de sciences sociales. Paris: Hatier.

Harvey, D. (2007), "Supply shifters". Available at http://www.staff.ncl.ac.uk/david.harvey/AEF873/DSS.html

Lidderdale, T (2003), "Introduction to macroeconomics". Available at [|http://mason.gmu.edu/~tlidderd/104/ch3Lect.html]

Portail communautaire de la gestion des risques et du management en Hygiène, Sécurité, Environnement (2007), "Principes de Macroéconomie". Available at http://www.previnfo.net/sections.php?op=viewarticle&artid=6

Infoplease (2007), "Supply, Demand and the Invisible Hand". Available at [|http://www.infoplease.com/cig/economics/ equilibrium-mr-demand-meet-mr-supply.html]

Wikipedia (2007), "Homo economicus". Available at http://en.wikipedia.org/wiki/Homo_economicus

Wikipédia (2007), "Offre et demande". Available at http://fr.wikipedia.org/wiki/Offre_et_demande

Wikipedia (2007), "Supply and demand". Available at http://en.wikipedia.org/wiki/Supply_and_demand