An understanding of the ways market equilibrium is attained after changes occur is critical for decision makers within any business. The elements of supply and demand are important economic principles and understanding the determinants are part and parcel in everyday decisions in a business. The process of equilibration is the movement between two equilibrium points and happens when changes occur in supply or demand. This paper will look at equilibration and explain the process of movements that occurs due to the behaviors of both consumers and suppliers. For this assignment, we will look at movement in the Oil Industry over the past year.
Supply and Demand
Economics is the science behind how individuals, institutions, and society make the best choices of how to use scarce resources (McConnell, 2009). One of the concepts which explain interactions between the supply of a resource and the demand for a resource is the law of supply and demand. The law of supply and demand states that the availability of any particular product as well as the demand for the product has an effect on price. In general terms we can see that if there is a lower supply and a higher demand then the price of the product or service will be higher. Comparatively speaking we see that the greater the supply and the lower the demand, the lower the price.
The reasons why the shift of both supply and demand occur is best explained by listing the determinants of supply and demand. These determinants are changes and cause shifts in the entire curve, either supply of demand. The determinants of demand are a change in consumer tastes, a change in the number of buyers, a change in consumer incomes, a change in the prices of complementary and substitute goods and/or a change in consumer expectations. The determinants of supply are a change in input prices, a change in technology, a change in taxes and subsidies, a change in the prices of other goods, a change in producer expectations, and/or a change in the number of suppliers. Any one of these determinants or a combination of factors can shift the supply or demand curves.
Efficient markets theory
The efficient markets theory was highly acclaimed in economic academia mainly in the 1970s. At that time, the rational explained that there was an epiphany in economic theory. Economists were filled with enthusiasm that a different and new idea explained everything about market theory. The idea was that speculative asset prices at all times included the best information about actual and real values and that those prices changed only because of worthy, reliable information which was interconnected very well with the theoretical trends and thinking of that time period. Highly thought of financial models of the 1970’s talked about asset prices using sensible expectations that linked together finance theory and the entire economy in one neat and tidy theory (Shiller, 2003). In essence, the theory was that it was impossible to guess what the market was going to do or “beat” the market since the stock market’s automatic efficiency caused prevailing share prices to always integrate and mirror all applicable information available, and on its own.
Surplus and shortage
Now we discuss shortages, surpluses and how price is affected to obtain equilibrium in the theory of supply and demand. When we find a surplus in the market of any product we wish to discuss, we see that the market forces will be the price determinant, and prices for the product or service will fall until an equilibrium is determined. This shows that the quantity in demand and the supply of the quantity will change as the price for the product or service as it moves downward until finally equilibrium is achieved. If a market price for the product or service is higher than what could be the equilibrium price, then we would see a shortage of the goods or services in the market. If no changes in either supply or demand will happen the market will attain equilibrium on its own.
Movement between the two equilibrium points
In our analysis inelastic demand is a “situation in which a price change leads to a less than proportionate change in quantity demanded” (Hirschey). However, what we have seen is that because of higher gasoline prices over a year ago Americans have tempered their use of gasoline and moved toward energy efficient cars and habituated themselves to lower usage or demand. Now demand continues to remain the same, as prices remain low. Beginning in the middle of last year, gas prices began to fall along with crude oil prices and went down to the lowest levels since 2009. Nine months ago drivers were paying $3.42 for a gallon of gas.
Almost six months later that price per gallon has fallen to an average of $2.61 per gallon. The six-month decrease in prices has been caused by multiple factors that put downward pressure on the market, said Hannah Breul, an analyst from the U.S. Energy Information Administration (Daily News Journal, 2015). “The combination of robust U.S. crude oil production growth and a return of Libyan production weakening expectations for the global economy” Breul stated. Visually below, we can see the implications of product surpluses in the oil industry that are passed directly to the consumer in the form of lower prices.
See graphs on next page.
The graph shows how the increase in supply moved the supply curve to the right, while the inelastic demand kept the demand steady as prices decreased to create a new equilibrium.
Most often a supply increase can cause a shift to the right in the supply curve, causing price to decrease and quantity to increase. An inelastic demand, however will not cause a shift to the left or right in the demand curve. The relative values of goods and services are established by supply and demand, and those relative values change over time as technology changes, resource prices change, tastes change, and substitute resources and new products emerge (Shiller, 2003).
Hirschey, Mark. (2008) Managerial Economics. (10th ed.), Florence, KY: Thomson South- Western.
McConnell, C. R., Brue, S. L., & Flynn, S. M. (2009). Economics: Principles, Problems, andPolicies (18th ed.). Boston, MA: McGraw-Hill Irwin, EBook
Michelle Willard, The Daily News Journal, (January 2015) Retrieved from: http://www.dnj.com/story/money/business/2014/11/28/gas-cheap-get-cheaper/19613213/ Shiller, Robert J. (2003) Journal of Economic Perspectives, v. 17 iss. 1, pp. 83-104 Retrieved from University of Phoenix eLibrary