the past decades, a lot of former communist countries that used to have planned economic systems have adopted the main principles of the market economy. Many Central and Eastern European Countries (CEE), China and former Soviet countries are examples of such a transformation.
2.6 Supply and demand: Households, businesses and the government meet in the market
[13]In a market economy, goods and services are offered and sold on/at markets. Buyers and sellers meet to communicate the conditions of exchanging goods and services and thus form a market. A market can be an actual place, like a flower market in the city of Rome or a flea market in a small village, but it can also be a virtual place like a market on the Internet (e.g. eBay, Amazon). Buying and selling take place in shops, but also on the phone. Therefore, there are many different markets, also depending on what is offered: consumer goods markets, labour markets (supply and demand for work), housing markets, money markets, capital markets, commodity markets (supply and demand for raw materials).
2.6.1 The law of supply
Supply of a certain good or service is the quantity of that good or service that is available for purchase. Basically, this quantity mainly depends on the businesses’ production capacities and the available resources, but also on the price that can be charged for the good or the service. The higher this price is, the higher the supply will be. All other things held constant (“ceteris paribus”), this relationship is true for most goods and services in the economy (law of supply).
In Tina’s and Steve’s case, the quantity of hours that they (as well as other providers of similar computer support services) are willing to work depends on the price they can charge and that will be paid. It is tiring work and the providers of this service need to be very skilled. If the price is low, let’s say below 30 euros per hour for example, no provider would offer that service. The opportunity cost would be too high: as the providers are very skilled, they could earn more money by doing something else (that is also less tiring), so they would leave this market and offer another kind of service. The higher the price, the higher the number of hours that would be offered. More potential providers would enter the market and would be willing to offer a higher number of hours of their service.
The shape of the supply curve can also be explained by the concept of increasing marginal costs faced by many industries and businesses. Marginal cost is the cost of producing an additional unit of a good or by providing an additional unit of a service. As output increases and exceeds a certain level it will become more and more costly to produce; businesses need to build higher capacities (machinery, personnel) so marginal costs would rise. Only if the price level increases and exceeds (or at least equals) marginal costs would businesses be willing to produce and supply a higher amount.
Figure 2. The supply curve (price in euros, quantity in 1,000 hours)
[14]Figure 2 shows the relationship between prices and supply in the market for computer support services (e.g. within a country).
2.6.2 The law of demand
Demand, on the other hand, is the quantity of a good or service that customers are willing and able to buy. Usually the higher the price is, the lower demand will be. The more Tina and Steve as well as other providers charge for their technical computer support service per hour, the more demand will decrease (because more and more people cannot afford such high prices or are not willing to pay such high prices for that service and will instead look for other ways to get help with their computer problems). People’s willingness to pay a certain price is related to the utility or the level of satisfaction the people get from consuming the service. Figure 3 gives you an idea of how many hours of technical support would be demanded in the market, depending on the price.
Figure 3. The demand curve (price in euros, quantity in 1,0 hours)
The graph in figure 3 shows that the quantity demanded decreases as the price rises. Accordingly, the quantity demanded (the quantity that people are willing and able to buy) increases as the price falls. Therefore, the quantity demanded is negatively or inversely related to the price. All other things equal (“ceteris paribus”), this relationship can be found with almost all goods and services in the economy, so that it is also called the law of demand.
2.6.3 The market equilibrium
If we have a look at both curves, we can see that they intersect at a certain point, at the price of 150 euros. At this point, the quantity of hours that is demanded in the market equals the quantity of hours that is supplied.
Assuming that these curves represent supply and demand in the whole market for computer support services, this price would also be called the market price or equilibrium price (because supply equals demand). At the price of 150 euros per hour demand and supply balance each other out. As the quantity supplied equals the quantity demanded, there is neither a surplus (higher supply than demand) nor a shortage (higher demand than supply). At a higher price, demand would be lower than supply and vice versa.
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Figure 4. Supply and demand intersect at the market price (price in euros, quantity in 1,000 hours)
In the real world, other factors than price also affect demand and supply.
Demand is also affected by:
■ Changes in income: If income increases, people can afford more (and more expensive) computer services and – all other things held constant – demand would increase (so the demand curve would shift to the right). Similarly, if income decreased, people would not be able to spend so much money on technical support anymore, and consequently, demand would decrease (and the demand curve would shift to the left).
■ Changes in consumer preferences: More and more people might want to have additional technical support, so demand would increase. In a different scenario, people could possibly like to have new and faster computers, so demand for used computers would decrease (regardless of the price).
■ Complementary goods: If an additional service is offered that is related to the computer support service and that people are highly interested in, demand for computer services would be very likely to increase.
■ The availability of substitute goods: If people found a service that perfectly substitutes computer support services, the demand for computer support service offers would also decrease. This effect will also be discussed in chapter 5, Marketing.
Supply is also affected by:
■ Number of suppliers: The more profitable a market is considered to be, the more suppliers will enter this market. As the number of suppliers increases, supply will increase (the supply curve would shift to the right), until supply is so high that prices fall again and no more additional suppliers enter the market.
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