A market is a social institution that brings together a buyer and a seller to make a transaction for the sale of a certain product and / or service. The market provides information about prices and volumes of goods. The market has a control and distribution function, since only demanded goods are sold, and the market “tests” products in terms of such parameters as product quality, service provision, advertising, etc.
The behavior of the main subjects of the market – buyers and sellers reflect two market forces: supply and demand . The result of their interaction is an agreement between the parties on the sale and purchase of goods or services in a certain amount at a certain price. Competitive pricing accumulates in the price a huge amount of various information about the quantitative and qualitative characteristics of economic processes, forms the information-incentive basis of a market economy.
The demand of buyers for certain goods is formed under the influence of needs . Needs are individual and are formed under the influence of a number of factors that determine the conditions of existence. Demand is the desire and ability of buyers to make transactions to purchase a product available on the market. Demand is the quantity of a good that buyers are willing and able to purchase at a given price in a given time period.
According to the law of demand , consumers, ceteris paribus, will buy the greater the quantity of goods, the lower their market price. This is explained by the following: firstly, a decrease in price leads to an increase in the number of buyers to whom this product becomes available; secondly, the same consumer can afford to buy a larger quantity of cheaper goods, since a decrease in prices is tantamount to an increase in the consumer’s income (manifestation of the income effect) ; thirdly, a cheaper product “draws off” part of the demand, which would otherwise be directed to the purchase of other goods ( the substitution effect) .
The functional dependence between the volume of demand (Q D ) and the price can be represented as a function Q D = f(P). The constructed curve D is called the demand curve and shows how much (Q) of the goods buyers are willing to buy at each given price level in a specific period of time, other factors remaining unchanged.
In other words, movement along the demand curve (from one point to another) reflects a change in the quantity of a good that consumers demand as a result of a change in the price of the good. For example, if the dependence is linear, it will take the form: Q D = a-bP, where a, b are numerical coefficients.
In economic theory, it is customary to distinguish between individual demand , as the demand of an individual buyer for a particular product, and market demand , the total demand of all buyers for each product price. The individual demand curve is not smooth, but rather has a stepped shape.
Price is not the only factor influencing demand. The action of non-price factors of demand can often neutralize the impact of price. Among the non-price factors that determine the volume of demand, it should be noted: consumer incomes, prices for other goods, for example, interchangeable (substitute goods) and complementary goods (complements), tastes and preferences of buyers, buyers’ expectations, including inflationary ones.
The income of the population and the amount of accumulated property are usually connected with demand by a direct relationship: the richer the population, the greater the demand; and the poorer it is, the less. A decrease in the price of substitute goods that can replace this product in consumption (for example, tea-coffee, beef-chicken) will lead to a decrease in demand for this product, i.e. preference will be given to cheaper goods.
A change in prices for complementary goods that complement this good in consumption (photographic film-cameras, gasoline-cars) causes a unidirectional change in demand (when the price of any of the complementary goods rises, demand falls on both, or vice versa). The increase in demand may be due to inflationary expectations. Seasonal, pre-holiday fluctuations in sales can also be attributed to changes in demand under the influence of consumer expectations. Quite dynamically changes the volume of demand and cultural and social factors (tastes and preferences of consumers, social status and traditions).
Supply can be defined as the willingness and ability of sellers to produce and sell a product. Supply is the quantity of a good that sellers are willing to produce and sell in a given period of time.
The volume of goods offered for sale, ceteris paribus, will be the greater, the higher the price of the goods, i.e., there is a direct relationship between supply and price; it is called the law of supply . The higher the price, the higher the producer’s profit. The curve constructed on the basis of the dependence of the volume of supply on price changes is called the supply curve (S). It shows how much of a good (Q) producers are willing to sell at any given price level in a particular time period. Movement along the supply curve reflects changes in the quantity supplied, caused only by a change in price, i.e., while maintaining other conditions unchanged.
In analytical form, the proposal can be represented in general form as a certain function of prices: Q S = f(P). If the dependence is linear, then it takes the form Q S = aP + b.
In addition to the price factor that affects fluctuations in the volume of supply, there are non-price factors that shift the supply curve:
technical capabilities of the manufacturer, the nature of the technology used;
the prices of the resources used;
· taxes and subsidies expectations of sellers;
the prices of other goods;
the number of sellers.
When the price changes, the amount of supply changes, which is reflected in graphical form by moving along the supply curve. A change in any other determinant of supply (non-price factors) in graphical form will be expressed by a shift of the entire supply curve to the right or left.
The coincidence of the interests of buyers and sellers on our chart characterizes the point of intersection of the supply and demand curves, traditionally denoted by the letter E. This point is usually called the equilibrium point, since demand is precisely balanced by supply at it.
The equilibrium price, formed as a result of the action of market competitive forces, performs the most important functions in the economy:
informational: its value serves as a guideline for all subjects of a market economy;
normalizing: it normalizes the distribution of goods, giving a signal to the consumer about his ability to consume and the producer about the cost recovery and the feasibility of production:
· stimulating: it forces the manufacturer to expand or reduce production, change technology and assortment.
The explanation of the establishment of equilibrium due to price fluctuations, during which their increase or decrease brings the market to a state of equilibrium, belongs to the Swiss economist L. Walras. A different approach to explaining the mechanism for establishing market equilibrium was used by the great English economist A. Marshall , who believed that, in response to a violation of market equilibrium, sellers maneuver not with prices, but with the volume of supply. At any volume of production below the equilibrium price, the supply price is less than the demand price. Having put their goods up for sale at this price, they will easily sell them, making a huge profit. There will be an increase in production volumes and the transition to this market of manufacturers of other industries. Supply will rise and prices will gradually fall until they reach an equilibrium level.
Both approaches to equilibrium reflect market realities, but the mechanism of L. Walras contributes to the establishment of equilibrium in the short period , and the mechanism of A. Marshall operates in the long run (in the long run , production facilities can be built to meet any volume of demand).
To characterize the degree of influence of price changes on the behavior of buyers and sellers in the economy, the concept of elasticity is used, which can be defined as the degree of response of one value to a change in another.
The dependence of a change in demand for a product on a change in its price is called price elasticity of demand (price elasticity). It is customary to distinguish between three options for price elasticity of demand: Elastic demand : with slight price reductions, sales volume increases significantly. Unit elasticity of demand : The percentage change in price equals the percentage change in sales. Inelastic demand means that the quantity sold does not change with the change in price.
Elasticity can be measured using the coefficient of elasticity . This is the ratio of the percentage change in the quantity of a good to the percentage change in its price:
In the case of elastic demand , when the increase in quantity is greater than the decrease in price, the value of the coefficient exceeds one (E D u003e 1); with inelastic demand , on the contrary, E D < 1; and in the case of demand of unit elasticity, when the percentage change in price is strictly equal to the change in quantity, the equality E D u003d 1 is established
Price-elastic demand is, as a rule, for luxury goods (jewelry, furs, black caviar) and for fairly expensive consumer goods (cars, televisions, washing machines, audio and video equipment, personal computers, etc.). needs with relatively low prices – for bread, potatoes, clothes, shoes, underwear, public transport costs, etc.
There are also perfectly elastic demand and perfectly inelastic demand . Absolutely elastic demand is typical for a situation of perfect competition when producers cannot influence the price, and buyers are ready to purchase any number of goods at a specific price. In the case of perfectly inelastic demand, they buy the same amount of goods at any price level. An example of demand approaching perfectly inelastic is the demand for medicines.
With elastic demand , a decrease in price causes an increase in sales. With unit elasticity of demand , the increase in sales volume with a decrease in price is such that total revenue remains unchanged. When demand is inelastic , a decrease in price leads to such a small increase in sales that total revenue decreases.
Price elasticity of demand depends on a number of factors:
1) indispensability. If the product has substitutes (substitute products), then the demand will be more elastic, the opposite effect is the absence of such;
2) the importance of the product for the consumer. As a rule, inelastic is the demand for essential goods, and more elastic – for all other groups of goods;
3) share in income and expenses . Goods on which a significant share of the budget is spent are elastic, while goods that occupy a small share of the budget are inelastic.
4) time frame. The elasticity of demand increases in the long run and becomes less elastic in the short run.
In addition to price elasticity of demand, income elasticity of demand is considered, which can be defined as the ratio of the percentage change in the volume of demand for a product to the percentage change in income (I):
If the consumer increases the volume of purchases with an increase in income, then the income elasticity is positive (E I > 0). In this case, we are talking, most likely, about a standard normal product , say, additional pairs of shoes that the consumer can afford to buy. If, at the same time, the growth in demand outstrips the growth in income (E I > 1), then one speaks of a high income elasticity of demand. Income elasticity is negative (E I < 0) when it comes to abnormal or low-quality goods (cheap sausages, cigarettes), which consumers, as a rule, buy less with growing income, replacing them with better goods.
The reaction of consumers to price changes also depends on the prices of other goods. The dependence of the elasticity of demand for one good relative to changes in prices for other goods is called cross elasticity , which is measured as the ratio of the percentage change in demand for good A to the percentage change in the price of good B:
where Q A is the volume of demand for product A; P B – price of goods B.
Cross-elasticity shows the existence of a relationship in consumption between the goods in question. If Ecross > 0, with an increase in the price of product B, the demand for product A increases, then we are talking about interchangeable goods ( substitute goods ). If Ecross < 0, an increase in product prices leads to a decrease in demand for product A, then we are dealing with complementary goods: for example, an increase in film prices reduces the demand for cameras. Goods can be indifferent to each other (Ecross = 0), a change in prices for one of them does not change anything in the quantitative demand for the other.
The sensitivity of the quantity supplied to changes in the market price shows the elasticity of supply , which can be defined as the degree to which the quantity of goods and services offered for sale changes in response to a change in the market price. Elasticity of supply is also measured using the elasticity coefficient, which is calculated as the ratio of the percentage change in quantity supplied to the percentage change in price. The formula for calculating the price elasticity of supply (ES) is:
There are elastic supply, inelastic supply, unit elasticity supply, perfectly elastic and perfectly inelastic supply.
The elasticity of supply is influenced by various factors: the price of raw materials and the level of wages, the interest rate, the availability of reserve production capacity, the nature of the product (industrial products or consumer goods). The time factor is of paramount importance for the elasticity of supply. In the short and long periods, as demand increases, supply will increase. At the same time, the price will also rise, but on a smaller scale than the increase in demand. The difference between the short run and the long run lies in the degree of elasticity of the curve. In the short term, it is small due to an increase in the utilization of existing capacities (only a limited increase in production can be obtained). So for the oil industry, the limiting factor is the “pipe” – the throughput capacity of oil pipelines.
In the long run, with a favorable change in demand, there are almost no limits to increasing supply. Therefore, the curve is very elastic. In the absence of resource constraints, the supply curve in the long run is very elastic, and sometimes absolutely elastic.
Market pricing underlies the self-regulation of a market economy. However, equilibrium prices are not always adequate to the interests of the national economy. State intervention in this case may take the form of legislative fixing of prices above or below the equilibrium price. The state is forced to resort to setting a maximum price when the equilibrium price is so high that it excludes goods that are essential items (bread, sugar, milk) from the consumption of the majority of the population. If the fixed price is below the equilibrium price, there is a shortage of the good ; if the forced price is higher than the equilibrium price, the consequence is a surplus of goods .
Another negative consequence of setting a price ceiling is the black market that is a companion to scarcity. The state can eliminate the deficit in a fixed price environment either by increasing supply through imports, or by reducing the demand for a product by rationing consumption through cards and coupons.
State price fixing in a less critical environment is usually focused on eliminating distortions in market pricing that have arisen as a result of market imperfections, say, the lack of competition in this particular market. Struggling with the imperfections of the market mechanism, the state sets a mandatory price that is as close as possible to the equilibrium price.
Taxes and subsidies can be considered another form of state action that affects the equilibrium price. Taxes are included in the price of the goods sold, affecting the equilibrium price. Subsidies , or grants to the producer, are designed to support important objects of the national economy, such as agricultural production or scientific and technical projects.
The imposition of taxes in markets with different elasticity of supply produces different results. The volume of tax collections is much higher with an inelastic supply than with an elastic supply. With inelastic supply, their burden falls on the producer, and with elastic – on the consumer.
The consequences of public policy are controversial. By intervening in market pricing , the state limits the freedom of consumer choice and assumes those functions that, in an ideal market model, the consumer should perform. As a result, economic efficiency decreases, administrative costs and bureaucratic guardianship increase.
In extreme economic situations, to eliminate violations introduced by market imperfections; to support individual economic entities, state intervention in the economy is certainly necessary.
Rate the following statements in true/false terms:
1. With elastic demand and supply, a decrease in price causes a decrease in purchases
2. The elasticity of supply and demand shows how much the price changes when demand and supply change.
3. At the equilibrium point, demand equals supply
4. Elasticity of supply increases as the time period under consideration increases
5. Giffen effect: an increase in price leads to a decrease in demand
6. The Veblen effect is expressed in the fact that when a product becomes more affordable, demand falls due to the need for some buyers to stand out from the general mass of consumers
7. If more than one product of the same type appears on the market, then its prices decrease
8. Elasticity of supply decreases as the time period under consideration increases
9. Function a – bP is a supply function and a+bP is a demand function
10. The disadvantages of the market system include such characteristics as monopoly, uneven distribution, spontaneity of economic processes
1. Market demand is NOT directly affected by:
a. consumer income
b. resource prices
c. prices of related goods
2. An increase in the price of one good leads to an increase in demand for another good if these goods:
3. When resource prices increase, producers buy fewer resources. This manifestation:
a. law of supply
b. law of demand
c. the law of limited resources
d. law of profit
4. If prices for suburban train tickets increase significantly, then the suburban bus market will experience:
a. a decrease in the equilibrium price and equilibrium volume of sales
b. an increase in the equilibrium price and a decrease in the equilibrium quantity sold
c. a decrease in the equilibrium price and an increase in the equilibrium quantity sold
5. The supply curve shifts up and down:
a. reduction in the price of a commodity
b. technology improvement
c. increase in production costs
6. . If the actual price in the market is higher than the equilibrium price, then
a. competition between buyers
b. trade deficit
c. commodity surplus
7. The law of demand suggests:
a. If the demand is greater than the supply of the good, then there is a shortage.
b. as the consumer’s income increases, the demand for the product increases
c. When the price of a good rises, the demand for the good falls
8. A change in the magnitude of demand for a product can be caused by:
a. rise or fall in the market price of a commodity
b. rise or fall in consumer income
c. changes in consumer preferences
9. Increase in the price of goods:
a. shifts the supply curve to the right
b. shifts the demand curve to the right
c. increases the volume of demand
d. increases the supply
10. In the classical theory of political economy, the use value of a commodity
b. not measurable
c. measurable in individual cases
Task 1 . The functions of supply and demand are given: Q D = 8000 – 12Р; Q S = = 4P – 750. Find the amount of shortage (or overproduction) and the market price in case of shortage or surplus when introducing the state price Р G = 500.
a) we substitute the value of the state price ( 500) sequentially into the equation of supply and demand.
Q D u003d 8000 – 12P u003d 8000 – (12 x 500) u003d 2000,
Q S = = 4P – 750= 4´500 -750 = 1250. Demand exceeds supply by 750 units, which is the amount of the deficit.
b) it is now known that producers will supply the market with a volume of products equal to 1250. Substitute this volume into the demand equation:
1250 = 8000 – 12R. We get that P u003d 562.5 . This price exceeds both the state and the equilibrium price and is the “black market” price.
Task 2 . Demand function: Q D u003d -2.5 P + 1000. Equilibrium price: P * u003d 200. It is necessary to find the volume of the total consumer surplus.
The volume of the total consumer surplus is equal to the area of the triangle bounded by the demand line, the price axis and the perpendicular to the price axis from the equilibrium point (horizontal line Р* = 200). The price axis intersects with the demand line at the point where Q=0, i.e. at Р= 400. For Р* =200 the equilibrium volume is Q*=-2.5Р + 1000= 500. Therefore; the excess can be found using the formula for calculating the area of a right triangle: S = S(400 – 200) ´500 = 50,000.
Problem 3. The demand line is given by the formula: Q D = 3 – 2P, where P is the price of the goods. At what P is the price elasticity of demand E D (p) =1?
Solution: According to the formula for calculating elasticity E D (p) u003d Δ Q D (p) ´P / Q D
We get: -1 u003d -2´P / (3 – 2P), from this equation it follows that P u003d 0.75.