This chapter takes an in-depth look at consumer and producer economic theories. Both theories play a central role in decision making by individuals, businesses, and the government. To help understand how these theories function, the chapter provides an overview of the economic “laws” of supply and demand. The chapter continues with an exploration of government intervention in the marketplace, including the subjects of market failure, regulation, incentives, price controls, taxation, governmental hiring, and the purchase of private sector goods by public sector entities. To conclude, the chapter links government actions to consumer and producer economic theories in its daily operations as a means to enhance efficiency, effectiveness, and equitable service delivery.
TopSupply And Demand
The interaction of supply and demand defines basically every possible economic event. Simply put, the “law of supply” states that the quantity of a product supplied increases as prices rise, and declines as the price drops. Conversely the “law of demand” suggests the amount of demand rises as prices fall, and declines as prices rise (Ehrbar, 2008; Henderson, 2008). This basic premise of supply and demand is widely accepted and easily recognized by economists and non-economists alike. After all, our own behavior at the grocery store, for instance, can change as prices of goods decline when items are on sale, or when prices rise due to things like a poor growing season or animal disease leading to a limitation in the amount of crops or meat produced (Henderson, 2008).
In a market economy, the optimal point sought by those producing and consuming a good is when the amount of supply produced is balanced with the amount of demand for that particular good. If prices are above that optimal point, sales will decline as demand is reduced. If prices are too low, consumers may like it but suppliers will reduce the amount of goods produced, leaving some amount of demand unfulfilled (Ehrbar, 2008). Figure 1 demonstrates the supply and demand curve, with the equilibrium point illustrated where the lines intersect.
The supply and demand curve shown in Figure 1 portrays the quantity of a good produced and sold respectively at a particular price. Markets in which producers determine their own prices allow for equilibrium of supply and demand to exist, or at least be sought by those who produce goods. That is to say the producers in a market economy have the ability to alter their price and see how consumers respond to an increase or reduction in either production of a good or the price of the good in terms of the amount sold (Ehrbar, 2008).
Shifts in demand happen when variables aside from the price of the specific good changes. The demand curve’s current position depends on all things remaining the same, meaning that competition exists and their prices do not change. If the price of a substitute good drops, the demand curve illustrated in Figure 1 shifts leftward. If the price of a complement good (a good that matches with another for use or functionality reasons) declines, the demand curve from Figure 1 shifts to the right. If the income of buyers increases, a rightward shift of the demand curve seen in Figure 1 is implied as consumers can afford to purchase additional quantities. If the preferences of consumers change, a shift in either direction of the demand curve can occur, depending if people want more or less of the product (Whitman, 2010).