Any business needs to understand the trend of the demand and supply of the goods and services they produce. The demand for products vary depending on the nature of the commodity, the price of the commodity, availability, and cost of substitutes, level of income, and most importantly, time. On the other hand, the supply of a product majorly depends on the demand and the existing market price. Firms normally use price elasticity and income elasticity in predicting trends of sales and economic cycles (Parkin 2000). In this case, we have a farming company specializing in wheat and barley production. These are raw materials in the production of bread, a staple food, whereas barley is also used in manufacturing breweries.
Change in demand, which emanates from the change in the price of a given community is the price elasticity of demand. The nature of the product matters a lot in instances where people have to purchase basic commodities such as food and clothing regardless of their cost. Bread is a basic commodity and its demand is less elastic. Depending on the number of substitutes that a product has in the market, the demand for the product with regard to its price is somewhat elastic (Taylor 2001). If bread is relatively expensive, people can seek substitutes.
The income elasticity of demand is the change in quantity demanded resulting from the change in the level of income. For normal goods, the number of goods demanded increases with an increase in income (Taylor 2001). In this case, we have bread, a product with a relatively less income elasticity of demand. All consumers must buy bread such that only those with a higher income will go for superior qualities of the bread. Therefore, bread is a normal necessity good. Breweries, on the other hand, are products with positive income elasticity of demand that is strong. Brewery’s products are thus normal goods as their demand increases with an increase in income.
The above descriptions occur under normal circumstances. However, the trend may change in the case of a shock. In this case, there were storms in the United States and South America that reduced the global wheat yield by 50 percent. The graph below shows the changes in the prices, the demand, and the supply of the wheat commodity after the shock.
The following actions will occur in response to the shock.
- The quantity demanded will be higher than the quantity supplied
- There will be a shortage in the supply of wheat.
- The prices of the wheat will shoot.
- The supply curve moves inward and upward
- The demand curve moves outward and upward
- A new equilibrium forms at a higher price. If the initial equilibrium price was $150 per unit quantity, it increases to $ 225 per unit quantity.
Understanding the market forces of demand and supply is very important as it helps firms to undertake stringent decisions when adjusting their level of production. Generally, basic products such as bread and other foodstuffs have a weak income elasticity of demand. The only difference is the change in taste and preference that comes with the rise in the level of income. On the other hand, breweries are luxuries with strong income elasticity of demand that is positive.
Parkin, M 2000, Economics, Addison- Wesley, New York.
Taylor, B 2001, Economics, Houghton Mifflin Company, Boston.