Classical economics or rather its
neo-classical variant posits economics revolving around the incentive mechanism.
Economic agents are rational and hence their decisions revolve around the
marginal cost-marginal benefit analysis. As discussed in the previous posts, economics
is all about understanding actions of the agents and the implications of such
actions. While economic agents might act in their self-interest, this need not
align at all times with the self-interest of the group or the community they
belong to. This misalignment might lead to the rise of externalities.
Yet, as agents act in their self-interest,
it is important to understand the incentive mechanism at work. While people
respond to incentives, they also respond to disincentives. There is definitely
cost benefit analysis at work when the agents plan their action. This would be
however contingent on the price they have to pay for the action. When someone over
speeds or travels in the wrong lane or parks their vehicle in no-parking zone,
they are essentially executing an action based on their subjective probabilities
of getting caught and the price they have to pay for the same. If their luck
holds, they would obviously calculating the benefits they are reaping from the
same. The price has an important role in business and markets in determining
the interactions of demand and supply.
Demand and supply decisions are
contingent on willingness and ability on the part of the economic agent to buy
or offer goods in the market at different prices. Implied is an explicit
connection of these decisions to purchase or offer with the prices prevailing in
the market. In conventional terms, supply is defined as the willingness and
ability on the part of the producer to offer goods in the market for sale at
all possible prices. Similarly, demand is usually defined as the willingness,
ability and desire on the part of the buyer to purchase goods in the market at
various prices. The ability might exist yet the absence of willingness would
curtail supply or demand. In the current content, demand patterns seem to be
affected not because of the lack of ability per se but even the willingness
seem to be missing. Those who are able to afford the goods are not willing to
buy to avoid going out thus being at risk for contracting the coronavirus. Similarly,
there are many who might have the ability to offer goods but are reluctant to
open their shop for fear of being infected by the coronavirus. The propensity
to self-protect is hindering willingness thus impacting the dynamics of demand
and supply. Construction industry both residential and commercial are hindered because
labour is unwilling to come to work and have migrated back to their home towns.
This again has to do with willingness and not the ability per se.
It is possible that ability has been
affected. People when they lose their jobs do not have sufficient income thus
forcing them to curtail their purchases. This lack of ability does affect
demand patterns. There might be many a young man, who would be keen to have a
ride on Harley Davidson, but given their income levels, they might not be in a
position to purchase the bike. It might remain an aspiration but does not get
converted to demand due to the missing ability.
Similarly the supply positions too
are influenced by the ability or the lack of it on the part of the producers. China
has been invading global markets with its cheap supply of goods. These are
constraining the ability of the domestic suppliers to offer goods at those
China prices. In India, many a small sector enterprises have been wiped out by
the flooding of China goods. If the Chinese manufacturers offer goods at lower
prices, the Indian counterparts must be in a position to offer the same. Yet,
given various constraints, Indian producers are not in a position to offer
those goods at the China price thus exiting the market. This is a reflection of
the ability of the Indian producer irrespective of the reasons for lack of the
ability to execute the things.
As we have noted already, the
dynamics is contingent on the prices. It is therefore a sort of relation
between goods on offer for sale or goods being purchased with the terms of
exchange of those goods or in other words the price. The graphical representation
of these relationship leads to the derivation of the demand curve or the supply
curve as the case might be. Yet what would be of interest is the possibility of
change in these terms of interactions.
The interplay of incentive mechanism
would again come to the fore. The price-demand-supply interplay is subject to
the assumptions of ceteris paribus something that rarely exists in reality. Implied
is the terms of exchange are not independent in itself but a function of
numerous factors. These might include income, nature of the good, the
complements resulted through purchase or sale of good, the availability of
substitutes, the necessity of the goods, random shocks that potentially disrupt
supply or demand, information about the good in question, the extent of
advertising, extent of differentiation, flexibility and mobility of the inputs
that go in production and distribution of the good, durability of the good
among many others. The degree of response of demand or supply to changes in
these factors obviously hinges on the elasticity with respect to that factor. The
elasticity of demand or supply with respect to price might be critical, yet
what is of equal importance is the elasticity of these factors in reference to
their impact on supply or demand.
A question might emerge whether the
forces of demand and supply would ever intersect. Contrary to textbook
analysis, the intersection need not be a logical outcome. The equilibrium in
fact would more of a scenario of prevailing of status quo rather than an
intersection of demand and supply curves. The post “Schelling’s
equilibrium” engages at certain depth the idea of economic equilibrium in
reality as opposed to the textbooks. In reality, the forces of supply and demand
move towards convergence if the price elasticity of supply is greater than the
absolute value of price elasticity of demand. In the other case where the price
elasticity of supply is less than the absolute value of price elasticity of
demand, rather than a movement of equilibrium, the forces of demand and supply
actually move the opposite or in other words, diverge away from the equilibrium,.
Implied is an elastic demand curve relative to supply moves the market towards equilibrium
whereas the elastic supply curve relative to demand moves the market away from
equilibrium.
As such the construction of a demand
or a supply function necessitates the presence of several variables that either
independently or interaction influence the patterns of play of demand or
supply. The current note is more an illustration of theoretical underpinnings
of these dynamics. The examination in detail of various variables that respond
and change positively or negatively the equation between price and supply or
demand must wait for another day.
Comments
Post a Comment