Sunday, May 8, 2011

Law of supply and demand

Supply and demand are probably the most recognized economics related   words. Even though they are commonly used, the true definition is   probably a little different from what most people think. Demand should   not be confused with want. People want many things, but if they are not   willing to pay for them, no demand exists. Similarly, supply deals with   salable or usable goods, and all other factors being equal, as demand   increases, the price goes up. Supply is more complicated than demand  and  an additional explanation shows that as long as long as costs stay  the  same, a higher price equals more profit. Therefore, a company will   increase output (Colander, 2004, p. 91).




The law of demand states  that, “quantity demanded rises as price  falls, other things constant”  (Colander, 2004, p. 84). Likewise, the law  of supply states, “quantity  supplied rises as price rises, other things  constant” (Colander, p.  90). Therefore, it can be extrapolated that  price has a direct relation  on demand and supply. For instance, as the  price of a commodity goes  down, its demand goes up and as its price  rises its demand falls. This  can be seen in the gasoline market; as  gasoline prices continue to  rise, less demand is created as consumers  find alternative methods of  transportation.

Factors Related to Supply and Demand

Shift factors are important factors relating to demand. Important   shift factors include income, price of other goods, tastes,   expectations, and taxes and subsidies (Colander, 2004, p. 85). Basically   any factor other than price that affects demand is considered a shift   factor. Most economists agree that while shift factors do influence   demand price is still the most important contributor to demand.

Supply can truly be thought of not as the actual number of units of a   widget produced, but rather as the amount of product a company is   willing to sell at any point on the price curve for a specific period.   Just like demand there are shift factors related to supply. These shift   factors include things like, costs, technology changes, expectations,   and taxes and subsidies (Colander, 2004, p. 92).

Case Study

In 2007 beer consumption was up 1.4% from 2006. This signals a shift   in the direction of beer consumption in the United States. The gains in   the craft beer segment (under 2,000,000 barrels with minimal use of   adjuncts) are even more astounding, up 12% (Theodore, 2008). Most   analysts predict a continued rise in beer consumption for the next   several years, although the smaller craft breweries may have a harder   time due to increases in costs.

American beer drinkers are exposed to more specialty and craft beers   every year, and even the giants of the industry are taking note.   Consumers are willing to pay premium prices (demand) for high quality,   unique products. Many of the smaller craft breweries are expanding at   rapid rates to supply this demand. The barrier to entry is getting   higher though as costs are increasing due to a weak dollar affecting   barley prices and a worldwide hop shortage expected to continue until   2010.

Many mega-mergers are taking place as the large beer companies are   shoring up holes in their product lines. For example, Budweiser is   talking to Grupo Modelo, makers of Corona and Negra Modelo, to thwart a   bid from the Belgian giant InBev NV. Budweiser has seen shrinking shelf   space and declining margins for the last several years and its  flagship  product Budweiser lost an astounding 3.4% market share,  $43,500,000, in  food, drug, and mass merchandise stores and was totally  flat in  convenience stores. Budweiser still holds the overall lead in  both  markets with its Bud Light product, although Miller Lite is  gaining in  some aspects.

The market seems to be favoring both light beer and craft beers with   traditional American style lagers losing favor. Imported beers are   showing mixed results as price pressure is reducing demand for many   beers and craft beers are gaining the reputation as high quality   alternatives to the imported equivalents.

Socially, beer is losing its reputation as a “blue collar” drink.   Many restaurants are now including beer guides as well as suggested   wines on the menu. Sommeliers are starting to understand the   complexities of the varied beer styles and many cookbooks and food shows are featuring beer, both for cooking and food-pairing. This all   combines to keep demand for beer high, despite higher costs and the   inevitable higher prices to come in the next year.

Conclusion

While most people have heard the terms supply and demand bandied   about for almost every conceivable price argument, the truth is that   markets create their own equilibrium. As prices drop, demand increases   as more buyers decide to buy the product. Likewise, if the price goes   up, due to demand causing shortages for example, suppliers will create   more of the product to take advantage of the increased profit margin. It   is important to understand that the terms supply and demand are really   concepts, both driving the market equally towards equilibrium. An   important note about equilibrium is the effect of government and social   forces on supply and demand. These external forces provide a   counter-pressure to the pure forces of supply and demand and create   false shortages and surpluses.

References

Colander, D. C. (2004). Economics (5th ed.). Boston: McGraw-Hill/Irwin.

Theodore, S. (2008). Beer raises a glass to rising sales: Signs of a   turnaround show reason for optimism. Beverage Industry, 99(4), 14-18.

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