Market_Equilibration_Process

Market Equilibration Process Market equilibrium occurs when the supply of goods and service are equal to its demand. To understand market equilibrium it is necessary to understand the law of supply and demand which is the heart of the market economy. It is necessary for business managers and leaders to maintain market equilibrium to ensure the business reach its goals and objectives. The content of this paper discusses the market equilibrating process, the law and determinants of supply and demand, efficient market theory, surpluses, and shortages. The Law of Supply At one time or another shortage of supplies or goods arise. In this instance buyers compete against one another in relation to the price. When this situation occurs, the price of goods rise and eventually the demand will decrease. As prices increase supplies will increase and as prices decrease supplies will decrease. This is known as the law of supply. In 2005 south Louisiana experienced the United States greatest natural disaster in history, Hurricane Katrina. As New Orleans and Mississippi coast lines were hit the hardest, thousands of residents fled to Baton Rouge and other surrounding cities for shelter. This affected the housing market drastically. The demand for housing increased while the supply of homes available for purchase and rent was limited, thus increasing the price of homes for sale and rent as buyers competed against one another. I purchased my home in 2004 for $100,500. A close friend purchased her home for about the same size and amenities in 2006 for $175,000. This was a drastic increase. Below is exhibit one courtesy of Pearson Prentice Hall, describing the how the excess demand and limited supply of homes available increased the market equilibrium price from $130,000 to $156,000. Determinants of Supply There are many determinants that affect supply, such as production cost. The goal of a company is to maximize profits and an increase in production costs will lower profits, which will defer supply. Factors that affect production costs are input prices, wages, taxes, and government regulations. Another determinant of supply is technology. When there are improvements in technology, this assist in reducing production cost and increases profit. This will generate greater supply. The number of sellers in a particular market and the expectation of higher prices in the future can also impact the law of supply. The Law and Determinants of Demand The law of demand explains the connection among price of a good or service and the quantity demanded of the good or service. It is surveyed that the price and demand are inversely related, thus they move in opposite direction (McConnell, Brue, and Flynn, 2009). An increase in price will lead to a decrease in demand and a decrease in price will lead to an increase in demand. There are several determinants that affect demand. Income affects the demand curve. As a person’s income increases their demand for goods and services will generally increase. The opposite will occur if income is decreased. The price of related goods also affects the demand curve. For instance, if the price of coffee increases, the demand for tea would increase because tea is a good substitute for coffee. Other determinants of demand include consumer preferences, number of buyers and expectation of future prices. Market Efficiency Theory This particular theory assumes that market contributors obtain and act on all of the important factors as it readily becomes available (Investopedia, 2012). Because information is made available to everyone at the same time it is believed that no one business will have the capacity to gain more profits than its competitors (Investopedia, 2012). When competition increases the market will move toward equilibrium. When there are surpluses business owners will reduce prices to sell inventor and when there are shortages business owners will increase prices. Surpluses and Shortages Shortages occur when there is an excess of demand, and a surplus occurs when supply out number demand (Arnold, 2005). If a shortage occurs, prices will usually rise. This happens because buyers will bid up the price competing against one another. This effect was viewed for the housing market after Hurricane Katrina. The opposite occurs if there is a surplus. This happens because sellers realize that they cannot sell their goods at the current price and the inventory increases beyond the level the seller can hold. To reduce inventory seller will reduce the price. This is how the market is moved toward equilibrium. See exhibit two below describing shortages and surpluses. Price Qs Qd Condition 20 200 100 Surplus 15 150 150 Equilibrium 10 100 200 Shortage 20 Surplus So 15 Price E 10 Shortage Do 0 100 150 200 Quantity Conclusion Market equilibrium is a necessary instrument in keeping the economy in sync. As discussed above, there are many determinants that affect the economy. It is up to the buyers and producers of goods and services to build up and maintain the economy. Supply and demand increase competition, which causes prices to rise and fall. In the end the market eventually returns to the state of equilibrium. References Arnold, R.A. (2005). Economics (7th ed.). Mason, OH: Thomson South-Western. Fernando Quijano, Kyle Thiel, & Aparna Subrmanian. (2007). Demand, Supply, and Market Equilibrium [PowerPoint slides]. Retrieved from http://www.prenhall.com/behindthebook/0132447029/pdf/O'Sullivan.... Investopedia. (2012). Retrieved from http://www.investopedia.com/articles/02/101502.asp#axzz1tYB4Mq7n McConnel, C. R., Brue, S. L., & Flynn, S. M. (2009). Economics: Principles, Problems, and Policies (18th ed.). Retrieved from The University of Phoenix eBook Collection database.