Market systems are favored by
Neoclassical economists for three primary reasons. First, agents only need
information about their own objectives and alternatives. The markets provide
information to agents that may be used to identify and evaluate alternative
choices that might be used to achieve objectives. Second, each agent acting in
a market has incentives to react to the information provided. Third, given the
information and incentives, agents within markets can adjust to changes. The
process of market adjustment can be visualized as changes in demand and/or
supply.
Shifts or Changes in Demand
The demand function was defined
from two perspectives:
A schedule of quantities that
individuals were willing and able to buy at a schedule of prices during a given
period, ceteris paribus.
The maximum prices that
individuals are willing and able to pay for a schedule of quantities or a good
during a given time period, ceteris paribus.
In both cases the demand function
is perceived as a negative or inverse relationship between price and the
quantity of a good that will be bought. The relationship between price and
quantity is shaped by other factors or variables. Income, prices of
substitutes, prices of compliments, preferences, number of buyers and
expectations are among the many possible variables that influence the demand
relationship. The demand function was expressed:
Qx = fx(Px, Pc, Ps, M,
Preferences, #buyers, . . . )
Pc is the price of complimentary
goods. Ps is the price of substitutes. M is income. Such proxies as gender,
age, ethnicity, religion, etc represent preferences. Remember that a change in
the price of the good (Px) is a change in quantity demanded or a movement along
a demand function. A change in any other related variable will result in a
shift of the demand function or a change in demand.
Shift of Supply
Remember that the supply function
was expressed,
Qxs = fs (Px, Pinputs, Tech,
regulations, # sellers, . . . #S)
A change in the price of the good
changes the quantity supplied. A change in any of the other variables will
shift the supply function. An increase in supply can be visualized as a shift
to the right, at each price a larger quantity is produced and offered for sale.
A decrease in supply is a shift to the left; at each possible price a smaller
quantity is offered for sale. If the supply shifts and demand remains constant,
the equilibrium price and quantity will be altered.
An increase in supply (while
demand is constant) will cause the equilibrium price to decrease and the
equilibrium quantity to increase. A decrease in supply will result in an
increase is the equilibrium price and a decrease in equilibrium quantity.
Changes in both Supply and Demand
When supply and demand both
change, the direction of the change of either equilibrium price or quantity can
be known but the effect on the other is indeterminate. An increase in supply
will push the market price down and quantity up while an increase in demand
will push both market price and quantity up. The effect on quantity of an increase
in both supply and demand will increase the equilibrium quantity while the
effect on price is dependent on the magnitude of the shifts and relative
structure (slopes) of supply and demand.
Should demand decrease and supply
increase, both push the equilibrium price down. However, the decrease in demand
reduces the equilibrium quantity while the increase in supply pushes the
equilibrium quantity up. The price must fall, the quantity may rise, fall or
remain the same. Again it depends on the relative magnitudes of the shifts in
supply and demand and their slopes.
When supply and demand both
shift, the direction of change in either equilibrium price or quantity can be
known but direction of change in the value of the other is indeterminate.
Equilibrium and the Market
Whether equilibrium is a stable
condition from which there "is no endogenous tendency to change," or
and outcome which the economic process is tending toward," equilibrium
represents a coordination of objectives among buyers and sellers. The demand
function represents a set of equilibrium conditions of buyers given the incomes,
relative prices and preferences. Each individual buyer acts to maximize his or
her utility, ceteris paribus. The supply function represents a set of
equilibrium conditions given the objectives of sellers, the prices of inputs,
prices of outputs, technology, the production function and other factors.
The condition of equilibrium in a
market, where supply and demand functions intersect ("quantity supplied is
equal to the quantity demanded") implies equilibrium conditions for both
buyers and sellers.
