Question

Recognize how changes in supply and demand affect market outcomes and explain the effect of government regulation on prices?

Use your own words and be sure to support your statements with logic and arguments.

• Please note that word limit for discussion is 150 words along with two constructive comments
• please attach the references
• Without hands-write
• Without pilgrim

the price, quantity, other factors that effect the demand and supply when the price is fixed.

Answer 1

Classical thinkers (the foremost being Adam Smith) based their analysis of economies on the assumption that prices vary freely.

A freely adjusting price signal (visualize it like the Volume slider on your phone) brings supply and demand into equilibrium no matter what – demand side shock like change in preferences or supply side shocks like sudden scarcity of factor inputs or an improvement in technology. Through the decentralized action of self-interest pursuing economic agents, the price signal orchestrates (like the man with the stick) i.e. coordinates economic activity until equilibrium – an optimal allocation of society’s scarce resources – is reached.

Keynes came along and showed that while this conditional proposition – IF prices are flexible THEN free market for the win – may be true, it’s empirical relevance is questionable since prices are not observed to be perfectly flexible in the real world (and so we can’t scientifically test the conditional proposition as a hypothesis)

Remember that the classicals had a lot to say about the best-case scenario (perfectly flexible prices) but next to nothing about the second-best (what do we do when prices aren’t flexible?). It is not necessarily the case that the second-best is the option (ideologically) “closest” to the best one.

Keynes circumvented this theoretical debate and offered a practical solution. The Government can help individual economic agents co-ordinate e.g. by setting common goals, and by channelizing loanable funds into Investment.

Investment into businesses creates jobs, jobs provide income, income enables people to buy the products of businesses, businesses reinvest profits – this is the cycle of the economy.

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Some factors that affect demand and supply when price is fixed:

1) Quality and product differentiation

2) Transaction costs e.g. have to go a long distance to make the purchase

3) Externalities

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Feel free to ask and clear doubts!