The law of demand and supply. A cost in market economy. An equilibrium price

Conceptions of “supply” and “demand” are one of the most important in economic science and practice, because market economy is an infinite interaction of demand and supply, that precedes any act of sale. Exactly the size of supply and demand defines the number of deals and the level of prices at the market. But demand reflects not only objective needs and rational decisions, but also subjective wishes and emotional deeds.

Demand is a desire and an ability of the purchasers to buy a definite amount of commodity at a present price during some period of time, that is, demand is a solvent want of the purchasers to a given commodity at a given price. Solvent demand differs from necessities in less necessity, because it is limited by a price. Demand can be: industrial (in the means of production); personal (in the items of use); negative (vegetarians, non-smoking people), that means, it is expressed in active refusal of a consumer of some goods and service; zero (demand for rubber boats in the places far from water); falling (a sign for developing production or change the range of goods); extraordinary of feverish demand or irrational (for example, drugs). There are objective and subjective factors – economic, social and demographic.

Economic: a basic level of development of production, a size of real necessities and a level of their accomplishing, mid level of money income of the population, market prices, a level of prices of alternate goods and complementary goods, principles of distribution of the profit, conditions of giving credits, a quality of goods.

Social: a level of development of mass culture, moral values, social structure of the society, educational level on the population, its professional structure.

Demographic: population size, sex and age structure, ratio between rural and urban population; size and structure of an average family.

Subjective factors include 3 groups:

1. psychological traditional: interests and tastes of consumers, fashion, relations, that happen between a purchaser and a seller, local traditions and principles of upbringing, strengths and peculiarities of religious traditions;

2. esthetical: advertising, form of realization, attractive look of commodity;

3. natural, climatic: climate, amount of fall-outs, average and extreme temperatures, relief, placement, flora and fauna.

The analysis of the objective and subjective factors gives a possibility to define people’s needs in definite goods and services.

The flow of demand is objectively regulated by the law of demand. It reflects a cause-effect relationship between a change of price and a change of the quantity demanded. The essence of this law is in an inverse negative relationship between a change of price and a change of the quantity demanded. Growth of the price (with all the other conditions remaining the same) causes falling of demand, that assist the salvation of the contradictory, that occurs between a change of a price and a constant scale of solvent demand of the population in present time. Besides, with the growth of the price of a given commodity purchasers try to use part of their money to buy cheaper alternate goods. So, substitution effect takes place. This is one of the forms of the law of demand. Another form of this law is an income effect. It shows up when the prices are decreasing, when a purchaser can buy more of the goods at the same level of income. At this time even when the prices are low, a scale of demand will not be limitless. For example, demand on water won’t grow limitlessly, it is limited by an amount that people need for a living. The highest limit of the quantity demanded for such commodity is defined by the limit of fulfillment of the needs, because when reaching a definite level, further growth of the quantity of bought goods leads to a decrease of its usefulness. In this case it is the law of decreasing of overall usefulness, that will be discussed in next topics. As a graphic, the law of demand is represented by building a curve of demand, that reflects a mathematic function of dependence of the quantity demanded from the price, in equal conditions. If these factors change, demand changes in general, that means, the whole curve moves to the right or to the left. (pic.1)

Pic.1.The curve of demand.

Where: CC – the curve of demand;

P – the price of a unit of commodity

Q – quantity demanded.

So, if the fashion on a given commodity increased extremely, thereafter, demand for the commodity decreases and the curve moves left. A change of the quantity demanded just because of a change of a price causes a movement along the curve from one point to another one. For some goods, there is a high overall price, that purchasers can pay for the commodity. For vitally important goods there is a low overall of demand, that will take place even when the prices are high, for example bread, and milk.

We should distinguish individual and market demand. Individual demand characterizes the change of the quantity demanded of a particular purchaser. Market demand reflects the size of demand for the goods of all the purchaser at the given market.
The curve of demand shows the change of ratio between prices and size of realization in pure form, while abstracting from non-price factors. But the most important in the market economy are price factors.

A measure of relation of quantity demanded to the change of price is called price c (coefficient of elasticity of demand). Mathematically price elasticity of demand is defined by ratio . Where?P- accession of the price (in%);?Q-accession of quantity demanded (in %)
Kx=

There are 5 types of elasticity of demand:
- elastic demand (the price increases by 1-2%, and the size of sale increases by 10-15%)
- singular elasticity of demand (the price increases by 1%, and the size of sale decreases by 1%)

- almost non-elastic demand (the price decreases by 15%, and the size of sale increases by 1%)

- very elastic demand (the price stays the same, and the size of sale grows, for example, a person who is ill with diabetes buys insulin however expensive it is, while limiting buying other products)

- very non-elastic demand (the size of sale does not depend on the price, for example, essential commodities).

Supply shows the amount of goods and services, that are in sale at present time, at present price. Supply, as well as demand, is influenced by objective and subjective factors. Objective factors include 3 groups:

1. economic: the level of technology, organizational infrastructural supply, a sphere of communication, state stimulation of market competition, flow of capitals;

2. social: professional qualificational structure of the force labor, social importance of an enterprise, its size and activity, economic independence;

3. demographic: scales and pattern of attracting into production and decreasing labor force, distribution of able-bodied population on the territory of the country.

Subjective factors include such groups:

1. psychological traditional – a change of interests and tastes of purchasers, local, national traditions, upbringing and religious traditions;

2. esthetic – change in fashion, a development of industrial design;

3. natural climatic – climate, relief and placement, flora and fauna.

The essence of the law of supply is that when other conditions that influence the supply stay the same, with the growth of the price the size of supply increases, because the growth of the price means the growth of income and profit, which is an interest for vendors and manufacturers. Also we should take into account that the growth of supply of the goods by manufacturers are connected with a range of problems, that’s why they are not always eager to increase the size of sale even at a higher price.

As an analogue to the law of demand, the law of supply is graphically showed by the curve of supply. It characterizes functional relation between the size of supply and the price (with all the other conditions staying the same). With the growth of the price, the size of supply grows to some definite high overall limit, and no more, for example because of the limitedness of the resources. A low limit of supply is that price, which a manufacturer will refuse from, because he will not get a necessary income.

There is a relation between a change of quantity supplied and the price, that is reflected in a movement along the curve of supply from one point to another one, and also a change of supply in general. A shift of the curve of supply is caused not by the price, but by non-price factors. The most important of them are resource prices, a level of production methods, charge and subvention, prices for fungible goods, anticipation of vendors for dynamics of supply, prices, incomes etc., the number of vendors.

Pic.2. The curve of supply
Where: P - the price for a unit of commodity;
SS – the curve of supply;
Q – the size of supply.

A change of the size of quantity supplied is shown in the movement through the points of the curve of supply: A >B; A>C
A relation between the price and the quantity of the supplied goods is reflected in elasticity of supply, which characterizes sensitivity (reaction) of supply to the change of the price. Mathematically elasticity of supply (the coefficient of elasticity) is defined by the ratio of accession of quantity supplied?Q to the accession?P, that means?P= ; K=

The supply can be: absolutely elastic, elastic, supply with single elasticity, non-elastic, absolutely non-elastic. Supply with single elasticity is set, when the growth of the price of the commodity by 1% is accompanied by the growth of supply of the given commodity by 1%. At the non-elastic supply the growth of the price doesn’t influence the amount of quantity supplied.

The elasticity of supply depends on difficulties that of redistribution of the resources between alternate regions of their use. At the same time, mobility of the resources depends on the time, that manufacturers have to accommodate to the given change of the price.

The more time manufacturers have to react on a change of demand, the more intense changes will happen in the size of production. Within the range of the shortest market period a manufacturer doesn’t have enough time to change the size of production, that’s why supply stays absolutely non-elastic. Within the range of a short period of time manufacturing capacity stay the same, but the size of production may be changed by intensity of its use and supply become more elastic.

In any case in market economy between supply and demand there is a definite relation – market balance.

A base of market balance is a balanced price, when the quantity of commodity, supplied at the market, equals the quantity of commodity, which is demanded. At the imposition of the graphics of supply and demand the curves will cross. At the point of the crossing demand and supply match. The price that was set at the concurrence of demand and supply is called the price of balance. (pic. 3)

If the price is higher than the balanced (P1), overplus, that is impossible to sell, will appear. In order to sell the production, vendors will have to decrease the price until it comes to the balanced one. If the price is lower than the balanced one (P2), the goods will be sold immediately, but demand will stay unsatisfied, and the price will grow up to the balanced one.

But, apart from the price, demand and supply are influenced by a range of non-price factors, which is accompanied by a change of balance prices. At the competitive market prices are not appointed, but appear by themselves under the influence of supply and demand. That’s why they are called free market prices. But the word “free” shouldn’t be understood literally. As the curves of supply and demand carry a trace of the interests of purchasers and vendors. You will hardly find a vendor who wants to sell his goods at the price less then the production costs, thus on the curve of supply a limit is put, that influences the balance market price. So, market price is free from outer dictation, but not free of the laws of the market, of psychological sets of the participants Also, free market prices are set only at an ideal competitive market.

Factors of Profuction: Labour and Capital

The productive resources exist in all types, shapes and sizes, and all are limited. The resources used in production of goods and services are also called the factors of production. They are land, labour and capital. These resources provide the energy and materials that make production possible. Production is a fundamental factor in our fife.

Land means natural resources not created by human efforts. Natural resources are the things provided by nature that go into the creation of goods and services. Natural resources include fertile soil, minerals, water, climate and forests. Land has little or no utility unless it is worked upon by man.

Labour is essential factor of production. Labour means human resources or people with all their efforts and abilities. Human resources - labour, skills and knowledge - are an important part of production.

In economic theory "labour" is any work undertaken in return for a fixed payment, i. e. the price for the use of labour. Most occupation have wage-rate -a standard amount of pay given for work performed. Money is a means of measuring the value of men's labour.

In order for any country to grow, it must have a large and skilled labour force. Labour force is the number of people employed plus all those who are unemployed and for different reasons they do not want to look for a job. So, "national labour force" is all those people who are available for work within the nation, that is the working population. Since the size of labour force is related to total population, the number of people available for productive activity varies as the population changes. Many factors such as immigration, famine, war, disease can influence on both the quantity and quality of labour. So, labour is a productive resource that may vary in size over time.

Labour can be mental and physical. But in many tasks it is necessary to combine mental activity with physical efforts.

There are four major categories of labour that are based on the general tevet of skills needed to do any kind of job. These categories are unskilled, semiskilled, skilled and professional or managerial.

Workers who do not have the training to operate machines and equipment fall into the category of unskilled labour. Most of these people work chiefly with their hands at such jobs as digging ditches, picking fruit, etc.

Workers who have mechanical abilities to operate any not very complex equipment fall into the category of semiskilled labour. They may operate electronic floor polishers or any other equipment that calls for certain amount of skills.

Workers who are able to operate complex equipment and can do their tasks with little supervision fall into the category of skilled labour. Examples are carpenters, typists, tool makers.

Workers with high (eve! skills fat? into the category of professional labour. Examples are doctors, lawyers and executives of large companies.

Capital means man-made resources. Capital includes those things that are used in production of goods and services. Capital may be physical and financial.

Physical capital are things that have already been produced and then are used in production of other goods and services. Physical capita! includes such things as buildings, equipment, machinery, roads, etc. Financial capital refers to money that business people use to buy buildings, machinery, tools and other productive resources used in the process of creating goods and services.

When three factors of production - land, labour and capital - are present, production takes place and commodities are produced.

The forth factor of production is entrepreneurship. The entrepreneurs bring together the other three factors of production.

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