Demand & Supply

Q 1. Identify Linkage Between the Economic Concepts (Demand& Supply, Price Elasticity of Demand, Market Equilibrium) With the Discussion in the Article.

The linkage between supply and demand triggers the forces that motivate resource allocation. In regard to the article, in a perfect market, pricing increases on commodity products and services would translate into a shift in quantity demanded. This is illustrated in figure 1 below. The law of demand stipulates that, when all factors are held constant, high prices of a commodity result in the decreasing demand for the commodity. Hence, pricing increases on commodities would translate into a shift in quantity demanded of the commodity (Arthur, 2004). Figure 1 below illustrates that the demand curve slopes downwards.

(Arthur, 2004).

Figure 1.Every point on the demand curve depicts a direct link between price (P) and quantity demanded (Q). Therefore, at point A, the price is P1, while the quantity demanded is Q1. The demand relationship curve exemplifies the negative correlation between quantity demanded and price demanded. On the other hand, contrasting to the law of demand, supply relationship depicts an upward inclined slope. This depicts that the higher the price of a commodity, the higher the quantity would be supplied (Daniel, 2009). This is illustrated in figure 2 below.

(Arthur, 2004).

Figure 2

Every point on the curve depicts a direct linkage between Price (P) and quantity supplied (Q). At point B, the price will be P2, while the quantity supplied will be Q2.

In the event that demand and supply are equal, the demand function and supply function would intersect. At this point, the economy would be at equilibrium, and the allocation of goods is most efficient. This scenario is depicted in figure 3 below.

(Arthur, 2004).

Figure 3.

Equilibrium takes place at the meeting point of the supply and demand curves. The quantity at this point will be Q*, while the price of the commodities will be P*. These figures in this case are known as equilibrium quantity and price. In the short term, market equilibrium is attained when the quantity supplied is equal to quantity demanded. In such an event, the market clears. This is because the market does not have additional quantity demanded or quantity supplied, at the market clearing price.

However, that specific market price may not result to equilibrium in the long term. In the short term, producers may lack adequate time to completely adjust to existing market conditions. Some existing producers may lack profits or they would be unable to cover all their operational costs at the existing market price. Producers in such a situation would consider exiting the industry, or refrain from further allocation of capital to the industry. If producers are generating profits, then more resources would be allocated to the industry. In the long term, the entire factors of production can be varied.Long-run equilibrium is anticipated in the market to over time. However, the process would take considerably a long duration. In reality this may never materialize since supply and demand curves are continuously shifting. Figure 4 below illustrates what would happen in the event of an increase in demand

Figure 4. Effects of a Shift in Demand

D0 is the initial demand curve, and D1 is the resultant new demand curve. The resultant market equilibrium price owing to a shift in the demand curve will rise from P0 to P1, tentatively in the short-run.  The quantity demanded and supplied will as well increase from Q0 to Q1.Eventually, in a market economy, there are two forces that will be experienced in the market:

Suppliers would have incentives to supply extra quantities of the commodity, and extra resources would be allocated for the production of this commodity. This interplay will tend to raise the quantity supplied and reduce the market prices.

Consumers would have incentives to explore for substitutes, thus lessening their purchase of the initial commodity. This interplay will tend to reduce the quantity demanded as well as the market price.

Oligopoly

However, the market economy in the case scenario is not a perfect market. The kind of market in the case scenario is referred to as an oligopoly. In an oligopoly, few firms comprise an industry. This group of firms controls the price and place high entry barriers. The oligopolistic firms offer commodities that are usually almost similar and, therefore, the firms, which compete for the market share, are co-dependent as a consequence of market forces (Weber, 2011). This is the case in the Singapore’s taxi market. The demand curve in the Singapore’s taxi market would be a kinked demand curve.

The kinked demand curve presupposes that a business such as ComfortDelgro may experience a dual demand curve for its services based on the expected response of other transport firms in the transport industry to an adjustment in its taxi fares. The general postulation of the theory is that businesses in an oligopoly are seeking to maintain and protect their market share and that competitors are less prone to contest another’s price increase but may contest a price reduction. This means that competitors in an oligopoly respond asymmetrically to adjustments in prices of a rival firm. This theory is illustrated in figure 4 below.

(Morgan, 2007).

Figure 5

In figure 5 the kinked demand curve, is composed of two sections BD’ and DB. The demand curve is bent at point B. The kink is produced at the existing market price level BM. The section of the demand curve above the current price level is highly elastic and the section of the demand curve under the current price level is comparatively inelastic (Morgan, 2007). Therefore in the event that an oligopolistic increases its fares from $10 per trip to $12 per trip, the firm would lose a large share of the market and its sales would decrease from 120 units to 40 units. This depicts a loss of 80 units in sales as most of its customers would engage the services of other transport providers from the competing firms who may be charging their services at $10 per trip. Therefore an increase in fares above the current level illustrates that the demand curve to the left of and over point B is comparatively elastic (Weber, 2011).

The taxi companies in the oligopolistic market have no inducement to increase or decrease their fares. They may prefer to charge at the current fare level as a result of the reaction function. The kinked-demand theory in oligopoly exemplifies the high level of interdependence in the firms that comprise an oligopoly. In this case, the market demand curve in each company in the oligopoly is established by the price decisions and output of the rival companies in the oligopoly.

However, the kinked-demand theory is regarded as an incomplete hypothesis of oligopoly for a number of reasons. The theory does not clarify how the oligopolistic find the kinked point in the market demand curve. Secondly, the kinked-demand hypothesis does not allocate for the prospect that price increases by one company in the oligopoly are matched by other companies in the oligopoly. In conclusion, the kinked-demand hypothesis does not reflect on the prospect that companies in the oligopoly conspire in setting price and output. The prospect of collusive behavior is illustrated in the substitute theory referred to as the cartel theory of oligopoly (Weber, 2011).

References

Arthur, W. (2004). Complexity & the Economy. Science 84 (2), 107–109.

Daniel, H. (2009). The S Corporation Financial Adjustment. Handbook of Business Appraisal & Intellectual Property Evaluation. New York, McGraw Hill.

Morgan, A. (2007). Econometric Ideas. Cambridge: Cambridge U.P.

Weber, H. (2011). Budgeting Process. Contemporary Strategic Investments. Montvale: Columbia Press.