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Deman And Supply Of Product And Factors

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Question:

Describe about the Demand And Supply Of A Product And Factors That Affect The Demand And Supply Sides Of The Market.

 

Answer:

Introduction

Demand and supply are factors that determine pricing for a commodity in a free market. While the pricing for goods tend to be determined by the demand and supply, the cross elasticity tends to have a significant bearing on the final pricing of the commodity (Mth, 1961). Interestingly, companies like Uber also use the demand-supply analysis for price determination of their service, often creating a sudden surge in pricing as demand moves up. The analysis of demand and supply is useful for both individuals as well as small businesses as it helps them in everyday decision making by accessing market situations in a better manner. The product that is being considered is airfares. This commodity is a classic example of the demand-supply model of price determination in a competitive market and exhibits a clear cross elasticity of demand due to the various options available for travellers, making it an apt example for consideration.

Demand –Supply Model Of Price Determination

The four scenarios to be considered in this model are

An increase in demand and no change in supply – results in a higher price and quantity for the commodity or service.

A decrease in demand and no change in supply- results in a lower price and quantity for the commodity or service.

An increase in supply and no change in demand - results in a lower price and higher quantity for the commodity or service.

A decrease in supply and no change in demand- results in a higher price and lower quantity for the commodity or service.

Assuming that the consumer uses accurate information and makes rational decisions, it can be seen that the pricing for the commodity would vary depending on the demand and supply conditions prevalent in the market. The fair market scenario tends to move towards an equilibrium, wherein the equilibrium price is determined by the balance between the supply and demand. Unfortunately, the real word situation tends to be different with a significant change in free availability of accurate information (Grossman & Stiglitz, 1980).

The Cross Elasticity Of Demand And Its Impact On Pricing

This pricing model is seen in commodities that can be easily substituted by competing products. Price discrimination is directly proportional to competition in this industry (Stavins, 2001). In such a scenario, when the price for a chosen product increases, consumers look at similar products that are available at a lower price, to satisfy their needs. Thus, the demand for a lower priced commodity would increase and a higher priced commodity would decree if they are substitutable. Sellers try and insulate themselves this situation by creating goods and services that cannot be easily substituted. For instance, airfare for budget airlines and premium airlines cannot be substituted. However, if there is a significant price variation between airfares in the budget class then cross elasticity would apply.

 

Airfares And Pricing Based On Demand-Supply And Cross Elasticity

By applying these theories to air fares, it can be seen that the higher disposable income as well as the comfort and convenience offered by flights have increased the demand for flight tickets. This is however regulated by the availability of alternative flights, thus ensuring a balanced pricing for air fare. This reflects the cross elasticity of demand, wherein a commodity is substituted by an alternative commodity available at a lower price. It is further observed that any spike in airfare tends to result in a drop in the demand for the same as travellers look at alternative modes of travel like road or rail. In the real world, the airfares tend to be high on weekends and lower on weekdays from Tuesday to Thursday. The exception to this rule is seen on extended weekends, wherein airfares tend to spike due to the sudden influx of persons looking forward to a mini-vacation. This reflects the classic case of pricing (of air tickets) being determined by the forces of demand and supply (Wei & Grubesic, 2016). However, governments do insist on a cap in pricing or ceiling price to ensure that consumers are not fleeced by airlines and the supply to genuine consumers continues within a certain price band (Posner, 1974).

It is further seen that airlines tend to offer exorbitant price discounts during lean seasons or in conjunction with special days (Lohatepanont & Barnhart, 2002). While the latter is a publicity gimmick; the former is an attempt to influence buyer behaviour by lowering prices. As the seller changes prices to lower levels, the commodity starts to look more attractive and often influences buyers to shift the purchase from competitors (Cattaneo, et al., 2016). It is important to remember that the nature of the demand curve is influenced by the industry in which the firm operates (Rosen, 1974). For instance, commodities that cater to a particular niche tend to be more rigid and do not exhibit any significant elasticity due to pricing. In case of airfares, the business class pricing tends to remain virtually unchanged over the shorter time frame as persons travelling for business continue to do so regardless of minor fluctuations in pricing.

Conclusion

Considered the backbone of any economy; the correlation between price, demand and supply help in the efficient allocations of resources to ensure maximum profits for organizations. In the real market, price equilibrium is mere theory as prices are constantly affected by fluctuations in supply and demand (Knittel & Pindyck, 2016). While, the consumer is able to regulate prices by influencing the demand, the seller controls the supply. In a free market, the seller tries to reduce supply to maintain prices at desired levels, the consumer works at reducing demand for the commodity to drive prices downwards.

 

References

Cattaneo, M., Malighetti, P., Morlotti, C. & Redondi, R., 2016. Quantity price discrimination in the air transport industry: The easyJet case. Journal of Air Transport Management, 54(1), pp. 1-8.

Grossman, S. J. & Stiglitz, J. E., 1980. On the Impossibility of Informationally Efficient Markets. The American Economic Review, 70(3), pp. 393-408.

Knittel, C. R. & Pindyck, R. S., 2016. The Simple Economics of Commodity Price Speculation. American Economic Journal: Macroeconomics, 8(2), pp. 85-110.

Lohatepanont, M. & Barnhart, C., 2002. Airline Schedule Planning: Integrated Models and Algorithms for Schedule Design and Fleet Assignment. Transportation Science, 38(1), pp. 19-32.

Mth, J. F., 1961. Rational Expectations and the Theory of Price Movements. Econometrica , 29(3), pp. 315-335.

Posner, R. A., 1974. Theories of Economic Regulation. Bell Journal of Economics, 5(2), pp. 335-358.

Rosen, S., 1974. Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition. Journal of Political Economy , 82(1), pp. 34-55.

Stavins, J., 2001. Price Discrimination in the Airline Market: The Effect of Market Concentration. The Review of Economics and Statistics, 83(1), pp. 200-202.

Wei, F. & Grubesic, T. H., 2016. The pain persists: Exploring the spatiotemporal trends in air fares and itinerary pricing in the United States, 2002–2013. Journal of Air Transport Management, 57(1), pp. 107-121.

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