Essential Market Theory

A market is a space where buyers and sellers meet to determine the quantities and prices at which goods or services exchange.

There are two sides to a market;

1. Buyers - they have a demand for some good or service

2. Sellers - They provide the supply of a particular good or service

The two sides interact to determine the prices and quantities exchanged. As a consumer you do not have an input in the price you pay, you accept price as given by the seller, though in some cases you can obtain reductions in price. Even though the seller sets the rate their influence over charge is limited by;

1. How much consumers are willing to pay

2. What other producers are charging

Prices are determined in the market by the process of markets moving toward equilibrium prices and quantities occur as buyers accept or reject the quantities on offer at the prices put forward by the sellers.

The Law of Supply and Demand

If we start from the simple theory that the logical action of a stock is to decline when offers are greater than the number of shares bid for, and to advance when the number of shares bid for is greater than the amount offered. Since the stock market deals in shares and price. If a trader wishes to purchase shares but can only gain those shares by offering more the price of the stock increases to absorb his purchase here demand is greater than supply. If the trader wishes to sell his shares and will accept a lower price than the seller before him, the price of the stock will be reduced here supply is greater than demand. In picture demand can outperform supply forever, though supply is limited by the zero point. In between too much supply over demand and too much demand over supply, is a state where the two are in equilibrium. This is where an equivalent exchange of shares for rate can happen. Every formula that develops is in selected way connected to this basic truth.

Law of Demand

To understand consumer behavior in relation to law of demand needs an understanding of fundamental analysis and factors, which characterize consumer choice? Factors which have affected demand in the past and individual consumer responses are reflected in the market place, and are a major component to understanding the economic theory relating to Law of Demand. Consumer asks for a product or service indicates how much people are willing to acquire at various prices. Thus, while all other factors remain constant consumer demand will determine the relationship between price and quantity.

As a universal rule the relationship within price and quantity is negative, meaning the higher the price the lower the quantity in demand. On the other scale the lower the price the higher the demand for the product. Factors that can affect market value in addition to price various added services, which can include packaging and handling, location, quality control and financing 

Consumers are the main driver of a free market economy and not producers. Value to a consumer of any goods and service is the determining factor of market value. The higher the price provides higher profits. Higher profits offer the impetus to expand production of goods and services. Profit driven expansion is the market's response to stronger buyer demand. Lower profits are the result of lower prices, which is induced by lack of consumer demand. Losses reduce the incentive to produce products, which have a weak demand therefore forcing production cuts resulting in loss of profits.

Law of Supply

Supply is distinct major component in market analysis, which relates to the behavior of production and sales within the market place. The supply represents what producers are willing to sell over a wide range of prices for any given time period. The manufacturer is keen to produce a product though the market price is equal to or greater than production costs. Therefore the total supply being the quantity the producer brings to the market place.

An increase in price will result in an increase in quantity of a product brought to market, therefore the relationship between the price and supply is positive. Factors that affect market supply behavior include; the number of producers bringing the same product to the market place, technology, the price of other commodities which could be produced, and the weather.

Greater profits are the result of higher prices which in turn result in expanded production thereby increasing supply. The increase in supply will eventually satisfy the underlying demand, so therefore future production needs to have a new demand in the product for the price increase to be sustained. Consumers are not interested in what it may cost to produce the item; low prices can be an indication of over production or lack of consumer interest.

How Supply and Demand Determine Market Prices

Price is determined by the interaction of supply and demand. An interchange of goods or services will occur if buyers and sellers can accord on a price. When an exchange occurs, the agreed upon price is called the "equilibrium price", or a "market clearing price”. Both buyers and sellers are eager to interchange the quantity "Q" at the price "P". At this point supply and demand are in balance or” equilibrium". At whatsoever price below P, the quantity demanded is greater than the quantity supplied. In this situation consumers would be anxious to acquire product the producer is unwilling to supply resulting in a product shortage. When there is a shortage of a product the consumer would need to pay a higher price to get the product that they want; though producers would demand a higher price in order to bring further product on to the market. The end result is a rise in prices to the point P, where supply and demand are once again in balance. Conversely, if prices were to rise above P, the market would be in surplus - too much supply relative to the demand. Producers would have to lower their prices in order to clear the market of excess supplies. Consumers would be induced by the lower prices to increase their purchases. Prices will fall until supply and demand are again in equilibrium at point P.

Equilibrium price changes with supply and demand. For illustration, the recent increase in supply of oil in the Middle East, on more products being made useable over a range of prices. With no increase in the quantity of product demanded, there will be movement along the demand curve to a new equilibrium price in order to clear the excess supplies off the market. Consumers will buy more but only at a lower price. This can be illustrated graphically: Any change in demand due to changing consumer preferences will also influence the market price. If there has been a shift in demand of coca cola drinkers toward the Cola a variety, away from the Cola B variety. A decline in the preference for Cola B shifts the demand curve inward, to the left. With no reduction in supply, the effect on price results from a movement along the supply curve to a lower equilibrium price where supply and demand is once again in balance. In order for prices to increase producers will have to reduce the quantity of Cola B brought to the market place or find new sources of demand to replace the consumers who withdrew from the marketplace due to changing preferences or a shift in demand.