Reduction of the supply of goods leads to an increase in the demand for complementary goods
The law of supply and demand is the basismarket economy. Without his understanding, it is impossible to explain how it functions. Therefore, it is with the study of the concepts of supply and demand that any course of economic theory begins. Since the type of management in most modern countries of the world is market, then any person will benefit from knowledge of this fundamental law. It allows us to understand that a reduction in the supply of goods leads to an increase in demand for its substitutes and a fall in complementary goods. But there are exceptions. Today's article will be devoted to this topic.
As a rule, the lower the price, the moreconsumers are ready to buy. So in simple words, we can formulate the law of demand. The more the price, the more manufacturers are ready to release the goods. This is the law of supply. Thus, we can conclude that, other things being equal, the price of the goods is lower, the greater the number of consumers willing to buy and the less the manufacturers release. The law of supply and demand was first formulated by Alfred Marshall in 1890.
The law of supply and demand
The point at which two curves intersect,indicates the equilibrium volume of the commodity and its market price. In it demand is equal to supply. This is a state of happy equilibrium. However, if this were always the case, the economy would not develop, because crises are inherently progressive, although they bring with them significant socio-economic upheavals.
But back to the demand. It is the volume of goods that a consumer is willing to purchase at a given price level. The magnitude of demand reflects not just a desire, but a willingness to buy a certain amount of product. In addition to the price, it is also affected by the level of income of the population, the size of the market, fashion, the availability of substitutes, inflation expectations. An exception to the rule of increasing demand with a decline in market value are Giffen's products, which we will discuss below.
As for the proposal, it does not characterizeonly desire, but also the manufacturer's willingness to offer its product for sale on the market at a given price level. This is due to the invariance of costs per unit of goods subject to increased profits. In addition to the price, the supply is affected by the availability of substitutes, complement, the level of technology, taxes, subsidies, inflationary and socio-economic expectations, market size.
The concept of elasticity
This indicator characterizes fluctuationsaggregate demand or supply, caused by a change in the price level. If the decrease in the latter causes a greater percentage change in sales, then demand is considered elastic. That is, in this case, we can say that this is the degree of sensitivity of consumers to the price policy of manufacturing firms.
However, one must understand that elasticity canbe related to the level of income of buyers. If the latter and the magnitude of demand change by the same percentage, then the coefficient considered is equal to one. In economic literature it is often said about absolutely and absolutely inelastic demand.
For example, consider the consumption of bread and salt. The demand for these products is completely inelastic. This means that an increase or decrease in the price of them has no effect on the amount of demand for them. Knowledge of the degree of elasticity is of great practical importance for manufacturers. There is no particular sense in raising the price of bread and salt. But a sharp reduction in the price of a product with a high elasticity of demand will lead to greater profits.
It is so advantageous to act on the market with a highcompetition, because buyers instantly switch to a seller whose products are cheaper. For products with a low elasticity of demand, the price policy considered is unacceptable, since a slightly changed sales volume does not compensate for lost profits.
The elasticity of the supply is calculatedas a quotient from the division of the change in the quantity of the produced goods into an increase or decrease in the price (both indicators should be expressed as a percentage). It depends on the features of the release process, its duration and the ability of the goods to long-term storage. If the increase in supply exceeds the rise in prices, then it is called elastic.
However, one must understand that not alwaysthe manufacturer has the opportunity to quickly adjust. You can not increase the number of cars produced in a week, although the price for them may well rise sharply. In this case, we can talk about an inelastic sentence. Also the considered factor will be low for the goods, which can not be stored for a long time.
The demand curve shows the relationship betweenthe level of prices in the market and the volumes of goods that consumers are ready to buy. This part of the graph displays an inverse relationship between these quantities. The supply curve shows the relationship between the level of prices in the market and the volumes of goods that the producers are ready to sell. This part of the graph shows a directly proportional relationship between these quantities.
The coordinates of the intersection of the data of two straight linesreflect the equilibrium volume of goods and the price that will be established in the market. Sometimes this chart is called "Marshall scissors" because of its appearance. Shifting the supply curve to the right-down means that the manufacturer has reduced costs per unit of product. Therefore, he agrees to lower prices.
Reducing costs is often due tointroduction of new technologies or improvement of the organization of production. The shift of the supply curve to the left-up, on the contrary, characterizes the deterioration of the economic situation. With each old price level, the manufacturer will be ready to release a smaller quantity of goods. Reduction of the supply of goods leads to an increase in the demand for substitute goods and a decrease in complementary products. But is it always so simple?
This group includes goods cross-valuedwhose elasticity of demand is zero. These are the benefits that do not complement and do not replace one another. An example of such benefits is a car and bread.
To this group of goods are goods that supplement one another or are consumed simultaneously.
An example of complementary goods is a carand gasoline. These are mutually complementary goods. The cross elasticity of their demand is less than zero. This means that a reduction in the supply of goods leads to a reduction in the purchased volumes of another. The demand for complementary goods always changes in one direction. If the price of one of these products rises, then consumers begin to buy less and another.
In the case of complementary goods, it can not be said thatReduction of the supply of goods leads to an increase in demand for the second. Why do we need gasoline, if we can not afford to buy a car. Since these are mutually complementary goods, the price increase for one of them leads to a reduction in demand for another. And how does this affect the economy as a whole? The price was raised by the sellers of one commodity, and the decrease in revenue was also observed in the producers of its products.
This group includes products that replaceeach other. Examples of substitutes are, for example, various brands of tea. Similar products have similar characteristics and satisfy a certain need of buyers. Their cross-elasticity is greater than zero. This means that a reduction in the supply of goods leads to an increase in demand for its substitutes.
With a drop in the price of one type of tea, many consumers will give up their usual brand and go to it if it meets all the quality parameters.
Thus, similar products competeamong themselves, forcing producers to seek to reduce the costs of their release. However, there are exceptions associated with demonstrative behavior, which we will discuss below.
Essential Goods and Luxury Goods
In a separate group, the so-calledinferior or inferior goods. Their feature is that the demand for them decreases with the growth of income of the population. The richer people, the less they tend to buy them. A special case is the so-called Giffen effect.
However, inferior goods are not goods of the first kindnecessity. The latter are products, the demand for which does not depend on the level of income. Their share in embezzlement decreases, but absolute consumption itself remains the same. Their income elasticity is less than one. Separately, you need to consider luxury goods. Their consumption increases at a higher rate than income.
Products of Giffen
This concept is connected, as well as the following, withthe concept of price elasticity. For this category of goods include, for example, bread and potatoes for Russia, and for China - rice and pasta. The effect of Giffen explains why an increase in price can lead to increased demand.
Indeed, the increase in the cost of potatoesleads to an agiotage in the market. Although, it would seem, it would be more rational to abandon it in favor of, for example, macaroni or croup. However, in practice this does not happen.
This concept explains another possibledeviation of practice from theory. In this case, the price of the goods is reduced, which leads not to an increase, but to a decrease in demand. The Veblen effect is associated with demonstrative consumption.
Therefore, an increase in the price of these goods leadsto increase their consumption. Often this happens with luxury goods, in particular works of art. This is another exception to the law of supply and demand. Their purchase is conditioned by their status, therefore for buyers the high price is more preferable.