The Father Of Modern Economics And Capitalism

Published Date: 02 Nov 2017

In the market economy, the interaction of the buyers and sellers determines how the market will work. Buyers demand and producers sell for a particular quantity of good and services at a certain level of prices. To Adam Smith, widely cited as the father of Modern Economics and Capitalism, in a free market, consumers are free to choose varieties of commodities, while producers have freedom to choose what commodity to sell and how to produce it. Market settles on the price that maximizes the benefit of the consumers and producers, resulting in "Happiness of Mankind".

DEMAND

Quantity demanded is defined as the number of a good or services that the buyer is able and willing to buy at a certain level of price. If a consumer has the ability to buy but it is not willing to buy or the other way around, demand is still considered as potential. An example of which is a "window shopper" who has the willingness to shop but has no money to spare. No transaction occurs for a potential demand. To convert potential demand to actual demand, numerous strategies are suggested like convincing, commercials, powerful slogans and salesmanship. Also, in the advent of credit system, consumers need not have to hinder their willingness to buy because credit and loans are extended to consumers to facilitate the process of consumption.

Demand Schedule is a table or matrix that shows the quantity of goods that are bought at a certain level of prices. The quantity demanded values are rates of purchases at alternative prices but it does not reveal at what particular price will actually exist in the market.

Table : Hypothetical Market Demand Schedule for Stuffed Animals The table only shows the quantity of stuffed animals this consumer is willing to buy to a corresponding price. The aggregate demand of a certain group of consumers is presented as the market demand schedule. Thus, demand tells us the purchasing behaviour of the buyer.

The connection concerning price and quantity demanded for any merchandise can be characterised on a simple graph, in which by nature, we measure price and quantity demanded on the vertical and horizontal axes respectively. Relating the Curve from the Table 1, logically, people buy more at a lower price.

Figure : Hypothetical Market Demand Curve for One Week A demand curve can be used to graphically represent the demand schedule. Any point on the demand curve reflects the quantity that will be bought at the given price. The demand curve is settled by linking these 10 points with a constant line. A normal demand slopes downward from left to right as shown in the Figure 1. Since price and quantity of goods bought have an inverse relationship, it shows a downward sloping curve.

From our observation of the demand curve and the demand schedule and with how the real world works, we can now state the law of demand as: assuming all other factors constant, when prices increases then the number that is demanded for the product decreases. On the other hand, if price decreases, the quantity demanded will increase. Why the counter-relationship concerning price and quantity demanded? Let us look at these three simple explanations:

The law of demand is dependable with common sense. Individuals normally do buy more of a product when the price is low than when it’s high. Price is a hindrance that dissuades consumers from purchasing. A higher price dissuades consumers to buy more, but at a low price, consumers will buy.

In any specific time, each buyer of a commodity will spring less satisfaction (utility) from each succeeding unit of the product that is being consumed. Suppose you were craving for pizza, your first slice of pizza made you so happy that you consumed in seconds, thus you took another slice of pizza. However, this time, your satisfaction will be lesser as compared to your first slice of pizza. This is in economics we term such case as Diminishing Marginal Utility, in which succeeding units of a specific product produce less and less marginal utility. Consequently, customers will buy further items if the price of these units is gradually bargained.

The law of demand can also be explained in terms of Income and Substitution Effects. Income effect shows change in consumption as a result of a change in real income. Real income is the purchasing power of your money. As real income increases, meaning price falls, consumer will buy more commodities. On the other hand, the substitution effect suggest that at lesser price, buyers have the motivation to substitute what is a less expensive product now for same products that are now comparatively more expensive. For example, deterioration in the price of chicken will raise the purchasing power of buyers’ incomes, allowing people to buy more chicken (Income Effect). When the price is lower, chicken is pretty more eye-catching and consumers be likely to to substitute it for fish, beef, lamb or pork (Substitution Effect). Income and substitution effects syndicate to make consumers capable and willing to buy more of merchandise at a lower price than at a higher price.

If our quantity demanded for a good increase if it is priced low, why is it then that Starbucks Coffee has consumers lining up? Is the demand for Starbucks Coffee exempted from the law of demand? In reality, there are many factors that influence our decision to buy or not to buy. Such factors includes: our taste and preferences, income, expectations on future prices, prices of the related good like substitute and complements, and the number of buyers. However, when we refer to the law of demand, we only take into account how quantity demanded reacts with price changes. Thus, we assume that all the other factors mentioned are assumed to be constant or "ceteris paribus" in economic parlance.

Going back to our question on the Starbucks Coffee, assuming that a young lady named Anna, who resides in a far-flung farm area where people grow their own vegetables, rice and even coffee. Most of the resident’s time is spent in the farm and community service, and they can seldom watch the television. So when Anna went to the mall to buy coffee, she was asked to make a choice between Starbucks’ coffee costing around $7 a cup and an unbranded brewed coffee costing $1 a cup. What coffee do you think she will buy? Naturally, she will buy the generic coffee because her taste of preference for coffee was not influenced by the media hype brand of coffee. Her demand of coffee was simply influenced by its price. Thus the law of demand still holds true, assuming all the other factors are constant or ceteris paribus.

In reference to Figure 1, the consumers are willing to buy 40 pieces of stuffed animals for $30 each. A drop in the price of $25, however attracts the consumers to increase their purchases to 50 pieces of stuffed animals. This is a movement from point F to E along the demand curve and is described as a change in quantity demanded. If we take into consideration the other factors that affect demand, then changes of demand will take place. This will result in change in position or slope of the demand curve and a change in the entire demand schedule.

Figure Hypothetical Shift of the Demand CurveChanges in demand will graphically show a shift of the entire demand curve. Increase in demand will shift the demand curve towards the right, while decrease in demand will shift the demand curve towards the left. If for example the demand for stuffed animals increased among children due to its fancy features and found effective in the development of learning skills, the effect is shown in Figure 2, which shows a shift of demand to the right (green).

SUPPLY

In this part of the market, we now analyse the seller or producers.

Quantity Supplied is defined as the number of a good or services that the seller is able and willing to sell at a certain level of price during a specified period. Sellers have "reservation price", which they hold on their good if price is too low. Therefore, if one of the qualities of supply is missing, supply transaction will not happen.

The Supply Schedule is a table or matrix that shows the quantity of the goods that are sold at a certain level of prices. We can also analyse the market supply by summing up the quantity of goods supplied at a certain level of prices for a certain group of sellers.

Table : Hypothetical Market Supply Schedule for Stuffed Animals From the given schedule in Table 2, we can observe that with higher prices, more sellers are willing to sell larger quantities of stuffed animals. However, at lower prices, many sellers are discouraged to sell; thus, only few quantities of stuffed animals will be available in the market

Figure : Hypothetical Market Supply for One WeekTo graphically illustrate the market supply of Stuffed Animals, we use the supply curse. We can plot the quantities sold at the different levels of prices as shown in Figure 3. A typical supply curve is upward sloping from the left to right. It shows a direct relationship concerning price and the quantity supplied. Any point on the supply curve reflects the quantity that will be supplied at a given price.

From our example above as well as from our observation in the real world, we can then state that the law of supply follows as prices increase, quantity supplied also increases, ceteris paribus. Thus, price and quantity supplied are directly related.

To a supplier, price signifies income and it serves as an enticement to produce more and sell the products. When the price is higher, the greater the incentive is and also the revenue and the quantity supplied. Why the direct relationship of price and quantity supplied? Let us look at the following reasons:

Like the law of demand, law of supply is also consistent with common sense. Price is an incentive to sellers to sell at each possible price. This means, they will sell at a high price rather than at a low price.

Every resource has corresponding alternative use. The cost foregone to obtain something is opportunity cost. Sellers have to sell their goods only at a price that they think they can receive revenue to cover up all their expenses resulting to a profit.

Every additional production means additional cost or marginal cost. Suppliers have to think about their cost before supplying goods. They are motivated to sell more if price is high.

Taking a look again at Figure 3, consider the price $25 per piece. At that price, the sellers will sell 400 pieces of Stuffed Animals. Should there be an increase in price to $30, quantity supplied will increase to 500 pieces. This is reflected as a movement along the supply curve and is referred to as a change in quantity supplied. This is a movement from point E to point F on the supply curve and is caused by change in the price of the good.

By dropping the ceteris paribus, we now take into consideration the other factors that affect supply. In reality, as a seller, there are various factors aside from price that affect our decision on how much goods we are to sell. Should these factors be included in our analysis of supply, we can expect a change in the position or slope of the supply curve and a change in the entire supply schedule. Increases or decreases of the supply are shown through a shift of the entire curve to the right or left, respectively. Factors such as use of improved technology will increase the number of sellers in the market and decreases the fee of production and it will all cause an increase in the actual supply. Thus, the supply curve will show a rightward shift.

For example, the company discovered a machine that works twice as much as the factory workers for the stuffed animals, thereby lowering the production cost of the toy company. In effect, the company could just increase the production number of the stuffed animals, thus increasing the market supply of the stuffed animals. The rightward shift of the supply curve is shown in figure 4.

Figure : Hypothetical Shift of the Market Supply for One Week (Ignore Demand Curve and Equilibrium point)A growth in the eagerness and capability of sellers to trade a good at the prevailing price is exemplified by a rightward movement of the supply curve. The rise in supply is triggered by a change in a supply factor. As above mentioned, the increase in supply is caused by the advancement of technology in the production process of the Stuffed Animals. The changes in non-price factors cause the corresponding shift in the supply curve.

Supply and demand is considered as one of the most vital perceptions of economics and it is also considered as the strength of a market economy. The supply of goods and resources are restricted in contrast to people’s necessities, and people must make choices based on what things to buy or produce and what goods to sacrifice, thus study of this concept can help elucidate how the market works and springs a better understanding of real market performance, and can also be used to improve economic and financial decisions and policies.