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Determinants for Demand and Supply
In a market where price is not controlled, market price for a product or service is determined by the interaction of demand and supply; that is, the consumers' willingness and ability to buy the product, and the sellers' willingness and ability to produce and sell the product. This page reviews these two basic economic concepts.
Determinants of Demand
The level of demand for a product is determined by the following factors:
- Consumer tastes
and preferences -- is the consumer interested in Product A or Product B.
- Will the consumer prefer a food product wherein the consumer can identify who, where, and how the underlying ag commodities were produced, or will the consumer be satisfied with a food product without knowing who, where or how it was produced?
- Number of buyers
in the market
- An increased number of interested buyers or consumers will lead to an increased demand for the product.
- What is the market? Does the market include all persons in the world or only those who can effectively buy the product? What impact do advances in information and transportation technologies have on the number of buyers in the market?
- An increased number of interested buyers or consumers will lead to an increased demand for the product.
- Consumer income
- Will an increase in the consumer's income lead to more consumption of the product (then it would be considered a normal product) or less consumption of the product (then it would be considered an inferior product)?
- What might cause a consumer's income to increase?
Note that this question assumes this consumer also is a producer and that production and sales generates the income with which this individual can then consume.
- Increased productivity due to advancing production technology?
- Increased productivity due to learning about the availability and application of production technology?
- Increased price for the product the consumer is producing? More people are buying the product the consumer is producing thereby generating more income for this consumer to spend on other products?
- Price of related
goods, such as substitutes, complements, or independent (with no impact)
- As the price of fuel rises, I am less interested in buying a vehicle that has low-gas mileage. Fuel complements the vehicle and a rising fuel price diminishes my demand for a vehicle that gets few miles to a gallon and increases my interest in (demand for) a vehicle that gets better gas mileage. In this example, fuel complements a vehicle.
- As the price of labor increases, I am less interested in hiring additional workers and more willing to invest in equipment that reduces the number needed workers. My demand for equipment increases while my demand for labor decreases as a result of increasing labor costs. In this example, equipment is a substitute for labor.
- Does information and transportation technology increase the number of substitute products that consumer can consider?
- Consumer expectations
of the future
- For example, buy more now if I think the increase in the price of this non-perishable will be greater than the cost of storing the product.
- Another example -- "I will not replace my computer now even though it is getting old; I expect that information technology (IT) will continue to advance thereby lowering costs of future IT equipment . Accordingly, I will use my current computer that is adequate for now and plan to replace it with a computer in the future that has even more capability than the computer currently on the market." This expectation about IT lowers demand for computers that are currently on the market and raises demand for future computers.
Determinants of Supply
- Resource or input
costs
- An increase in the cost of livestock feed will cause me to sell the livestock at an earlier time and at a lower weight thereby reducing my output of "pounds of livestock."
- Production technology
- An advance in the technology used to produce a product will lead to an increase in the production of that product; as food processing became more automated,
- What impact is production technology having on the quantity of the goods available in your market?
- Taxes and subsidies
- A supplier will reduce production if the cost of production rises as the result of a tax or other government-imposed cost on the production process
- A supplier will increase production if a government program subsidizes the producer's income or otherwise pays a portion of the supplier's production cost.
- Price of other
goods the supplier could produce
- How does this relate to opportunity cost?
- Supplier's expectation
about the future
- Expectation about future price of product, which reflects expectations about future demand and future supply of the product.
- How might the supplier's expectation about future communication and transportation technologies influence the supplier's concept of future prices?
- Expectation about total cost of production which reflects expectations about future cost of inputs and future production technology.
- Expectation about future price of product, which reflects expectations about future demand and future supply of the product.
- Number of sellers/suppliers
in your market
- What impact is information and transportation technology having on the number of sellers in your market?
An increase in the demand for your product without an increase in supply will lead to a higher market price for your product.
An increase in supply of your product without an increase in demand will lead to a lower market price for your product.
What can a business owner do to influence demand or supply? How do these strategies relate to the topics discussed in the changing agriculture industry? How do these strategies relate to the topics discussed in managinng a business?
Relationship between Determinants and Market Price
It is important to distinguish between "change in demand" and "change in quantity demanded," and to distinguish between "change in supply" and "change in quantity supplied."
A "change in demand" or a "change in supply" means one of the determinants of demand or supply has changed. This shift in the demand or supply will lead to a change in the market price.
A "change in the quantity demanded" or a "change in the quantity supplied" means the consumers or producers are responding to a change in the market price. For example, a change in consumer preferences (a determinant of demand) will cause a "change in demand." This will impact the market price for the product. In response to the difference market price, producers will alter the amount they produce; that is, a "change in quantity supplied."
Note the distinction between these four concepts (change in demand, change in supply, change in the quantity demanded, and change in the quantity supplied) as well as their relationships.
Defining the Product Market
When applying the concepts of demand and supply to a situation, carefully define the market being analyzed. For example, the market for a renewable fuel is different than the market for the vehicles that will use the fuel, and the market for the crop that will be used to produce the fuel. These are three distinct markerts with three distinct supply and demand relationships, and three distinct sets of determinants of supply and demand.
However, there will be relationships among the markets; for example, the supply of vehicles that use renewable bio-based fuels will impact the demand for the fuel; that is, as the supply of the vehicles increase, the price for the vehicle should decrease thus causing the demand for the fuel to increase. Restated, the price of the vehicle (a related product) is a determinant of demand for the fuel. The vehicle and fuel are distinct markets, but they are related and thus influence one another.
A market can also be defined by time; for example, what is the demand and supply for a product during June and what is the demand and supply for that product December.
It is critical that the "market" be carefully defined, otherwise, there is a risk that the analysis will be confused and incorrect.
Impact of Technology
Several determinants of demand and supply are impacted by production, communication and transportation technologies. As these technologies continue to advance, what can we expect will be the impact on demand and supply within many of our product markets and our geographic markets?
Last Updated September 4, 2010
Email: David.Saxowsky@ndsu.edu
This material is intended for educational purposes only. It is not a substitute for competent professional advice. Seek appropriate advice for answers to your specific questions.
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