Following the standard theory of microeconomics, equilibrium in a market is defined as a balanced state of demand and supply. At this point, the interest of buyers and sellers coincides. The self-interest of buyers and sellers help the market to attain a stable free market equilibrium. The change in either demand or supply or both lead a change in equilibrium position altering market price and traded quantity. An important determinant of demand is income. Consumers’ income determines the purchasing power (Baumol and Blinder 2015). An increase in income indicates an increase in purchasing power, which in turn increases demand. The resulted increase in demand shifts the demand the rightward. The market then approaches to a new equilibrium raising both price and quantity traded. The figure below explains the impact of an increase in consumers’ income on equilibrium of car market.
Figure 1: Increase in income and effect on car market
(Source: as created by Author)
The initial demand curve in the car market is shown as DD. The initial market supply curve is SS. With interaction of forces of demand and supply, the car market attains equilibrium at the point E. At this point, the equilibrium price of car is P*. The equilibrium quantity traded in the market is Q*. Now, an increase in income of consumers increase affordability of cars among buyers. The demand for car thus increases. The increased demand for car is captured by the new demand curve D1D1. As the demand curve shifts, the new equilibrium is attained corresponding to the intersection point of new demand and existing supply curve (Sloman and Jones 2017). The new equilibrium is achieved at point E1. Under the new equilibrium price of car increases from P* to P1. The quantity traded in the market increases to Q1.
The joint forces of demand and supply attain equilibrium under free market condition. External factors causing change in demand and supply leads to a change in market equilibrium and associated market outcome. Under the given scenario, the market of mobile phone is initially in equilibrium. The entry of new suppliers in the market increase availability of mobile phones in the market. The increasing availability of mobile phones increase supply (McKenzie and Lee 2016). The expansion of market supply shift the market supply curve outward. The demand however cannot adjust immediately. Given the demand, increase in supply causes a change in market equilibrium of mobile phone altering price and number of mobile phones under initial equilibrium. The figure below portraits scenario of mobile market following the change in supply.
Figure 2: The market of mobile phones
(Source: as created by Author)
In the above figure, the downward sloping curve D1D1 indicates the initial demand curve for mobile phone. The upward sloping curve S1S1 shows initial supply curve of mobile phones. With the initial demand and supply curve, the initial equilibrium in the market is attained at the point E. The initial equilibrium yields a market price of P1 and equilibrium number of mobile phones as Q1. Now, consider the effect of entry of new mobile phone producers in the market. As more producers are now supplying mobile phones, there is an increase in supply of mobile phones. The expansion in market supply is shown by the outward shift of the supply curve to S1S1 (Friedman 2017). Given the demand, the new supply curve shifts the equilibrium from E1 to E2. The excess supply in the market lowers the equilibrium price from P1 to P2. Because of the increased supply, the equilibrium quantity in the market for mobile phone increases from Q1 to Q2.
Initial equilibrium in a market is determined from the demand and supply condition in the market. Several exogenous factors influence demand and supply of a good. Apart from own price, price of related goods affect the demand of a particular good. Related goods include substitute and complementary goods. An increase in price of substitute goods make the good relatively cheaper. People then tend to substitute their demand toward the cheaper alternative. This increases demand for the concerned good. The reverse is the case for a decline in price of substitute good. A decline in price of substitute good, make the good relatively expensive (Hill and Schiller 2015). This lowers the demand of the particular product. Pepsi is a close substitute of Coca Cola. When price of Pepsi falls, Coca-Cola seems to be relatively expensive to the buyers. They then tend to increase their demand for Pepsi substituting the demand for Coca-Cola. The lower demand in the Coca-Cola market affect the market equilibrium, which is illustrated in the following figure.
Figure 3: Fall in price of substitute and effect on Coca-Cola market
(Source: as created by Author)
Figure above portraits the market of Coca-Cola. The initial equilibrium in the market is E0. The equilibrium is obtained from the interaction of initial market demand and market supply curve of Coca- Cola. The equilibrium price and quantity in the market is given as P0 and Q0 respectively. Following a decline in price of Pepsi, the demand for Coca-Cola declines as people prefers the cheaper alternatives (Cowell 2018). The decline in demand of Coca-Cola causes the market demand curve to shift inward to D2D2. The new equilibrium is at E1. At the new equilibrium, a lower quantity (Q1) of Coca-Cola is traded. The equilibrium price also falls to P1 under the new equilibrium.
Gross Domestic Product of a nation captures the national income of a country. GDP is used as the simplest measure of tracing living standard. GDP however is only a quantitative measure computing monetary values of produced goods and services in a nation (Decancq and Schokkaert 2016). GDP though is a simple measure but it has several shortcomings that prevents GDP to be a complete measure of living standard.
GDP computes the value of goods and services that are exchanged in the market. This creates a problem of measurement. In a society, there are different activities that are not exchanged in the market such as housework, volunteer work, home care and community service. These are the virtual aspects of economic well-being (Robert et al. 2014). No components of GDP that can captures the non-marketed activities. A society where children drive recklessly in the road, older citizens do not receive proper care and dominance of drug dealers in the society cannot be considered as enjoying a good quality of life. The increase in per capita GDP thus does not always mean an increase in living standard.
GDP is a quantitative measure and hence is unable to capture qualitative change in living standard. GDP though measures the value of produced goods and services, it does not deduct the cost of bad activities such as pollution and over exploitation of natural resources. When tobacco or a soap pollute water and air, the market value of soap and tobacco are included in the GDP. It however does not exclude the cost of pollution (Jones and Klenow 2016). A higher per capita GDP with poor quality of environment cannot ensure a good living standard. The more industrial production takes place in a country, the more is environmental pollution hampering quality of life.
In order to evaluate true living standard, focus should also be given on enjoyment of leisure time and happiness. It is difficult to measure these things through GDP. The working hours are included in GDP but leisure time is not captured in GDP. With increase in working hours, GDP increases. In contrast, an increase in work hours means a lesser time for leisure (Feldstein 2017). The lesser time for enjoyment hampers the quality of life. GDP does not include the economic inequality. A nation with higher GDP but high inequality in income distribution does not have a high living standard.
Following the shortcomings of GDP as a measure of well-being complementary measures of GDP for capturing living standard needs to be used. Two alternative measures of living standard are Genuine Progress Indicator (GPI) and Human Development Index (HDI).
Genuine Progress Indicator (GPI) is a well-known indicator of sustainability. This in addition to GDP captures a variety of indicators. This include commuting cost, transport accidents, cost of pollution, crime water pollution, land degradation, industrial action, use of irrigation water, land degradation, loss of forest, climate change, depletion of natural resources, depletion of ozone layers and many others (Andrade and Garcia 2015). As GPI includes many other indicators, which GDP does not, it a better measure of well-being.
HDI is measure for capturing human development. It has three main components – life expectancy at birth, adult literacy and combined ratio of primary, secondary and tertiary gross enrollment and per capita GDP adjusted in purchasing power parity also called Gross National Income (GNI) (Çilingirturk and Kocak 2018). The measure ranged between 1 and 0. Value closer to 1 means better quality of human development while value closer to 0 means lower quality of living.
References
Andrade, D.C. and Garcia, J.R., 2015. Estimating the genuine progress indicator (GPI) for Brazil from 1970 to 2010. Ecological Economics, 118, pp.49-56.
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Nelson Education.
Çilingirturk, A.M. and Kocak, H., 2018. Human Development Index (HDI) Rank-Order Variability. Social Indicators Research, pp.1-24.
Cowell, F., 2018. Microeconomics: principles and analysis. Oxford University Press.
Decancq, K. and Schokkaert, E., 2016. Beyond GDP: Using equivalent incomes to measure well-being in Europe. Social indicators research, 126(1), pp.21-55.
Feldstein, M., 2017. Underestimating the real growth of GDP, personal income, and productivity. Journal of Economic Perspectives, 31(2), pp.145-64.
Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University Press.
Hill, C. and Schiller, B., 2015. The Micro Economy Today. McGraw-Hill Higher Education.
Jones, C.I. and Klenow, P.J., 2016. Beyond GDP? Welfare across countries and time. American Economic Review, 106(9), pp.2426-57.
McKenzie, R.B. and Lee, D.R., 2016. Microeconomics for MBAs: The economic way of thinking for managers. Cambridge University Press.
Robert, C., Kubiszewski, I., Giovannini, E., Lovins, H., McGlade, J., Pickett, K.E., Vala Ragnarsdo?ttir, K., Roberts, D., De Vogli, R. and Wilkinson, R., 2014. Time to leave GDP behind. Nature, 505(7483).
Sloman, J. and Jones, E., 2017. Essential Economics for Business. Pearson
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