Demand/supply model is an economic prototype used to explain the behavior of different macroeconomic variables within a market. The model is also used in price determination of products within a free and competitive market. Different determinants of demand and supply affect the demand and supply of various products i.e. both goods and services differently. As such, the prices of these products usually vary or change depending on the behavior of their determinants until a point where quantity that consumers demand at a particular price equals the quantity which producers supply at that exact price. This is a point known as an economic equilibrium for price and quantity traded. This paper is going to analyze the market of a particular product, Tempur -Pedic Mattresses, using the demand and supply economic model.
1.
Different determinants cause changes in demand and supply of a particular product. Some of the determinants of demand include changes in consumer preferences and taste, their income level, their population, changes in their future expectations and changes in prices of related products i.e. substitutes and complementary goods. Determinants of supply include a change in input prices, technological advancement, change in prices of other related goods, government intervention in the market through a change of taxes and subsidy levels, change in producer’s future expectation and changes in the number of producers within the market. Those factors or determinants which increase the cost of production decrease supply while factors which decrease the cost of production increase supply (Chand, 2015).
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Demand for a particular product or commodity changes directly with the changes in the price of its substitute. If the price of Sleep Number Mattresses, a substitute for a Tempur-Pedic Mattresses, increases, holding other factors constants, the demand for Tempur-Pedic Mattresses will increase. This is because Tempur-Pedic Mattresses will be relatively cheaper to consumers compared to Sleep Number Mattresses. The main factors which could be responsible for the increase in the price of Sleep Number Mattresses include an increase in the cost of inputs for the product or an increase of tax charged on this particular product. Another factor which could lead to an increase in prices of this product includes a change in technology, probably inefficiency in the factory. All these supply determinants will increase the cost of production which will translate to the increased price of Sleep Number Mattresses.
With the increase in demand for Tempur-Pedic Mattresses, at the current price, though consumers are able and willing to buy more of the Tempur-Pedic Matresses, producers will continue supplying the original equilibrium quantity. This will create a market shortage of Tempur-Pedic Mattresses in the market. Producers will be reluctant to supply more of the product unless the price of the product increases to compensate them for the rising marginal cost of production. To satisfy the market, given the shortage, producers will increase production of the product to satisfy the market demand and at the same time increase price of the product to cover the increasing marginal cost of production. This increase in quantity demanded and the price will bring a new equilibrium of quantity transacted. The net effect of increasing the price of a substitute is a net increase in quantity and a net increase in the price of the commodity. Producers now will have to supply more of the mattress at a higher price while consumers will also increase the quantity demanded and buy the product at a higher price.
2. a ) Graphical representation of effect of price changes of substitute
From the graph below, when the price of Sleep Number Mattresses increased from P to P1, the quantity demanded of its substitute, Tempur-Pedic Mattresses, increased from Q to Q1. This increase in quantity demanded is brought by the increase in the price of a substitute.
P: - Price
Q: - Quantity
When quantity for Tempur-Pedic Mattresses demanded, increases due to increase in the price of its substitute, the demand curve is going to shift from Demand curve 1 to Demand curve 2. Consumers will be willing to buy more mattresses at Q2. Since supply curve has not shifted and the price of the mattress is still P1, producers will continue producing at Q1. Hence there will be a market shortage. To satisfy the market demand, Producers will increase production to Q3 and charge P2 to the cutter for the increase in the marginal cost of production. The net effect of the increase in the price of Sleep Number Mattresses will be an increased demand of Tempur-Pedic Mattresses with a subsequent increase in its price.
3.
If the price of memory foam, a resource needed to produce Tempur-Pedic Mattresses, increases, holding other factors constant, the supply of the product will also decrease due to the increase in the cost of production brought about by the hike in the price of raw material (Boundless, 2016). Since the cost of production of Tempur-Pedic Mattresses has increased owing to the increased cost of its raw material, the price of the mattress will increase proportionately to the increased cost of production. This increase in the price of the mattress will cause a net decrease in demand for the same commodity since the purchasing power of consumers will have been decreased. The increase in prices of a commodity causes a decrease in demand for the same commodity.
With the increase in the cost of production, at the original equilibrium price of the mattress, quantity demanded will be higher than quantity supplied. This will cause a shortage in the market. As a result, consumers wanting more of the mattress will bid higher prices and producers will start producing more but at a higher price than the initial equilibrium price. This new shift in quantity demanded and quantity supplied will bring new market equilibrium of supply and demand at a higher equilibrium price than the original. The net effect of the reduction in supply is that the equilibrium price will go up while the equilibrium quantity will decrease.
P: - Price
Q: - Quantity
When supply decreases due to increased price of an input or cost of production, the supply curve shifts from supply curve 1 to supply curve 2. At the new supply curve, given the original equilibrium price of P1, producers will be supplying mattresses at Q2 while the market will be demanding a supply of Q1. This will create a market shortage of mattresses. This shortage will bring an upward pressure on price as consumers willing to have more mattresses will bid for higher prices. Producers will also increase production but at a higher price. Eventually, new market supply and demand equilibrium will be found at equilibrium price P2 and equilibrium quantity Q3.
5.
In the event that the demand curve of a commodity has to shift to the right due to an increase in the price of its substitutes, in concert with the shift to the left of the supply curve because of increases in the cost of production, there will be a net adjustment of equilibrium values. The two movements will bring a net increase in price and a small increase in quantity demanded. By increasing the price of a substitute of a commodity, its net effect is an increase in price and an increase in quantity demanded. The net effect of an increase in the cost of input is a net increase in price and a net decrease in quantity demanded. Graphical representation of the two effects is shown in the graph below.
The increase in the price of a substitute will not cause the supply curve to shift. The producer will only adjust goods produced to match what consumers are willing to pay for i.e. movement along the demand curve. As such change in the price of Sleep, Number Mattresses will not affect the supply curve of Tempur-Pedic Mattresses but its demand curve from D1 to D2. Change in input price of Tempur-Pedic Mattress will cause the supply curve to shift and movement in the demand curve. The new supply curve will move inwards from S1 to S2. The resultant market equilibrium will be found at Q2 and P2. From this, we can see that the change in quantity will be significantly small compared to the change in the price of the commodity.
References
Boundless (2016). Changes in Supply and Shifts in the Supply Curve. Retrieved from https://www.boundless.com/economics/textbooks/boundless-economics-textbook/introducing-supply-and-demand-3/supply-47/changes-in-supply-and-shifts-in-the-supply-curve-178-12276/
Chand, S (2015). Effect of Demand Curve on Substitute Goods and Complementary Goods | Micro Economics. Retrieved from http://www.yourarticlelibrary.com/economics/effect-of-demand-curve-on-substitute-goods-and-complementary-goods-micro-economics/8914/
