Perfect Competition and Monopolistic Competition
There are several factors that affect supply and demand. One way of looking at these changes is by examining each part of the equation in relation to the equilibrium price. Supply is affected by basically a change in the quantity that is made available. When the price of an item is above the equilibrium or asking price, assuming ceteris paribus, then it is normal for firms to increase the amount of goods that they are supplying to economies of scale. It is not only the current suppliers who increase supply but also new comers who want to take advantage of the price.
Usually, these result in changes along the supply curve. Shifts along the supply curve, on the other hand, occur when there are new technologies that increase productivity or a new source that makes the good abundant, independent of the price that it is currently selling for, these result in a shift of the supply curve. Changes in demand, on the other hand, are caused by factors that can be influenced by price or external factors. In relation to changes in price, demand generally increases when the price is lower since that it more favorable to the buyer since it shows optimum allocation of resources.
When the price increase, demand is directly affected because buyers are not willing to buy more, especially when demand for the good is price elastic, meaning that every increase in price directly relates to a lack of interest or disincentive to buy. Other external factors that can lead to changes in demand can be brought about by increase in income, introduction of substitutes, unexpected increase or supply. In these instances, there are shifts along the demand curve that will affect the equilibrium price.
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One way of accurately looking at these changes is to examine a basic supply and demand model wherein there is a shortage or a surplus of a certain good. In these instances, either supply or demand usually reacts to adjust to determine a new equilibrium price. This can be seen in the illustration shown below: Supply and Demand Assuming that there is perfect competition and the demand is price elastic, it means that when the price increases or decreases, the relationship is such that demand also adjusts accordingly to the same degree.
In such a case, when price increases by one unit, demand can also be expected to decrease by one unit. If price decreases by one unit, demand can be likewise expected to increase by one unit. This is under a perfectly elastic price demand model. The basic law of supply and demand dictates that when there is a change in supply, such as in the case of surplus, there is a correlated and directly proportional change in the price which in turn affects demand.
Accordingly, in the first scenario, if there is a surplus of supply, this means that the price that demand (consumers) is willing to purchase at is lower. If there is a scarcity in supply, it can be expected that if demand remains the same there will be an increase in price since there is a limited number of goods that are available. This basic law of supply and demand is only applicable, however, if the goods are considered as it is. In cases there exist substitutes or when there is no real demand (necessity) for the good, the rules are now different.
When a good is not necessary, demand is affected by changes in price at a higher degree than the normal direct correlation. This means that if consumers do not need an item, a slight change of 1 unit in price can directly translate into a decrease of demand by more than 1 unit. This means that the demand is elastic in that if there are sudden changes in price, due to the fact that the good is deemed unnecessary, the consumers will decide not to purchase that item.
On the other hand, the concept of substitutions is also based on the elasticity (willingness) to the price. In this case, when the price of good A increases, demand will decrease and shift, depending on the available substitutes. An example is the sale of Shampoo, when the leading brand increases its price, the availability of another brand of shampoo will meant that consumers will forego the purchase of the leading Shampoo and instead purchase another brand of shampoo.
As such, it can be seen that the necessity of a good and the availability if substitutes makes the impact of changes in price vary from the basic model of supply and demand.
Davidson, Scott. (2003). Economics: Perfect Competition and Monopolistic Competition. 2nd Series. Bantham Books: 103-105. Monopoly. (2008). In Everyday Finance: Economics, Personal Money Management, and Entrepreneurship. Detroit, MI: Gale.