Economics is the social science studying production and consumption through measurable variables.

It
involves analyzing the production, distribution, trade and consumption of goods and services. Economics is
said to be positive as it attempts to explain the consequences of different choices, given a set of assumptions
or a given set of observations and normative when it prescribes that a certain action should be taken. To
simply put it, economics is really the study of how individuals, businesses (suppliers and the creation of
supply), governments use their limited resources to satisfy unlimited wants (demand). This paper however
focuses on the economic concept of demand and supply and how through its interaction the market
equilibrium is achieved.
It seeks to answer to the following questions:
1. Explain why shortages and surpluses of goods in a market imply that it is not in equilibrium
2. What opposing forces balance the market equilibrium?
3. An increase in the popularity for CD players increase the demand for CD disc use supply and demand
analysis to show the impact of the increase in demand on the price of the CD disc.
Before these questions are answered, one must have a clear understanding of the basic economic concepts.
The first being that of demand and supply, There are a number of factors that affect the demand and supply of
a product. The level of demand is determined by factors other than price, for example the level of incomes,
tastes and advertising levels. A shift in the curve occurs when a factor other than price changes causing a
change in the level of supply or demand AT EVERY PRICE.
So no matter what the price is, there is either more or less demanded or supplied. For example, if incomes
increased we would expect the demand for most goods to increase at all prices. A movement along the curve
shows the response of consumers and producers to changes in price alone. Movements along the curve will
occur when there has been a shift in either the demand or supply curve causing a surplus or shortage in the
market, as market forces cause price to either rise or fall, consumers or producers will respond to the
changing price altering the quantity they wish to buy or sell.

Price elasticity is another important concept because it tells us how responsive the demand or supply will be
to changes in price. If prices rise by ten percent will the demand or supply fall or rise by less than ten percent
or more than ten percent and if so by how much? This is important to businesses because it influences their
behavior in terms of pricing strategies and the degree of market power they exercise. Some businesses are
able to charge different prices for the same product at different times because the degree of elasticity is
different - for example, electricity prices, or 'happy hours' at your favorite bar. Elasticity has an important
influence on the total revenue earned by the firm following changes in price and is therefore very important
in analysing the extent of the impact on a market as a result of a change in demand and supply conditions.
The ceteris paribus principle is important because it allows us to identify the impact of a change in the
market on that market. In reality, changes in demand and supply are occurring all the time, it would be
extremely difficult to be able to make any sense of what is happening and why without using this principle.
In reality demand and supply are constantly changing but in order to try to assess the impact of such changes
on markets we adopt a principle called ceteris paribus which means 'other things remaining equal'.
In effect in economics, we always start at an equilibrium position imposing some change - usually just the
one change - and then explain what happens to the market. This now brings us to the question:Explain why
shortages and surpluses of goods in a market imply that it is not in equilibrium and what opposing forces
balance the market equilibrium?
To answer this question one must define the term market equilibrium. Market equilibrium is defined as the
point at which the price consumers want to pay and the quantity that suppliers want to supply meet. In many
aspects of economic analysis, we tend to assume that a condition of equilibrium exists with respect to key
economic variables. Common examples include different models of market behavior known as supply and
demand analysis.
In these models of the market, the behavior of sellers are based on the goal of profit maximization in the
production and/or sale of a particular good. Higher selling prices allow a seller to reap a gain over and above
the price initially paid for a final good or asset. In the case of business firms, the production of additional
units of a particular good involve increasing opportunity costs in drawing resource inputs away from other
productive uses. Higher prices are necessary to cover these increasing costs of production. Thus, these types

of behaviors on the selling side of the market typically lead to a positive relationship between market price
(the dependent variable) and quantity supplied (the independent variable).
Separately, the behavior of buyers is based on the goal of maximizing the utility gained from the purchase
and consumption of this same good. As prices fall, holding income constant, the buyer finds that his/her
purchasing power has increased allowing for buying greater quantities of a particular good. It is also the case
that, for the consumer, additional quantities of a good consumed provide less additional satisfaction relative
to previous units consumed. This notion known as diminishing marginal utility implies that the consumer is
willing to pay less for these additional units as it becomes more efficient to use his/her income for the
purchase of other goods. For the buyer, these types of behaviors typically lead to a negative relationship
between the market price (dependent variable) and quantity demanded (another independent variable).
It is best to understand what is behind each curve; the demand curve shows the quantity demanded by
consumers at various prices (if everything else is held constant). The curve illustrates what happens to the
quantity consumers will buy when price changes. "Everything else held constant" means that the graph
shows the effect of a different price on the quantity demanded without mixing in other changes that could
effect quantity demanded. The demand curve shows a negative relationship between price and quantity
demanded. As you would expect, consumers buy more when the price is low and less if, the price is high
(wouldn't you?). This is why the demand curve has a negative slope it illustrates the "Law of Demand".
This can be illustrated in the following diagram:

The supply curve represents producers in the market the same way the demand curve represents consumers in
the market. The supply curve shows he quantity supplied by producers at various prices (if everything else is
held constant). The curve illustrates what happens to the quantity producers will sell when price changes.
"Everything else held constant" means that the graph shows the effect of a price change on the quantity
supplied without mixing in other changes that cold effect quantity supplied. The supply curve shows a
positive relationship between price and quantity supplied. As you might expect, producers will sell more only
if the price is higher. It generally costs producers more to produce more and therefore they will only sell
more if they receive a higher price for the quantity they sell. Producers will sell less when the price is lower.
This is why the supply curve has a positive slope it illustrates the "Law of Supply" This can be illustrated
in the following diagram:

One may typically ask the question where does the gravity come from to establish and maintain an
equilibrium price? The answer is in the reaction of sellers and buyers to disturbances in the market. This is
represented by the interaction of both the demand and supply for a product in this case homes is explained
numerically in the table and graphically in the following diagram, which illustrates the interaction of the
demand and supply. A picture is worth a thousand words, so let's look at the following graph of demand and
supply.

From the diagram, one can identify the market equilibrium as the point at which the supply of goods and the
demand for those goods meet. Numerically this is the price of $236. This is the point at which the suppliers
willingness to supply is equal to the price that buyers are willing to pay. When the demand exceeds the
supply, you have a situation of excess demand, also known as a shortage. When the demand is less than the
supply you have a situation of excess supply, also know as a surplus. Therefore, it can be said that in cases of
shortages and surpluses that market equilibrium does not exist.
It can be then said that the interaction of supply and demand determines an equilibrium price: at a stable
price. Both buyers and sellers realize they have no real control over the price. Buyers look at the price and
decide how much to buy. Sellers look at the price and decide how much to sell. The result? Buyers find they
can buy what they want to buy and sellers discover they can sell what they want to sell. This will only be true
at the equilibrium price.
To understand the idea of market equilibrium, it is useful to remember the general concept of equilibrium.
Equilibrium refers to a balance, where opposing forces are equal and there is no tendency for change. The
concept of equilibrium is not unique to economics or to the supply and demand model it is found in many
models in many disciplines. In the supply and demand graph, equilibrium occurs at the price where quantity
demanded equals quantity supplied the point where the supply and demand curves cross. The best way to
rationalize why this is equilibrium is to think about what happens at prices that are NOT the equilibrium
price. If price is ABOVE the equilibrium price, quantity demanded is relatively low (consumers buy less
when the price is higher). On the other hand, quantity supplied is relatively high (the higher price causes
producers to supply more). At a price above equilibrium, quantity supplied is greater than quantity
demanded.
If the quantity that producers supply exceeds the quantity demanded by consumers, the market has a surplus.
That is, consumers do not buy all that was supplied. The unsold quantity (surplus) increases producers'
inventories. Producers, seeing that they are not selling all that they produce, lower the price (put the surplus
"on sale") and decrease quantity supplied. Consumers respond to the lower price by increasing quantity
demanded. This continues until the surplus disappears when quantity supplied equals quantity demanded.
Any price above equilibrium will cause a surplus and lead firms to lower price until the surplus is gone (at
equilibrium).

Above equilibrium, there is a tendency for price to change (decrease) at equilibrium, there is no tendency
for change. In equilibrium, quantity supplied and quantity demanded are in balance supply and demand
forces are equal. If the price is BELOW the equilibrium price, quantity demanded is relatively high
(consumers buy more when the price is lower). On the other hand, quantity supplied is relatively low (the
lower price causes producers to sell less). At this price, quantity demanded is greater than quantity supplied.
So let us now look at these concepts of shortage and surplus in a little detail so as to understand why the
market equilibrium does not exists in this case. If the quantity that producers supply exceeds the quantity
demanded by consumers, the market has a surplus. That is, consumers do not buy all that was supplied. The
unsold quantity (surplus) increases producers' inventories. Producers, seeing that they are not selling all that
they produce, lower the price (put the surplus "on sale") and decrease quantity supplied. Consumers respond
to the lower price by increasing quantity demanded. This continues until the surplus disappears when
quantity supplied equals quantity demanded. Any price above equilibrium will cause a surplus and lead firms
to lower price until the surplus is gone (at equilibrium). Above equilibrium, there is a tendency for price to
change (decrease) at equilibrium, there is no tendency for change. In equilibrium, quantity supplied and
quantity demanded is in balance supply and demand forces are equal. This can be illustrated in the
following diagram.

In the above case that the market price has been forced above equilibrium such that supply decisions by
producers with respect to output exceed the amount demanded by consumers. In this case, a surplus is the
result. This surplus is often first recognized by the sellers through the accumulation of inventories.
If the quantity that consumers demand exceeds the quantity that producers supply, the market has a shortage.
That is, consumers want to buy more than producers supply. The excess demand for the product signals
producers to raise price. Producers see that consumers want to buy more than is supplied and realize that they
can sell their product for a higher price. The higher price causes quantity demanded to decrease and quantity
supplied to increase (Laws of Demand and Supply!). Producers continue to raise price until the shortage
disappears when quantity demanded equals quantity supplied. Any price below equilibrium will cause a
shortage and lead firms to raise price until the shortage is gone (at equilibrium). Below equilibrium, there is a
tendency for price to change (increase) at equilibrium, there is no tendency for change. In equilibrium,
quantity demanded and quantity supplied are in balance supply and demand forces are equal.

In the above situation, the market price has differed from the equilibrium price such that the quantity
demanded exceeded the quantity supplied, a different disequilibrium condition known, as a shortage would
result. Often, but not always, shortages are first recognized by buyers in the form of empty shelves, queuing,
and general difficulty in making a desired purchase. For example, in this case you may go to the store and
you pick out a pair of shoes. Then you ask the salesperson if you can try them on. If the market is not in
equilibrium, the salesman may tell you that the shoes are sold out and you may leave the store dissatisfied.

In reality, surpluses and shortages are caused by changes or shifts in either the demand or supply functions.
These shifts are the result of shocks to other (exogenous) variables that affect supply decisions by producers
or demand decisions by consumers. Typically, outward shifts in demand will lead to an increase in both the
equilibrium price and quantity due to movement along an upward sloping supply curve. Inward shifts of
demand will have the opposite effect (a decrease in equilibrium quantity and price). Outward shifts in supply
(along a downward sloping demand curve) will lead to an increase in equilibrium quantity and a reduction in
equilibrium price
Shortages and surpluses signal firms (through changes in inventories) to raise or lower prices. The desire of
firms to maximize their profits by adjusting price to prevent surpluses and shortages moves markets to the
equilibrium price and quantity. This process that moves the market to equilibrium is powerful. On the supply
and demand graph, markets that are allowed to operate without interference will always move to equilibrium.
But what about "everything else" that was held constant along demand and supply curves? Others things
CAN change and lead to changes in the graph. If any other factors change, the quantity demanded or supplied
at various prices will change for EVERY price. That is, the entire demand or supply curve will shift. Maybe I
should consider each side of the market separately.

Other factors (in addition to price) affect the quantity of a product consumers will buy: Consumer's income
and tastes determine how much they will purchase. Also, consumers will consider the price of substitute
goods (things they can purchase instead for example we could buy donuts instead of muffins for
breakfast) and the price of complements (things that are consumed together for example we could buy
coffee with their donuts). Consumer expectations and the number of buyers can also affect demand for a
good. If any of these change, the quantity demanded at any price will increase or decrease the demand
curve will shift to the right or left. If changes in other factors lead to an increase in demand, the curve will
shift right. Graphically, increases and decreases can be shown as in demand graph below.

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Here are some other factors (in addition to price) that will affect the quantity of a product producers will sell.
The costs of production, technology, the number of sellers, and sellers' expectations also affect producers'
decisions about how much to supply. If any of these change, the quantity supplied at any price will increase
or decrease the supply curve will shift to the right or left. If changes in other factors lead to an increase in
supply, the curve will shift right. It should be noticed that on the graph, quantities are higher to the right on
the horizontal axis (as you move away from the origin). To the left on the horizontal axis, quantities are lower
if the supply curve moves left it shows the change in a factor has led to a decrease in supply.
Increases and decreases in supply are shown on the graph below.

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Now we should probably consider how these changes would affect the market equilibrium. If there is a
change in a factor that affects supply, the entire supply curve shifts. The old supply curve no longer exists, so
the market moves to a new equilibrium. The new equilibrium is found where the new supply curve intersects
the demand curve (which hasn't changed).
For example, if the cost of production increases and causes a decrease in supply, the change in equilibrium is
illustrated on the graph below.

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In the same fashion if there is a change in a factor that affects demand, the entire demand curve shifts. The
old demand curve no longer exists, so the market moves to a new equilibrium. The new equilibrium is found
where the new demand curve intersects the supply curve (which hasn't changed).
For example, if consumer tastes change and causes demand to increase, the change in equilibrium is
illustrated on the graph below.

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An increase in the popularity for CD players increase the demand for CD disc use supply and demand
analysis to show the impact of the increase in demand on the price of the CD disc
Interestingly enough one of the key other factors that will affect the demand for a product is the price of its
compliment. Thus, will also affect the market equilibrium price. A general definition of a complementary
good are used together and are usually demanded together. CD players and CDs are examples of
complementary goods. Complementary goods are not the same as substitute goods and should not be
confused. Substitute goods are those that can be used in place of each other. Like Crest and Colgate, if the
price of Crest rose, then the demand for the cheaper Colgate would go up.
In this part of the question, we need to consider the effects of changes in the conditions of demand and
supply on the market for CD players and CDs. In my example, due to the increase in the popularity of CD
players the demand for such product has increased. Consequently, other consumers and I would purchase
more CD players; the demand for CD players would increase, and so would demand for CDs, which is
usually used with CD players . Thus, CD players and CDs are jointly demanded; they are complements.
Besides popularity, a decrease in the price CD players can also increase the demand for CDs. When two
products are complements, the price of one good and the demand for the other good move in opposite
directions. However in my example we are really looking at the increases in demand of one complement and
its effect on the other.
Diagram 1 Increase in the demand for CD players

Diagram 2 the consequent increase in demand for CDs

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To explain the above diagram the demand for CD players has increased due to a change in taste or fashion
making it popular. The demand curve moves to the right, giving a higher equilibrium price and quantity.
(diagram 1) Since consumers are demanding more CD players, they will obviously more CDs the demand
curve for CDs moves to the right as well giving rise to a higher price and quantity demanded. A new demand
curve is drawn to symbolize the change in the conditions of demand. Conversely if the price of CD players
were to increase then the demand for CDs will fall. In this case if this was illustrated on a graph the demand
curve for both products wouldnt move because the conditions of demand has remain constant. Therefore the
price of a complement good may either decreases or increase the demand for the product.
In conclusion one may now wonder why is this concept of market equilibrium so important. The answer is
obvious since the supply and demand graph describes the relationship between price and quantity in the
market. It can be used to illustrate the effect of changes in the market on equilibrium price and quantity. The
ability to predict how an expected change will affect market price or quantity can be very useful. For
example, on the supplier side a firm can more accurately determine how much to produce, one the demand
side a consumer can determine whether the price of a good they plan to buy will increase or decrease and an
investor

can

better

predict

when

to

"buy

low"

or

"sell

high"!

price of related goodscomplements

A change in the price of one good can change the demand for another good. One type of
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related goods is complements-goods that are purchased together. A decrease in the price of
strawberries will cause an increase in the demand for whipped cream. An increase in the price
of hamburger will cause a decrease in the demand for hamburger buns.
The price of the substitute good and demand for the other good are directly related. If the price of
Coke rises (because of a supply decrease), demand for Pepsi should increase.
ii. Complementary goods (those that are used together like tennis balls and rackets): When goods
are complements, there is an inverse relationship between the price of one and the demand for
the other.

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