Economic Factors Affecting Demand and Supply of Commodities and the Resultant Price

Economic Factors Affecting Demand for commodities

The demand of product varies according to some given elements. Factors affecting demand are categorized in price and non-price factors. Price factors include the price of the commodity that has a direct influence on the demand for a given product. Non-price factors include other factors that do not affect demand directly through the altering of the price. Price factors will cause a movement along the demand curve while non-price factors will be indicated by a shift in the demand curve.

Price factors

Own Price

Arguably enough, it is the most important factor affecting the demand for a given commodity. As the rule of the thumb, an increase in price of a particular product results to the reduction in the demand of the product ceteris paribus. Hence, there exist an inverse relationship between price and quantity demanded. The relationship is known as the ‘law of demand’ (Buchholz & Todd 1995). From this relationship, a mathematical equation linking both price and demand can be derived, and it is as follows:

D=f(P)

Where:

D- Demand for the product

P- Price of a given product.

As seen from above, demand is a function of price. The equation defines the change in demand. As a result, in the change in own prices of the product.

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Where:

P- Price                        Q- quantity demanded

Increase in demand is indicated by an upward move up the demand curve while a decrease in demand is indicated by a downward move down the demand curve. Increase in price of the product lead to the decline in quantity (q) demanded.

Non-Price Demand factors

Changes in prices of related goods

  • Complementary products – These are products that are used together to the satisfaction of a particular want. A good example is car and fuel. The increasing price of a complementary good leads to the decrease in demand for a given commodity. The vice-versa is true. This is because the additional products becomes expensive and unaffordable by the buyer.  It is known as joint demand.
  • Supplementary goods – They are also known as substitutes. These are products that can be used in place of other goods for the satisfaction of particular need. An excellent epitome is tea and coffee. Increase in price of a substitute good leads to the rise in demand for the cheaper product (Hubert 2004). There is hence a direct relationship between demand and the price of a substitute good.

Income of the consumer

Demand is also affected by the change in income of the consumer. The higher the income of an individual, the greater the demand for goods and services. The reason for his is that higher wages increase the purchasing power of individuals and hence their budget set also increases. People can buy more products with higher incomes. However, the effect of the change in demand depends upon the nature of the commodity depends upon the nature of the product.

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  • Standard/normal goods: An increase in income of an average product leads to the rise in demand of the product.
  • Inferior goods: An surge in the income level of an individual leads to the decrease in the demand for the good while as a reduction in income leads to the reduction in demand level.

Customer tastes and preferences.

According to Pindyck, Robert & Daniel, (1992) postulated that the extent, to which a consumer is biased towards a particular good, will determine its demand. When a commodity is in fashion or is preferred by a consumer, the demand for such a product will increase greatly. The demand curve for the product will tend to lie at a high level. On the likewise, if the customer had no regard to the product, the demand for such a product will decline in case the customer had no taste and preference for it. Other factors affecting tastes and preference apart from fashion include pressure from advertisements from manufacturers and sellers.

Future expectation of changes in price.

In case the consumers anticipate the increase in price of a given commodity, people will buy the product in bulk above average purchases in order to evade buying the commodity in the future at a higher price. There is, therefore, a direct relationship between future expectations of changes in price and the demand. A good example would be the expectation of future increase in price of petrol. Many consumers of the product will fill their tanks with petrol in order to avoid purchasing gasoline in the future at a high price.

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Economic state of the commodity.

Some products such as the umbrellas are seasonal, and their demand varies according to the prevailing conditions. During boom seasons characterized by economic prosperity, investment, employment and income increases. The implication of this is to increase the demand for capital and consumer goods (Langabeer & Jim 2000). However, in periods of depression, low investments and income lead to decline in the market level.

Population size and composition

Increase in population lead to increasing the demand level. Additionally, if the population is composed of a significant target group such as youngsters, adults, women, men, or is dominated by a particular gender say men or women, the increase in population of the target group will lead to the rise in demand for that product.

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From the diagram above, an increase in the demand curve will be shown by a shift to the right while a change will indicate a decline in the demand level to the left., it is only the changes in own price of product that will cause a movement along the demand curve. All the other factors including changes in price of related products, customer preferences and tastes, income of the individual result to a shift in the demand curve.

Economic Factors affecting the supply of commodities

Supply may be best termed as the quantity that suppliers wish to avail of the market at a given price. A rise in the price of the product leads to an increase in the amount supplied in the market. The price of a product has a direct relationship with the provision of the good. This is known as the ‘law of supply’. Reduction in cost of production will motivate the supplier to offer more quantities into the market. Supply is, therefore, a function of price, and it is expressed mathematically as follows:

S=f (P)

Where:

s- Supply of a given commodity

p- Price of the commodity

Factors affecting supply of the commodity:

Price factors

Price factors are shown by a movement along the supply curve.

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Price of Commodity

An elevation in the price of the  product leads to rise in the amount supplied in the market. The converse is true (Buchholz, M & Todd G 1995)

An increase in the price of the commodity will lead to an increase in the quantity supplied. This is shown by an upward move along the supply curve.

Non-price factors

These factors are represented by a shift in the supply curve.

Price of other related goods.

An increase in the price of a similar commodity will lead to an increase in supply of the production. In case it is more profitable offering the product than supplying another commodity, producers will tend to prefer to provide the good with the higher price tag.

Change in cost of production.

Increase in any factor of production will result in a decrease in the supply of the commodity. The reduced profits brought about by increase in cost of production will prompt producers to offer less in quantity of a particular commodity. Heilbroner et al., (1994) put forward the argument that suppliers use inputs in order to produce outputs. The inputs in production include raw materials such as labor, utilities, licensing fees etcetera. When the price of a given input increases, the cost, as well as the price of the product will increases.

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Technological advancement

Technical progress results in the lowering of the cost of production and hence increased profits for the producer. The producer will hence tend to supply more of the product in the market.

The Weather changes.

Agricultural products are the most affected commodities since their produce is greatly determined by climatic conditions. When the weather is favorable, producers will tend to increase the production of agricultural products and vice versa.

Number of producers.

An increase in a number of manufacturers in the market will lead to a rise in supply since each manufacturer is bringing in an additional product into the market.

Government subsidies.

Increase in government grants leads to a decrease in cost of production. Consequently, a decline in production costs leads to the rise in supply and hence a shift towards the right.

Resultant product prices

Human requirements are unlimited in nature. With the supply of resources being scarce, the wants cannot be catered for fully. A choice has therefore to be made. It is the forces of demand and supply that determines the prices to charge for a particular product. The demand of product at any given time is determined by the willingness, ability to pay and the desire to possess a good by the consumer (Mann 2002).  The degree to which the demand and supply are responsive to the changes in price brings about the elasticity concept. The more resilient the product is, the more it is affected by the variations in rates. As stated earlier on, prices are arrived at by the interaction between demand and supply schedules. Individual supply and demand schedules generate the market demand and supply schedules and with the buyer, the buyer bears the cost that is equivalent to the equilibrium price. At this point, the amount is equal to the demand.

Suppliers are known to be profit maximisers while consumers are known to be utility maximisers.

Any attempt to shift the demand/supply will cause the equilibrium to change. The point above the equilibrium point indicates an excessive amount from the side of the suppliers while the point below the equilibrium point shows excessive demand from the side of the consumers.

Excessive supply/demand will generate pressure from either the supplier or the buyer and will force one of the parties to change the terms of purchase thereby restoring the equilibrium between price and quantity. Hence, the equilibrium point will remain in balance.

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