Supply And Demand In Economics: Role, Impact, And Factors

The Importance of Supply and Demand in Market Economies

Supply and demand are the basic factors of market economy based on which producers take decision about production with limited resources.

Hence, these two concepts help to answer three basic questions of economy, viz., what to produce, how to produce and what amount to produce.

The producer may decide to produce a product by large amount, if it has excess demand in market. On the other side, the concerned person may reduce the production of another product, which has limited comparatively low demand in market (Vahlne & Johanson, 2017). Hence, according to the market demand, the person can allocate limited resources.

b) Movement along demand curve for a particular occurs when it represents negative relation between price and quantity demanded (Glaeser & Gyourko, 2018). This means, the amount of quantity demanded for a product can increase after the reduction of its price while the opposite situation can occur as well. 

Similarly, movement along supply curve represents the positive relation price and quantity supplied of a product. This implies that supplier can increase supply of a product in market if its price increases accordingly. 

Except price, other demand influencing factors as tastes and income of consumers and prices of related commodities can shift the demand curve for a product, which means at given price more or less amount of product can be demanded. Consumer’s income, tastes and prices of substitute product has positive relation with demand for any product.   

Shift of supply curve can be determined from other supply influencing factors, for instance, technology, weather, prices o related products and prices of input factors and so on. At fixed price, the supply curve can change if any one of the factor changes. 

a) Under free market structure equilibrium amount of price and quantity cab be determined by equating demand and supply curve of the produce. If the government intervenes within this free market structure, then inefficiency can be seen due to price ceiling and price flooring (Friedman, 2018). These two tools, used by the government, prevent market to obtain its equilibrium amount of price and output.   

b) Consumers get higher amount of surplus under price flooring while producers’ loss their surplus value (Harris et al., 2017). On the other hand, price ceiling helps producers to get higher amount of surplus while the surplus amount of consumers decreases.

However, price control is required during some uncertain situations, while protecting self-interests of government and consumers become important (Ardalan, 2018). This in turn helps the government to control unfair practice of producers. 

Difference Between a Movement Along and a Shift of Demand and Supply Curves

1) The USA GDP has into four parts, which are, personal consumer expenditures, business investment, government spending and net exports of goods and services. In 2017, share of personal consumption expenditures has remained $11.89 trillion while the share of business investment to the country’s total GDP has $2.95 trillion. For government spending and net exports of goods and services, this amount are $2.9 trillion and $0.62 trillion (“U.S. Bureau of Economic Analysis (BEA)”, 2018).

2) Real gross domestic product (GDP) of a country measures the value of products produced within a year in terms of base-year prices. This is an inflation-adjusted measurement. On the other side, nominal GDP measures the value of a country’s total production for a particular year, based on current prices (Reinsdorf & Yuskavage, 2018). Nominal GDP considers inflation for which its value remains high compare to the real GDP.

The business cycle can be expressed as a series of expansions and contractions, which affect the real GDP of a country as well (Lee & Werner, 2018). At the ending point of expansion, real GDP starts to decline and during the period of recession, it continues to fall.

a) The GDP measure of an economy is underestimating national production along total income of it. This is because the GDP considers those people, who are not working at all (Furtado, 2018). Moreover, inflationary pressure decreases the actual growth of country’s income, which GDP cannot represent.

b) The GDP has various limitations to measure total output and national welfare of a country. Firstly, GDP does not consider any transactions that occur outside the market place. Secondly, it does not consider any contribution of products on the lives of people (Knaap & Oosterhaven, 2017). Thirdly, this measurement does not measure quality of environment during production of a commodity. Lastly, GDP does not include contribution of leisure regarding the quality of life.

The GDP of a country does not include transaction of products, which have been produced outside the economy. Moreover, it does not consider transaction of used commodities along with transfer payments of the government (Lee & Werner, 2018). Intermediate goods and transactions within black market are also not considered within this measurement.

a) Within an economy, various types of unemployment can be seen, for instance, frictional, seasonal, technological, structural and cyclical. Those types of unemployment can be seen for various economical conditions. Frictional unemployment generates when people change their job. It is a temporary issue and consequently does not affect the economy in an adverse way (Michaillat & Saez, 2015). Seasonal unemployment generates due to changing nature of season, which in turn affects the business activities of some market, for instance, agriculture. Technological unemployment occurs due to improvements of technology for which, workers are replaced. Structural unemployment occurs during the structural changes of the economy while cycle unemployment can be seen during the recession period within an economy. The number of employed workers and unemployment rate can increase together if labour participation rate increases within the economy (Dosi et al., 2016).

Factors That Lead to Shifts in Demand and Supply Curves

b) Wage rate and demand for labour has an inverse relationship. Hence, by increasing minimum wage, producers can decrease their demand for labours, which in turn can increase the unemployment rate within an economy (Deininger et al., 2018).   

Labour market participation does not provide any accurate number of people, who are unemployed (Elsby, Hobijn & ?ahin, 2015). Moreover, increasing number of labour market participation can reduce the amount of unemployment benefit due to huge demand.

a) Changes within the consumer price index (CPI) are used to measure changing prices related with the cost of living (Dunn, Grosse & Zuvekas, 2018). To measure inflation rate, consumer price index of current year and previous year is required to obtain the percentage change in consumer price index for one year.

b) Through measuring price fluctuations, one can get almost an accurate CPI based on price changes.

The nominal exchange rate is measured in terms of domestic currency and it does not adjust inflation. On the other side, real interest rate is measured after adjustment of inflation (Friedman, 2017). To understand the role of average price for explaining the difference between nominal and real interest rates, it can be beneficial to understand the relation between these two interest rates with the one of inflation.

Real interest rate = Nominal interest rate – inflation rate

Hence, change in average price of inflation rate can explain the relation between these two interest rates.

a) Long-term economic growth represents the increment of market value of both goods and services, produced within an economy over time (Ayres, 2017). Hence, it can be measured as the percentage change in the gross domestic product of a country. Key determinant of this long-term growth are demographic changes, growth of productivity and labour force participation.

b) Economics growth and productivity has a positive relationship. Higher amount of productivity leads a country to produce more amount of output at given technology compare to before (Huchet?Bourdon, Le Mouël & Vijil, 2018). Consequently, this higher amount of revenue helps the country to increase its national income and to achieve economic growth as well. The major source of increasing labour productivity is the technological improvement. With modern technology, a labour can produce more amount of product with limited resources at same time duration.

a) Financial intermediaries and loanable funds help households and firms to deposit or withdraw cash accordingly (Quartey, Danquah & Iddrisu, 2017). Hence, firms through these financial institutions acquire funds and promote their production, which in turn helps the economy to achieve economic growth. Firms collect funds from market to increase their production through large amount of investment. On the contrary, households save money within those institutions for earning interest rates.

The Limitations of GDP as a Measure of National Welfare

b) Crowd out affects occur due to large amount of government borrowing (Quartey, Danquah & Iddrisu, 2017).

 Government deficit occurs when government spending exceeds its revenue.

a) The Fed uses three types of instruments for its monetary policy (Baker, Bloom & Davis, 2016). Those instruments are discount rate, open market operation and reserve requirements.

b) Through contractionary monetary policy, the government controls inflation and stabilize prices within market. Those are pros of this policy. On the contrary, this policy reduces production and increase unemployment rate (Delis, Hasan & Mylonidis, 2017). On the other side, through expansionary monetary policy, the economy gets opposite outcomes.

Contractionary monetary policy is more appropriate today as it helps to reduce inflation within economy. 

1. a) Inflation tax refers the situation when the purchasing power parity (PPP) of consumers reduces due to inflation (Al-Marhubi, 2018). When the government remain unable to charge taxes on people, it creates inflation through printing money and this in turn reduces the purchasing power of people.

During inflation, overall price level increases and consequently cost of living also increases (Geromichalos & Herrenbrueck, 2016). This leads the people to save less amount of money, which tends to investment to decrease further.

b) Relative prices measure value of one product in terms of others. This indicates relative scarcity of goods and allocation of them efficiently (Fama & French, 2016). However, changing in relative prices through inflation and changing in scarcity of commodities do not have any relation and this consequently leads an inefficient allocation of resources and commodities.   

1. a) The importance of aggregate supply (AS) and aggregate demand (AD) model is that, it can represents a country’s goods and services for a particular time (Challe et al., 2017). Moreover, it represents that an economy can suffer under recession through creating unemployment, if it has an insufficient AD.
2. b) To shift the AD or AS curve, there are various factors exist within an economy. Those factors are population, income, credit availability, wealth and government demand (Hein, 2017). Through Micreoeconomical fluctuation can be explained with the help of AS-AD curve if one of it shifts its position from equilibrium condition.

1. a) Long-term economic goal are full employment, steady growth, stable prices and stable interest rates. Under long-run macroeconomic equilibrium, aggregate demand and aggregate supply equate with each other to determine real GDP along with price level of the economy (Salter & Smith, 2017). Stable equilibrium can provide those economic goals easily.
2. b) Consumers can reduce their spending and consequently, AD can shift to the left and output can decrease further. 

1. a) Through creating money supply within economy, the government takes expansionary monetary policy (Geromichalos & Herrenbrueck,  2016). On the contrary, by contractionary policy, the government reduces money supply.

Thorough contractionary fiscal policy, the government decreases its expenditure and increases tax for leaving lower amount of capital available for firms (Elmendorf & Sheiner, 2017). The opposite situation occurs under expansionary policy to increase economic growth.

  Fiscal policy influences AD by changing government expenditure and amount of tax. Monetary policy, on the contrary, influences money supply. This in turn affects net exports, cost of debt, employment and business of the country and consequently affects the AD.

1. b) Fiscal policy helps to reduce unemployment, budget deficit and promote economic growth. However, it brings inflexibility within economy (Geromichalos & Herrenbrueck, 2016). Monetary policy leads no currency depreciation, and budget deficit. However, it brings tie lags, lack of economic growth and reluctant borrowers. 

1. a) Being macroeconomical policy makers, it can be better o use the Phillips curve to establish negative relation between employment and inflation (Hasenzagl, Pellegrino, Reichlin & Ricco, 2017). Setting inflation rate at it prescribed level; corresponding unemployment level can be measured.
2. b) The U.S experiences inverse relationship between these macroeconomical factors. Current unemployment rate is 4.1% while inflation rate is 2.65% (S. Bureau of Economic Analysis (BEA). 2018). This figure says that to reduce unemployment rate, the country needs to increase its inflation. 

1) During recession, stabilization policy helps the country from wasting resources, as capitals remain unproductive.

Policymakers face difficulties to indentify exact problem of economy and corresponding action to overcome this (Shepherd & Hamanaka, 2015). Thus, at the time of policy implementation, the economy may start recovering it and thus this policy may destabilize the economy again.

2) The justification includes redistribution of income through preventing recession, taxes ad by producing public goods. The chief reason is freedom. 

1) Balancing budget is required for the government. For doing so, the government can follow some steps. For instance, making a complete budget request for the coming financial year, hearing and developing budget resolution by the Congress and enact budget resolution by them (Wildavsky, 2018).

Types of Unemployment and Their Impact on the Economy

 2) Budget deficit and national debt are closely interlinked (de la Porte & Heins, 2016). When the government faces any budget deficit, it takes debts from national or international market. Hence, increasing budget deficit tends national debt to increase further.

The national debt of the U.S.A is increasing due to its higher governmental expenditure. Compare to its revenue (Ramey & Zubairy, 2018). The government has spent on national defence, Medicare and Medicaid and so on. 

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Measurement and Impact of Consumer Price Index and Real Interest Rates

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