Demand and Supply: Elasticity and Market Equilibrium

Demand, Supply, and Market Equilibrium

Demand and supply are the two most basic concepts in economics. They define the market and how it dictates price. The forces of demand and supply are normally the key determinants of price and operations in the market. Demand is the quantity of a commodity demanded over a given period at a certain price. It may also be defined as the ability and willingness to acquire a good or service desired by a consumer. In contrast, supply is the amount of goods and services that suppliers are willing to avail to the market at the prevailing price. Given their opposite nature, these two forces meet at only one point referred to as equilibrium. Such a state in the market shows that both buyers and sellers agree on the set price.

Price Elasticity of Demand

Elasticity is the extent of reaction of a commodity to changes in price. When the price of an item falls or rises, consumers will responsively change the quantity demanded of the same product. These changes are guided by the basic law of demand and supply, which states that quantity demanded is inversely proportional to price, all else being equal. This means that when all other factors are held constant, an increase in price will result in a fall in demand, and vice versa.

Price elasticity is classified into three types: elastic demand, unit elasticity, and inelastic demand. Elastic demand refers to the condition where a price change will bring a more than proportionate change in the quantity demanded. In unit elasticity, changes in price and quantity are proportionate. Inelastic demand is characterized by a case where a price change will lead to a less than proportionate change in the quantity demanded.

Cross-Price Elasticity and Related Goods

Cross-price elasticity measures the changes in quantity demanded due to changes in prices of goods that are related. Goods can be related in two ways: as complements or as substitutes. Complementary goods are those that are used together, such as bread and butter. Supplementary (or substitute) goods are those that can be used interchangeably, such as tea and coffee.

An increase in the price of a commodity will lead to a fall in demand for its complement and vice versa. Conversely, an increase in the price of a commodity will lead to a rise in demand for its substitute and vice versa. Reasonably, consumers will demand more of the alternative when the commodity becomes more expensive.

Income Effects on Inferior and Normal Goods

Inferior goods are those goods that are of poor quality and limited use. These goods do not attract much value from users. Normal goods are the ordinary goods that are commonly used by everyone. Elasticity of demand has diverse benefits depending on the type of good.

For inferior goods, an increase in income will lead to a decrease in demand, and vice versa. The notion that customers get from increased income is that the commodity can be left out in favor of consumption of a better alternative. When income falls, it is understood to mean that the only affordable commodity is the inferior one. On the same note, income elasticity for normal goods follows the direct proportion rule: the higher the income, the higher the demand, and vice versa.

Substitutes and Consumer Behavior

Substitutes alter the way elasticity behaves. Elasticity is greater where substitute goods are many. Reasonably, customers will always have an option to switch in case the commodities they prefer become more expensive. A high price for a commodity such as tea will force consumers to start consuming coffee or other substitutes available like cocoa. There will be no point where they will stick to high-priced commodities when cheaper substitutes are available.

In a situation where the product is the only one of its kind in the market, consumers will find it difficult to change their consumption even with price hikes. It is only in extreme circumstances that they will stop consuming the commodity altogether.