What Drives the Market

Class 09 Social Science

This chapter explores the concepts of demand, supply, and price determination and provides a glimpse of the outcomes of their interplay in real-world situations.

Demand

The quantity of a product that people are willing and able to buy at a particular price, depending on their needs, preferences, season, trend, and income, is called the demand for the product. Demand is not just the desire to buy something; it is the willingness complemented by the ability or purchasing power to buy it.

When the price of any product rises, the quantity demanded decreases, and when the price falls, the quantity demanded increases. This phenomenon is called the Law of Demand, which highlights the inverse relationship between the price of a product or service and its quantity demanded.

The quantity of a good or service that an individual consumer wants to buy at different prices, keeping other factors constant, is known as individual demand. Market demand is the sum of all individual demand.

Other Determinants of Demand

The demand for a product does not necessarily change only because of price. Many other factors influence how much people want to buy, even when the price of the good or service remains the same.

Price of related goods

The demand for a good can be affected by changes in the prices of related goods. There are two types of related goods:

• Substitute goods: These goods can replace each other, like tea and coffee. If tea’s price remains the same while coffee becomes more expensive, people who consume coffee may switch to tea, thereby increasing its demand.
• Complementary goods: These goods are generally used together to provide utility to the consumer, for instance, smartphones and earphones, or cars and petrol. If the demand for printers increases, the demand for printer cartridges may also rise, even though the price of cartridges remains unchanged.

Income of the consumer

When household income rises, consumers can afford to buy more or choose higher-quality products. A rise in income generally makes people feel more confident about their ability to spend, so the quantity demanded for several goods rises, even if prices remain the same.

Taste and preference of the buyer

Every consumer has specific tastes and preferences for certain products, which determine their demand.

The demand also depends on the size and composition of the nation’s population. For example, being the most populous nation, India’s domestic consumer demand contributes to its economic growth. In addition, the population’s composition shapes the demand for types of products and services. More children indicate increased demand for sports shoes, more working adults means a higher demand for formal shoes, and more elderly people imply a higher demand for comfortable or orthopaedic shoes.

Seasonality

Individuals may demand different products at different times of the year, and these changes often depend on weather, festivals, and cultural habits rather than the price of the good.

Future price expectations

Future price expectations influence current demand even when current prices have not changed. If consumers expect prices to fall, they postpone purchases, decreasing present demand. If they expect prices to rise, they buy immediately, increasing present demand.

Supply

Supply is the quantity of a product that sellers are willing and able to offer at a particular price.

As price increases, quantity supplied increases, and as price decreases, quantity supplied falls. This is because higher prices increase profitability, incentivising producers to increase output, and also attract new firms to the market. This is known as the law of supply.

Individual supply is the quantity a particular seller offers at different prices. Market supply is the sum of all individual supplies.

Other Determinants of Supply

Price of related goods

Suppose a farmer faces two choices. If wheat prices are low but chickpea prices are high, he will grow more chickpeas in the next season. Therefore, the supply of one good depends on the profitability of other alternatives for the supplier.

Number of sellers in the market

If there are more sellers in a market due to higher competition and increased production, the market supply of the product would exceed the demand. As a result, prices would fall. Likewise, if there are fewer sellers in the market, supply would be lower than demand, and prices would rise.

Technology

Improvement in technology reduces the cost of production, allowing producers to produce more and supply more and vice versa.

Future expectations

If producers or suppliers expect a boom in the demand for goods in the near future, they will produce more, and supply will rise. Similarly, if the producer is expecting lower demand, they will reduce production, leading to a fall in supply.

Market Equilibrium

Every market involves negotiation between what buyers are willing to pay and what sellers are willing to accept. Thus, prices are determined by the interaction between demand and supply.

The point where the quantity demanded equals the quantity supplied, is known as the market equilibrium. At this point, there is no pressure for prices to change, and the market is ‘cleared’, which means that there is neither a shortage (excess demand) nor a surplus (excess supply).

Does Market Equilibrium Exist in the Real World?

In theory, equilibrium is an intersection point between demand and supply. But in the real world, markets are dynamic with constantly changing conditions. For example, changes in technology, wages, interest rates, as well as wars, political events, pandemics, weather, and natural disasters alter demand and supply. Therefore, ‘equilibrium’ in the real world is never stable and moves all the time, i.e., the market is always in a process of adjusting to a new equilibrium, never fully settling at the previous one.

Role of Government in the Economy

Regulation of Unfair Practices

The government regulates unfair practices to protect consumers, workers, and producers from exploitation and injustice. For example, the government sets maximum prices (price ceiling) for essential goods like medicines to prevent overcharging. Similarly, the government sets a minimum wage to ensure workers earn enough for their hard work. This lower limit is known as the price floor.

Sometimes a single or a few sellers dominate the market; they can charge higher prices and supply less than a competitive market would. This form of monopoly would be detrimental to consumer welfare as it may charge higher prices, provide poorer quality of goods and services, restrict supply, and so on. The government regulates such practices by keeping the prices and quantity supplied in check.

Provision of Public Goods

Public goods are goods and services that are provided by the government for the benefit of all citizens, for example, roads, bridges, public parks, and street-lighting are provided for public use; national defence protects the country from external threats; sanitation, and drainage systems improve living conditions, and so on. These goods are usually not provided by private companies because they do not generate direct profit.