We have been very careful in our discussions thus far to separate household decisions about how much to demand from firm decisions about how much to supply. The operations of the market, however, clearly depend on the interaction between suppliers and demanders. At any moment, one of three conditions prevails in every market: (1) the quantity demanded exceeds the quantity supplied at the current price, a situation called excess demand; (2) the quantity supplied exceeds the quantity demanded at the current price, a situation called excess supply; or (3) the quantity supplied equals the quantity demanded at the current price, a situation called equilibrium. At equilibrium, no tendency for price to change exists.
Excess Demand
Excess demand, or shortage, exists when quantity demanded is greater than quantity supplied at the current price. Figure 9, which plots both the supply curve and a demand curve on the same graph, illustrates such a situation. As you can see, market demand at $1.75 per bushel (50,000 bushels) exceeds the amount that farmers are currently supplying (25,000 bushels).
When excess demand occurs in an unregulated Market, there is a tendency for price to rise as commanders compete against each other for the limited supply. The adjustment mechanisms may differ, but the outcome is always the same. For example, consider the mechanism of an auction. In an auction, items are sold directly to the highest bidder. When the auction starts the bidding at a low price, many people bid for the item. At first there is a shortage: quantity demanded exceeds quantity supplied. As would-be buyers offer higher and higher prices, bidders drop out, until the one who offers the most ends up with the item being auctioned. Price rises until quantity demanded and quantity supplied are equal.
 At a price of $1.75 (see Figure 9 again), farmers produce soybeans at a rate of 25,000 bushels per year, but at that price the demand is for 50,000 bushels. Most farm products are sold to local dealers who in turn sell large quantities in major market centers, where bidding would push prices up if quantity demanded exceeded quantity supplied. As price rises above $1.75, two things happen: (1) the quantity demanded falls as buyers drop out of the market and perhaps choose a substitute, and (2) the quantity supplied increases as farmers find themselves receiving a higher price for their product and shift additional acres into soybean production.
This process continues until the shortage is eliminated. In Figure 9, this occurs at $2.50, where quantity demanded has fallen from 50,000 to 35,000 bushels per year and quantity supplied has increased from 25,000 to 35,000 bushels per year. The process has achieved an equilibrium, a situation in which there is no natural tendency for further adjustment. Graphically, the point of equilibrium is the point at which the supply curve and the demand curve intersect.
Increasingly, items are auctioned over the Internet. Companies like eBay connect buyers and sellers of everything from automobiles to wine and from computers to airline tickets. Auctions are occurring simultaneously with participants located across the globe. The principles through which prices are determined in these auctions are the same: when excess demand exists, prices rise.
While the principles are the same, the process through which excess demand leads to higher prices is different in different markets. Consider the market for houses in the hypothetical town of Boomville with a population of 25,000 people, most of them live in single-family homes. Normally about 75 homes are sold in the Boomeville market each year. However, last year a major business opened a plant in town, creating 1,500 new jobs that pay good wages. This attracted new residents to the area, the real estate agents now have more buyers than there are properties for sale. Quantity demanded now exceeds quantity supplied. In other words, there is a shortage.
 Auctions are not unheard of in the housing market, but they are rare. This market usually works more subtle, but the outcome is the same. Properties are sold very quickly and housing prices begin to rise. Boomville sellers soon learn that there are more buyers than usual, and they begin to hold out for higher offers. As prices for Boomville houses rise, quantity demanded eventually drops off and quantity supplied increases. Quantity supplied increases in at least two ways: (1) Encouraged by the high prices, builders begin constructing their house new houses, and (2) some people, attracted by the higher prices their homes will fetch, put their houses on the market. Discouraged by higher prices, however, some potential buyers (demanders) may begin to look for housing in neighboring towns and settle on commuting. Eventually, equilibrium will be re-established, with the quantity of houses demanded just equal to the quantity of houses supplied.
Although the mechanisms of price adjustment in the housing market differ from the mechanics of an auction, the outcome is exactly the same: This process is called price rationing. When a shortage exists, some people will be satisfied and some will not. When the market operates without interference, price increases will distribute what is available to those who are willing and able to pay the most. As long as there is a way for buyers and sellers to interact, those who are willing to pay more will make that fact known somehow. (We discuss the nature of the price system as a rationing device in detail in later posts).
Excess Supply
Excess supply, or a surplus, exists when the quantity supplied exceeds the quantity demanded at the current price. As with a shortage, emergence of price adjustment in the face of a surplus can differ from market to market. For example, if automobile dealers find themselves with unsold cars in the fall when the new models are coming in, you can expect to see price cuts. Sometimes dealers offer discounts to encourage buyers; sometimes buyers themselves simply offer less than the price initially asked. In any event, products do no one any good sitting in dealers' lots or on warehouse shelves. The auction metaphor introduced earlier can be applied here: If the initial asking price is too high, no one bids, and the auctioneer tries a lower price. It is almost always true that certain items do not sell as well as anticipated during the Christmas holidays. After Christmas, most stores have big sales during which they lower the prices of overstocked items. Quantity supplied exceeded quantity demanded at the current prices, so stores cut prices.
 Across the state from Boomville is Bustville, where last year a drug manufacturer shut down its operations and 1,500 people found themselves out of work. With no other prospects for work, many residents decided to pack up and move. They put their houses up for sale, but there were few buyers. The result was an excess supply, or surplus, of houses: the quantity of houses supplied exceeded the quantity demanded at the current prices.
As houses sit unsold on the market for months, sellers start to cut their asking prices. Potential buyers begin offering considerably less than sellers are asking. As prices fall, two things are likely to happen. First, the low housing prices may attract new buyers. People who might have bought in a neighboring town see that there are housing bargains to be had in Bustville, and quantity demanded rises in response to price decline. Second, some of those who put their houses on the market may be discouraged by the lowering prices and decide to stay in Bustville. Developers are currently not likely to be building new housing in town. Lower prices thus lead to a decline in quantity supplied as potential sellers pull their houses from the market.
Figure 10 illustrates another excess supply/surplus situation. At a price of $3 per bushel, suppose farmers are supplying soybeans at a rate of 40,000 bushels per year, but buyers are demanding only 20,000. With 20,000 (40,000 - 20,000) bushels of soybeans going unsold, the market price falls. As price Falls from $3 to $2.50, quantity supplied decreases from 40,000 bushels per year to 35,000. The lower price causes quantity demanded to rise from 20,000 to 35,000. At $2.50, quantity demanded and quantity supplied are equal. for the data shown here, $2.50 and 35,000 bushels are the equilibrium price and quantity.
Changes in Equilibrium
When supply and demand curves shift, the equilibrium price and quantity change. The following example will help to illustrate this point.
South America is a major producer of coffee beans. A cold snap there can reduce the coffee harvest enough to affect the world price of coffee beans. In the mid-1990s, a major freeze hit Brazil and Colombia and drove up the price of coffee on world markets to a record $2.40 per pound.
At the initial equilibrium price, $1.20, there is now a shortage of coffee. If the price were to remain at $1.20, quantity demanded would not change; it would remain at 13.2 billion pounds. However, at that price, quantity supplied would dropped to 6.6 billion pounds. At a price of $1.20, quantity demanded is greater than quantity supplied.
 Notice that as the price of coffee rose from $1.20 to $2.40, two things happened. First, the quantity demanded declined (a movement along the demand curve) as people shifted to substitutes such as tea and hot cocoa. Second, the quantity supplied began to rise, but within the limits imposed by the damage from the freeze. (It might also be that some countries or areas with high costs of production, previously unprofitable, came into production and shipped to the world market at the higher price.) That is, the quantity supplied increased in response to the higher price along the new supply curve, which lies to the left of the old supply curve. The final result was a higher price ($2.40), a smaller quantity finally exchanged in the market (9.9 billion pounds), and coffee bought only by those willing to pay $2.40 per pound.
Since many market prices are driven by the interaction of millions of buyers and sellers, it is often hard to predict how they will change. While a series of events in the mid-1990s lead to the leftward shift in supply, thus driving up the price of coffee, the opposite occurred between 1995 and 2003, when the world supply of coffee beans shifted sharply rightward. Brazil's crop was up 39 percent in 2003 alone. Brazil and the other large producing nations of Mexico, Vietnam, Indonesia, and Colombia combined to produce the largest crop ever in 2003. The result was that coffee prices fell to $0.40 per pound, the lowest price since July 1969. Very low coffee prices hurt the producing countries that rely heavily on coffee revenues.
*MAIN SOURCE: CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 60-65*
|
No comments:
Post a Comment