Demand can be
described economically as a desire for owning anything, ability to incur
expenses for the item in terms of payment, and definitely the will to pay. More
clearly, it shows willingness and ability to purchase a commodity at a certain
time. It is recorded by economists on demand schedule and plotted characteristically
downward slopping on a graph (demand curve). Generally every product that a
consumer considers to buy, there exists a demand curve for that particular
product and for that particular consumer. Demand curve of a consumer is always
the equivalence of the marginal utility i.e. gain or loss attributed to an
increase or decrease in consumption of a particular good or a particular
service. Therefore the law of demand can be described as while everything else
is held at constant as quantity of services or goods which are well defined
that can willingly be bought by consumers in a particular time period and which
increases or decreases as price for the service or good falls or rises
(Epstein, 2005, p.116).
Aggregate demand curve
Aggregate
demand refers to amount of goods or services which will be acquired or
purchased by consumers at any given possible price level. It can be defined as
the country’s Gross Domestic Product (G.D.P) when levels of inventory are
static. It is described as summation of demand curves from the different
economic sectors. i.e.
Y = C +J +G + NX
(Perloff, 2008, p.98), given that NX = Ex – Im whereby Y describes Aggregate Demand,
C describes consumption, G descries Government spending, Ex describes the total
exports and Im describes the total imports therefore NX describes the net
Imports.
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In
the graph above, a fall in price level to p2 from p1 leads to increase in
demand to y2 from an initial y1. This is attributed to increasing wealth with a
fall in the interest rates and increase in wealth. Consumption is thus stimulated with an
increase in exports and investments. The above described would thus lead to
higher demand for services and goods.
Effect of falling
demand on the number of firms and firms’ profitability
Revenue derived from produced goods
and services is of outmost importance to firm. Though firms may influence sales
volumes, it is largely limited by demand and production capacity (Krizanova,
2006, p.221). Therefore a fall in demand will definitely cause the firms to
react because this would mean a fall in their revenue collection. This fall in
demand causes firms to cut back on investments and thus reduces employment.
Fall in demand leaves the firms at a
point whereby the cost of production of goods and services that they have at
hand was high and if they are to sell those goods and services at all, they
would have to lower their prices (Blanchard 1987, p.24). This coupled with a
drop in marginal interests and a general increase in marginal costs affects
their revenue and some of the firms’ begin running at a loss. Eventually with
production cut backs and lay off of workers, the firms are left with no other
alternative than to close.
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Unless the above
trend is checked, with by such measures as increased spending by the government
or cutting on interest rates, it could lead to a recession i.e. a general
economic slowdown in all sectors of the economy.
Effect of rising demand
on the number of firms and firms’ profitability
An
increase in demand causes firms to produce more to meet the markets demand.
Firms will try to employ more workers off course at a lower marginal cost and
even though as per the aggregate demand curve, the prices are decreasing, the
firms are enjoying large scale sales which eventually do bring in the, much
needed revenues.
Therefore
in the short run, there will be massive investment due to the low prices and
the firms will produce more to counter this overspending habit and a general
feeling that the same money they had had increased its value. With inability of
only the existing firms to meet the market demand for goods and services, new
market players will see the opportunity and seize the moment and also start
production. Though the prices are a bit low, they are encouraged by the high
demand (Duetsch, 1993, p.96).
In
the long run, due to increasing demand, the prices will again begin to steadily
rise since by now the rate of unemployment has reduced and thus the employees
steadily demand more from their employers (Deustch, 1993). Since the firms do
not want to incur the associated costs of employment and other marginal costs
incurred, they would eventually pass down the expenses to the consumer. Despite
this, the firms continually make profits from the demand and the number of
firms will continue to be on the rise until there is a drop in the demand for
the goods and services.
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The
two scenarios above give the impression that from one year to another, economic
activities within the market usually fluctuates. However goods and services
production increases in most years together with an increase in the overall
number of firms due to increasing demand and a number of other factors. These
other factors include labor force, technological advancement, and many other
minor factors which eventually lead to improved economy.
Unfortunately in some other years,
there is a down-turn of economy when firms cannot successfully sell their goods
and services thus leading to losses. To prevent further loss, they do cut on production
as some people lose their jobs and when it becomes worse, firms close down.
Conclusion
From the above assessment, it comes
to a conclusion that a drop in demand for goods and services leads to drop in
firm’s profitability in the short run. However in the long run, it will
certainly lead to closing of some firms due to increased costs of production. Conversely,
an increase in production leads to an increase in profitability of firms in the
short run and a further increase in the number of firms operating in the long
run due to increasing profits.
References
Krizanova A. & Martin H.
(2006). The analysis of demand and price
effect on firm’s revenue. EDIS ŽU Žilina
2(11) 212-234.
Epstein, R.L. et al. (2005). The Guide to Critical Thinking in Economics.
South-Western: Thomson.
Duetsch, Larry L. (1993). Industry
Studies. Englewood Cliffs, NJ: Prentice Hall.
Perloff, J. (2008). Microeconomic
Theory & Applications with Calculus. Pearson.
Blanchard O.J & Kiyotaki N
(1987) Monopolistic Competition and the
effects of aggregate demand. The American Economic Review.77(4) 23-35
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