All About the Economic Problems of the Philippines

Though a fast-growing economy, Philippines still needs to address the issues of poverty,
unemployment, and poor infrastructure. Here is some information on the economic problems of
the Philippines.
Did You Know?
In January 2015, out of the 62.87 million Filipinos in the age group of 15 years and above, the
labor force comprised 40.11 million. Out of these, 2.65 million were unemployed.
Located in Southeast Asia, the Republic of the Philippines comprises 7,107 islands. With more
than 100 million people currently living in the Philippines, it is ranked as the 12th most populous
country in the world. Philippines' economy largely depends on the remittances from the Filipinos
residing overseas and investing in the homeland. More than 10 million Filipinos are currently
living abroad.
Philippines has emerged as one of the fastest growing economies in Asia, with an annual GDP
growth rate of 6.1% in 2014. According to the Asian Development Bank, the GDP growth,
Inflation, and Current Account Balance (share of GDP) in 2015 is estimated to be 6.4%, 2.8%,
and 4%, respectively. While these figures might paint a rosy picture, there are certain serious
issues that need to be addressed.

Economics Problems of the Philippines

Like most other southeast Asian regions, Philippines too has a history of European colonization.
It was a colony of Spain and the USA. The country is now home to multiple cultures and ethnic
groups. It is also looked upon as a perfect example of a 'mixed economy'. Traditionally, the
economy stabilized on the agrarian contributions and the manufacture of garments,
pharmaceutical products, and semiconductors. In the last decade, electronic exports added to
the exports, along with various products obtained by mining. Though Philippines too suffered in
terms of exports, remittances from overseas Filipino workers, and foreign direct investments,
during the 2008 global economic crisis, there has been steady economic growth in the recent
years. However, there are certain economic problems that cannot be ignored. The following
sections list out some of the economic problems of the Philippines.

Unemployment
In 2012, 10 million Filipinos were either unemployed (three million) or underemployed (seven
million). In October 2013, unemployment rate was 6.5% in comparison to 6.8% in 2012.
According to the Labor Force Survey, the unemployment rate was 6% and 6.6% in October
2014 and January 2015, respectively.
Only one-fourth of the Filipinos that enter the labor force are able to find good jobs in the
country, and the rest of them find jobs overseas, leave the labor force, or end up becoming
unemployed/underemployed. Thus, three-fourth of the workers are unemployed or informally
employed, with lack of opportunities to find good jobs. Though jobs are being generated, there's
a need to generate jobs at a much faster rate, to be able to bring down the unemployment rate.
Many of the unemployed individuals are college graduates. Many wait for job opportunities
abroad, and many families depend on remittances from family members who are staying
abroad.
Poverty

Despite the talk about economic growth, the poverty rates have not changed significantly since
2006. As per the National Statistical Coordination Board (NSCB), poverty incidence of the
population improved from 26.3 percent in 2009 to 25.2 percent in 2012.
Even though Philippines is a fast-growing economy, there's been just a minor decline in the
incidence of poverty. Poverty is very much linked to unemployment. Unfortunately, the growth is
restricted to the BPO, retail, and real estate sector, and a large number of Filipinos remain
without jobs. On top of that, natural calamities further push people below the poverty line. Thus,
economic disparity is a common feature. In general, the gains from higher economic growth
have not really trickled down to the poor.

Poor Infrastructure
Infrastructure is one of the biggest challenges. In the Global Competitiveness Report 2014-2015
of the World Economic Forum, Philippines didn't fare well in terms of the quality of the overall
infrastructure. It ranked at number 91 among 144 countries. This can be attributed to
underinvestment in infrastructure.

In order to host global companies, Philippines will have to pay more attention to enhancing the
infrastructure. A well-developed transportation (roads, railroads, ports, and air transport) and
communication system is extremely essential for economic activities. As per the World Bank's
Ease of Doing Business 2015 report, Philippines ranked 95 out of 189 economies. It needs to
improve its ranking in certain categories. It ranked 161 in the category of starting a business,
124 in dealing with construction permits, 108 in registering property, 104 in getting credit, 154 in
protecting minority investors, 127 in paying taxes, and 124 in enforcing contracts. Thus, the
policy makers should take steps to attract global companies or investors.

Heavy Dependence on Remittances

Philippines was the third-highest recipient of migrant remittances in 2013, after India and China.
According to the Philippine Central Bank, remittances from overseas Filipino workers (OFWs)
reached USD 25.1 billion in 2013. It was 7.6% higher than the remittances from the last year,
and accounted for 8.4 % of Philippine gross domestic product (GDP) in 2013.
The source countries for the remittances included the United States, Saudi Arabia, the United
Kingdom, the United Arab Emirates, Singapore, Canada, and Japan. The country heavily relies
on these funds. Their economic growth can primarily be associated to the remittances from the
overseas Filipino workers, as well as the growth in the Business Process Outsourcing (BPO)
sector. Also, one cannot rule out that the growth is connected to the global economy. In the
event of any crisis, economic growth is bound to suffer. Thus, greater attention has to be paid to
addressing to the internal problems of the economy and enhancing domestic-oriented growth. A
policy of removing structural impediments to growth has to be adopted, with lesser focus on
foreign investors and exporters.
Besides the aforementioned issues, corruption is another aspect that needs to be taken care of.
The current administration needs to prepare an industrialization program that encourages value-
addition manufacturing or services and builds Filipino-owned industries. Being overly dependent
on global economy or remittances from Filipinos living abroad will make the nation vulnerable to
external shocks. Thus, the aim should be to encourage inclusive growth in the country by
creating employment opportunities and reducing poverty.
List of Basic Economic Problems and Their Solution
January 27, 2017 by zkjadoon

Basic Economic Problems

Any society, regardless of its size, degree of development and political system, tries to
solve the basic economic problems of deciding how to satisfy the unlimited needs of its
market through limited Resources. Below is the list of basic economic problems that
must be in your mind as an entrepreneur.

1. What to produce
2. How to produce
3. For Whom to Produce

List of Basic Economic Problems

These basic economic problems are fundamental and interdependent: what to produce?
how to produce? And for whom to produce? Every society must decide how to allocate
its resources between the different productive activities and how they are going to
distribute the goods and services of consumption between the individuals that compose
it.

Well, the mechanism by which a society is organized to address these issues is

its economic system. Consequently, the economic system of a society is the set of
relationships and institutionalized procedures with which it tries to solve the basic
economic problem.

What to produce? The answer to the first question indicates in which the productive
resources will be used and how much of the final product will be obtained with these
means of production. This will depend on the needs of the members of society and the
resources available, since the latter are limited and susceptible to alternative uses. This
fact raises other questions: Will more consumer or production goods be consumed? Will
the quantity or quality in the production be the primary factor? Will the production of
material goods or the provision of services increase? Will goods be produced for the
internal market or will production be directed towards the outside?

More from Business Study Notes:- What is Economy

How to produce? This question refers to the organization of production, that who is
going to be in charge of carrying out the productive activity, how this activity is going to
be undertaken and how the productive factors that are available will be combined. All of
this implies that society will ask questions such as whether intensive technologies will
be used in machinery or labor, whether it will be done through private companies or
public initiative, what sources of energy will be used in production or if the productive
processes by Those that will be chosen will be polluting or respectful with the
environment.

For whom to produce? Every society should design a system of distribution of goods
and services, which leads to reflect on issues such as: Who will be the target of that
production, a few or the vast majority of citizens? What method or system will be used
to distribute the entire production? Will the distribution of income be equal or will there
be very sharp differences between members of society?

It is very easy to understand that: WHAT, HOW, and for WHOM to produce would not
be problems if the usable resources were unlimited. However, in reality, there are
unlimited needs and limited resources available and manufacturing techniques. Based
on these restrictions, the Economy must choose between the goods to be produced and
the technical processes capable of transforming scarce resources into production.

This factor and the answer to these questions are closely linked to the production
management, the economy and of course the Financial Management, because as seen
previously, to produce you need to invest and to invest you need planning and
resources. Therefore, Financial Management comes to support the economy.
Presenting now a classical division of economics, microeconomics and macroeconomics,
it will be verified that, however great the differences between them, Financial
Management is present and with a high degree of importance.
Generally, microeconomics is conceived as the branch of Economic Science focused
on the study of the behavior of consumer units represented by individuals and / or
families (these being characterized by a single budget), the study of companies, their
respective productions and costs, And the study of the production and prices of the
various goods, services and productive factors.

In this way it is distinguished from macroeconomics, because it is interested in the

study of aggregates as the production, consumption and income of the population as a
whole.

The bifurcation of Economic Science in these two branches, that is, macroeconomics
and microeconomics, date of 1930. decade of beginnings
Both segments revolve around the problem of limited and finite character of productive
resources in the face of the vital needs of Civilization, infinite and limitless, underlying
the human being, a problem that underlies and justifies the reason for the existence of
economics as a science. However, micro and macroeconomics go as initially noted, for
different channels and can be identified and / or distinguished according to certain
parameters.

The criteria adopted for the distinction are, however, fragile, since the understanding of
any economic phenomenon inevitably requires the interrelationship of the theories that
are inserted both within the scope of the micro segment and in the macro branch of
Economic Science. Among these criteria, the first one is based on the level of
abstraction-ism involved. Indeed, as author Robert Y. Awh ponders, microeconomics,
in laying down general principles, is far more abstract than macroeconomics, which is
concerned with the examination of questions and measures peculiar to a given place
and instant of time.
Secondly, microeconomics presents a microscopic view of economic phenomena, and
macroeconomics, a telescopic lens, that is, the latter has much larger amplitude,
appreciating the functioning of the economy in its global.

It follows a comparative title: considering a forest, microeconomics would study the

plant species that comprise it, that is, the composition of the product as a whole, while
the macroeconomics would worry about the total product level the forest and its
operation.

A third way of distinguishing microeconomics and macroeconomics encompasses the

analysis of the behavioral forms of aggregate variables and individual
variables. However, the aggregativity here explained must be understood in terms of
the homogeneity or not of the set considered.

Thus, if the aggregate could be extracted, at random, an element as representative of

the behavior pattern of the others, the area of microeconomics performance would
be; otherwise, if there were no possibility of isolating one element of the group in such
a way as to reflect the pattern of behavior, the others would enter the field of
macroeconomics.

For example, the large aggregates studied by macroeconomics such as income,

employment and unemployment, consumption, investment, and savings are all
heterogeneous in nature. Microeconomics is devoted to the appreciation of the
individual units of the economy.

Thus, the study of Consumer Theory considers the behavior of the individual (or family,
as long as the unit of consumption and / or expenditure is unique) and will subsidize
the Demand Analysis; Also, in the Theory of Firm, which unfolds in Theories of
Production, Costs and Income and based on the Analysis of the Offer, again we have
the analysis of the forms of behavior of individual units, in this case, the companies. But
both Consumer Theory and Firm Theory allow instrumental and / or notions to be
inferred, such as those underlying Individual and Aggregate Searches and Individual
and Aggregate Bids. It should be noted, however, that both Aggregate Demand and
Aggregate Supply allow us to obtain a standard element of the set, given the
homogeneous character of which they are endowed.
The last and no less important criterion of distinction between microeconomics and
macroeconomics rests on the price aspect. The last segment, at most, addresses the
absolute levels of prices, while relative prices are concerns, par excellence, of the first
segment.

Effectively, microeconomics is also known as Price Theory, since it seeks to evidence

the formation of prices of goods and services, as well as of productive resources. How
is this accomplished?

In the Consumer Theory, microeconomics extols the intention of individuals, in view of

their respective incomes, to appropriate a combination of quantities of goods in order to
maximize their satisfaction. In other words, the searches (individual and aggregate)
that will result in income for the firms originate there.

In the Firm Theory, one has the figure of the individual-entrepreneur striving to
combine the factors of production, due to its budget constraint, with the intention of
maximizing the level of profit of his organization. Put another way, we obtain from the
analysis of this procedure, the elements necessary to derive individual and market
offers.

The combination of the quantities of factors of production, goods and / or services that
consumers would be willing to buy (which are usually infinite and unlimited), and the
quantities of these elements that entrepreneurs would be able to sell (which always
translate into a supply Finite and limited, in the face of the scarcity of productive
resources), imposes the determination of a common denominator, which will be nothing
more than the price.
The determination of this price, the level of which will depend a great deal on the
economic framework or the market structure involved, is the task that microeconomics
proposes when studying the question, both in terms of factors of production and in the
case of goods and / Or services. It is clear that the theme of economics is vast and can
cover much more topics and in more depth, but since the course is Financial
Management, the main concern is to insert in the course of the course the economy,
with its basic concept and the elementary division between micro And macroeconomics.

Clarifying now some concepts about market will be approached the generic concept of
market and a greater detail on the market that interests more in this course, the
financial market.

There are classic market definitions, such as Adam Smith’s, but in a more simplistic way
the market is defined as a set of voluntary contact points between sellers and potential
buyers of a good or service that, under contractual conditions of purchase and Sale,
they do business.

Implicit aspects in the market concept

1- The context include any type of exchange: direct exchange (direct negotiations
between sellers anywhere) and indirect exchange (trading through commodity
exchanges, intermediaries, such as brokers or similar institutions). Thus, the definition
of the market is characterized by the idea of economic space, that is, it is not confined
to a specific region that is to say that there is no physical or geographical limitation.

2- Negotiations are voluntary and the price system functions as a common denominator
in trade.

3- There is no need for the explicit presence of the parties involved in the process. This
possibility is possible through the development of international real-time
telecommunication networks and product standardization (commodities). Markets thus
develop in local, regional, national and international terms.

It is worth noting that there are different stages in the transaction process, but the
most common and known is the wholesale and retail.

Economic Systems
An economic system is a way of answering these basic questions. Different
economic systems answer the above questions differently. An economic system
refers to how the different economic elements will solve the central problems of
an economy: what, how and for whom to produce. It refers to the production and
distribution of goods and services within which economic activity takes place. It
refers to the way different economic elements, individual workers and managers,
productive organization such as factories or firms and government agencies are
linked together to form an organic whole.
Economic system consists of various individuals and their institutions like
banking institutions, educational institutions and economic institutions. The most
general economic systems are:

1. Traditional Economy

2. Capitalist Economy

3. Socialist Economy
4. Mixed Economy

I. Traditional Economy

In traditional economy, the basic problems are solved by traditions and custom
rules every aspect of behaviour. It produces exactly to its consumption
requirements. It is a subsistence economy. There is not much of sales as there is
only small scale production. The same product will be produced by every
generation. The production techniques are traditional.

II. Capitalist Economy

A capitalist economy is an economic system in which the production and

distribution of commodities take place through the mechanism of free markets.
Hence it is also called as market economy or free trade economy. Each individual
be it a producer, consumer or resource owner has considerable economic
freedom. An individual has the freedom to buy and sell any number of goods and
services and to choose any occupation. Thus a market economy has no central
coordinator guiding its operation. But self-organization emerges amidst the
functioning of market forces namely supply, demand and price.

III. Socialist Economy

In a socialist economy, the means of production are owned and operated by the
State. All decisions regarding production and distribution are taken by the central
planning authority. Hence the socialist economy is also called as planned
economy or command economy. The government plays an active role. Social
welfare is given importance; hence equal opportunity is given to all. All such
advantages have delivered high level of human development. Some of the most
successful socialist economies are China, Cuba, Vietnam and North Korea.

IV. Mixed Economy

In a mixed economy, both public and private institutions exercise economic

control. The public sector functions as a socialistic economy and the private sector
as a free enterprise economy. All decisions regarding what, how and for whom to
produce are taken by the State. The private sector produces and distributes goods
and services. It manufactures consumer and capital goods in the interest of public
welfare. A mixed economy possesses the freedom to hold private property, to earn
profit, to consume, produce and distribute and to have any occupation. But if these
freedoms affect public welfare adversely, they are regulated and controlled by the
State. The main features of mixed economic system are:

Co-existence of Public and Private Sectors: In a mixed economy, both the public
and the private sectors initiatives will be there. The most strategically and
nationally important sectors of the economy will be reserved for the public sector.
The rest will be left for private operation. While the public sector will have social
welfare as the prime motive, the private sector will function with profit motive.

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Three Basic Economic Problems

All modern economies have certain fundamental or basic economic problems
to deal with. In every single economy, including the so-called “affluent society”,
resources are limited. As a result, decisions regarding the resource use have to be
made together by individuals, by business corporations, and by society.
It is the social choice and community preferences which give substance to the
question of macro-economic decisions.
Three Basic Economic Problems of Society
Following figure shows the 3 fundamental economic problems faced by all
societies worldwide.

1. What to produce ?
Each and every economy must determine what products and services, and what
volume of each, to produce. In some way, these kinds of decisions should be
coordinated in every society. In a few, the govt decides. In others, consumers and
producers decisions act together to find out what the society’s scarce resources
will be utilized for. In a market economy, this ‘what to produce?’ choice is made
mainly by buyers, acting in their own interests to fulfill their needs. Their demands
are fulfilled by organizations looking for profits.
For instance, if cellphones are in demand it will pay businesses to produce and
sell these. If no one desires to buy radio sets, it is not worth producing them.
In case a manufacturer produces an item which buyers don’t buy in much quantity,
there will likely be inadequate income. The manufacturer will have to enhance the
quality and modify the product to match buyer tastes. If the item is still not
preferred, the producer will most likely halt the production. In this manner, buyers
get the goods they need.
Customers rule the ‘what?’ decision. They ‘vote’ for certain products and services
by spending money on those they like. Each and every manufacturer has to offer
what buyers want so that they can compete effectively against other
manufacturers. Government authorities also perform some part in making ‘what?’
decisions. For example, a law demanding all ladies to wear a helmet generates
demand for helmets, and profit-seeking businesses will produce them.
Read More: What to Produce?
2. How to produce ?
This basic economic problem is with regards to the mix of resources to use to
create each good and service. These types of decisions are generally made by
companies which attempt to create their products at lowest cost. By way of
example, banking institutions have substituted the majority of their counter service
individuals with automatic teller machines, phone banking and Net banking. These
electronic ways of moving money, utilizing capital as opposed to labour resources,
have decreased the banks’ production costs.
In the Nineteen fifties dams were being constructed in China by countless people
making use of containers and shovels. On the other hand dams were being
constructed in the united states by using huge earth moving devices.
The initial approach to production, using a resource combination which includes a
small capital and much labour, is labour-intensive while the second, utilizing a little
labour and a lot of capital, is capital-intensive. Each one of these ‘how’ decisions
was made based on lowest cost and accessible modern technology.
Read More: How to Produce Goods and Services?
3. For whom to produce ?
This basic economic question is focused on who receives what share of the
products and services which the economy produces. The portion of production
which each person and family can consume is determined by their income. Income
is distributed in line with the value of resources we have to sell.
As an example, a top cricket player will earn far more income than a professor. A
top cricket player has a resource to sell for which many people will pay a high price.
Professors are not so rare, and few people pay for their services.
The for whom decision can even be dependent upon skills shortages, in which
case organizations will provide higher incomes to attract workers with rare skills.
In the same way, high wages may be required to attract employees to rural
locations.
The economic problem is at times referred to as the basic, central or fundamental
economic problem. It is one of the crucial economic theories in the functioning of
any economy in this world. Due to scarcity, choices have to be made by
consumers, businesses and governments.
Scarcity can be caused by the possible lack of availability in resources, from
individuals insatiable desires, or from a combination of the two. Due to the fact that
resources are scarce and many of our desires are substantial, a choice needs to
be made about how to use scarce resources in the most effective way.
This rule is applicable to companies, society as a whole, and to individuals. This
article has discussed the 3 fundamental economic questions or three basic
economic problems common to all societies. If anything is missing please post in
the comments section.

Investopedia defines applied economics as “the application of economic theories and principles to real
world situations with the desired aim of predicting potential outcomes.” Moreover, applied economics
can lead to “to do” lists for steps that can be taken to ensure stability in real world events.

In the 21st century, the Philippines has been faced with several economic problems such as the
following:

1. Unemployment – occurs when a person is unable to find a work

2. Shortage – occurs when there is less supply than consumer demand
3. Surplus – occurs when there is excess supply than consumer demand
4. Corruption - refers to dishonest of fraudulent behavior by people with power such as managers
5. Poverty – refers to the state or condition in which people do not have the minimum standard of
life deemed accepted by the society.
6. Price Volatility - refers to the unpredictable changes in prices (i.e. commodity price)
7. Tax issues – refers to compulsory contribution to the country’s revenue
8. Issues on education – includes tuition and other fees increase, bullying, and even graft and
corruption
9. What to produce – refers to the first main problem of the economy which is to decide what
products and services to produce and in what quantity.
10. How to produce – refers to the economy’s basic problem which is to decide on how to produce
the products. This involves finding the efficient and effective technique for production.
11. Who gets what it produced - this refers to the problem on who will receive the products and
services an economy produces.

On the brighter side, applied economics can be used to solve these problems. To use applied economics,
look at the different economic theories and concepts such as the law of supply and demand (which can
be used to explain why shortage and surplus occur), efficient pricing, scarcity, and others. Take and
apply these into real world scenarios.

Study for example why price increases as the demand for cellphones increases. The law of demand, in
this case, can be used to analyze the reason for price increase. The law of demand states that as demand
increases, price and quantity of the product increase as well. Hence, since demand for cellphones
increases, price also increases.

Businesses are confronted with issues on economics. Competition compels businesses to produce
products of high quality and at an affordable price. A business should also have a competitive advantage
over its competitors to distinguish itself from the rest. Businesses would want to have more customers
to have more profit. Business managers and even entrepreneurs must understand economics to better
their decision-making skills. From the simplest concept of scarcity and choice; down to the law of
demand and supply, it is essential to have economic knowledge.

Moreover, statistical methods can also be used in solving economic problems. Students in econometrics,
a branch of economics that uses statistical and mathematical theories in economics for “forecasting
future trends” use this method intensively.

Observe the logical thinking behind the application of economic theories and concepts. From theories
written in books to the application in solving real problems, applied economics has successfully proven
to be helpful in addressing the country’s unending economic dilemmas.

Investopedia defines applied economics as “the application of economic theories and principles to real
world situations with the desired aim of predicting potential outcomes.” Moreover, applied economics
can lead to “to do” lists for steps that can be taken to ensure stability in rea; world events.

In the 21st century, the Philippines has been faced with several economic problems such as the
following:

1. Unemployment - occurs when a person is unable to find work

2. Shortage – occurs when there is less supply than consumer demand.
3. Surplus – occurs when there is excess supply than consumer demand
4. Corruption - refers to dishonest or fraudulent behavior by people with power such as managers
5. Poverty – refers to the state or condition in which people do not have the minimum standard of
life deemed accepted by the society.
6. Price Volatility – refers to the unpredictable changes in prices (i.e. commodity price)
7. Tax Issues – refers to compulsory contribution to the country’s revenue
8. Issues on education - includes tuition and other fees increase, bullying, and even graft and
corruption.
9. What to produce - refers to the first main problem of the economy which is to decide what
products and services to produce and in what quantity.
10. How to produce – refers to the economy’s basic problem which is to decide on how to produce
the products. This involves finding the efficient and effective technique for production.
11. Who gets what it produced - this refers to the problem on who will receive the products and
services an economy produces.

On the brighter side, applied economics can be used to solve these problems. To use applied economics,
look at the different economic theories and concepts such as the law of supply and demand (which can
be used to explain why shortage and surplus occur), efficient pricing, scarcity, and others. Take and
apply these into real world scenarios.

Study for example why price increases as the demand for cellphones increases. The law of demand, in
this case, can be used to analyze the reason for price increase. The law of demand states that as demand
increases, price and quantity of the product increase as well. Hence, since demand for cellphones
increases, price also increases.

Businesses are confronted with issues on economics. Competition compels businesses to produce
products of high quality and at an affordable price. A business should also have a competitive advantage
over its competitors to distinguish itself from the rest. Businesses would want to have more customers
to have more profit. Business managers and even entrepreneurs must understand economics to better
their decision-making skills. From the simplest concept of scarcity of choice; down to the low of demand
and supply, it is essential to have economic knowledge.

Moreover, statistical methods can also be used in solving economic problems. Students in econometrics,
a branch of economics that uses statistical and mathematical theories in economics for “forecasting
future trends” use these methods intensively.

Observe the logical thinking behind the application of economic theories and concepts. From theories
written in books, to the application in solving real life problems, applied economics has successfully
proven to be helpful in addressing the country’s unending economic dilemmas.

Economics Basics: Supply and Demand

By Adam Hayes, CFA

Supply and demand is perhaps one of the most fundamental concepts of economics and it
is the backbone of a market economy. Demand refers to how much (quantity) of a
product or service is desired by buyers. The quantity demanded is the amount of a
product people are willing to buy at a certain price; the relationship between price and
quantity demanded is known as the demand relationship. Supply represents how much
the market can offer. The quantity supplied refers to the amount of a certain good
producers are willing to supply when receiving a certain price. The correlation between
price and how much of a good or service is supplied to the market is known as the supply
relationship. Price, therefore, is a reflection of supply and demand.

The relationship between demand and supply underlie the forces behind the allocation of
resources. In market economy theories, demand and supply theory will allocate resources
in the most efficient way possible. How? Let us take a closer look at the law of demand
and the law of supply.

A. The Law of Demand

The law of demand states that, if all other factors remain equal, the higher the price of a
good, the less people will demand that good. In other words, the higher the price, the
lower the quantity demanded. The amount of a good that buyers purchase at a higher
price is less because as the price of a good goes up, so does the opportunity cost of
buying that good. As a result, people will naturally avoid buying a product that will force
them to forgo the consumption of something else they value more. The chart below
shows that the curve is a downward slope.

A, B and C are points on the demand curve. Each point on the curve reflects a direct
correlation between quantity demanded (Q) and price (P). So, at point A, the quantity
demanded will be Q1 and the price will be P1, and so on. The demand relationship curve
illustrates the negative relationship between price and quantity demanded. The higher the
price of a good the lower the quantity demanded (A), and the lower the price, the more
the good will be in demand (C).

B. The Law of Supply

Like the law of demand, the law of supply demonstrates the quantities that will be sold at
a certain price. But unlike the law of demand, the supply relationship shows an upward
slope. This means that the higher the price, the higher the quantity supplied. Producers
supply more at a higher price because selling a higher quantity at a higher price increases
revenue.
A, B and C are points on the supply curve. Each point on the curve reflects a direct
correlation between quantity supplied (Q) and price (P). At point B, the quantity supplied
will be Q2 and the price will be P2, and so on. (To learn how economic factors are used
in currency trading, read Forex Walkthrough: Economics.)

Time and Supply

Unlike the demand relationship, however, the supply relationship is a factor of time.
Time is important to supply because suppliers must, but cannot always, react quickly to a
change in demand or price. So it is important to try and determine whether a price change
that is caused by demand will be temporary or permanent.

Let's say there's a sudden increase in the demand and price for umbrellas in an
unexpected rainy season; suppliers may simply accommodate demand by using their
production equipment more intensively. If, however, there is a climate change, and the
population will need umbrellas year-round, the change in demand and price will be
expected to be long term; suppliers will have to change their equipment and production
facilities in order to meet the long-term levels of demand.

C. Supply and Demand Relationship

Now that we know the laws of supply and demand, let's turn to an example to show how
supply and demand affect price.

Imagine that a special edition CD of your favorite band is released for $20. Because the
record company's previous analysis showed that consumers will not demand CDs at a
price higher than $20, only ten CDs were released because the opportunity cost is too
high for suppliers to produce more. If, however, the ten CDs are demanded by 20 people,
the price will subsequently rise because, according to the demand relationship, as demand
increases, so does the price. Consequently, the rise in price should prompt more CDs to
be supplied as the supply relationship shows that the higher the price, the higher the
quantity supplied.

If, however, there are 30 CDs produced and demand is still at 20, the price will not be
pushed up because the supply more than accommodates demand. In fact after the 20
consumers have been satisfied with their CD purchases, the price of the leftover CDs may
drop as CD producers attempt to sell the remaining ten CDs. The lower price will then
make the CD more available to people who had previously decided that the opportunity
cost of buying the CD at $20 was too high.

D. Equilibrium
When supply and demand are equal (i.e. when the supply function and demand function
intersect) the economy is said to be at equilibrium. At this point, the allocation of goods
is at its most efficient because the amount of goods being supplied is exactly the same as
the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is
satisfied with the current economic condition. At the given price, suppliers are selling all
the goods that they have produced and consumers are getting all the goods that they are
demanding.

As you can see on the chart, equilibrium occurs at the intersection of the demand and
supply curve, which indicates no allocative inefficiency. At this point, the price of the
goods will be P* and the quantity will be Q*. These figures are referred to as equilibrium
price and quantity.

In the real market place equilibrium can only ever be reached in theory, so the prices of
goods and services are constantly changing in relation to fluctuations in demand and
supply.

E. Disequilibrium

Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*.

1. Excess Supply
If the price is set too high, excess supply will be created within the economy and there
will be allocative inefficiency.

At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At
P1, however, the quantity that the consumers want to consume is at Q1, a quantity much
less than Q2. Because Q2 is greater than Q1, too much is being produced and too little is
being consumed. The suppliers are trying to produce more goods, which they hope to sell
to increase profits, but those consuming the goods will find the product less attractive and
purchase less because the price is too high.

2. Excess Demand
Excess demand is created when price is set below the equilibrium price. Because the
price is so low, too many consumers want the good while producers are not making
enough of it.

In this situation, at price P1, the quantity of goods demanded by consumers at this price is
Q2. Conversely, the quantity of goods that producers are willing to produce at this price
is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of the
consumers. However, as consumers have to compete with one other to buy the good at
this price, the demand will push the price up, making suppliers want to supply more and
bringing the price closer to its equilibrium.

F. Shifts vs. Movement

For economics, the "movements" and "shifts" in relation to the supply and demand curves
represent very different market phenomena:

1. Movements
A movement refers to a change along a curve. On the demand curve, a movement denotes
a change in both price and quantity demanded from one point to another on the curve.
The movement implies that the demand relationship remains consistent. Therefore, a
movement along the demand curve will occur when the price of the good changes and the
quantity demanded changes in accordance to the original demand relationship. In other
words, a movement occurs when a change in the quantity demanded is caused only by a
change in price, and vice versa.
Like a movement along the demand curve, a movement along the supply curve means
that the supply relationship remains consistent. Therefore, a movement along the supply
curve will occur when the price of the good changes and the quantity supplied changes in
accordance to the original supply relationship. In other words, a movement occurs when a
change in quantity supplied is caused only by a change in price, and vice versa.

2. Shifts
A shift in a demand or supply curve occurs when a good's quantity demanded or supplied
changes even though price remains the same. For instance, if the price for a bottle of beer
was $2 and the quantity of beer demanded increased from Q1 to Q2, then there would be
a shift in the demand for beer. Shifts in the demand curve imply that the original demand
relationship has changed, meaning that quantity demand is affected by a factor other than
price. A shift in the demand relationship would occur if, for instance, beer suddenly
became the only type of alcohol available for consumption.

Conversely, if the price for a bottle of beer was $2 and the quantity supplied decreased
from Q1 to Q2, then there would be a shift in the supply of beer. Like a shift in the
demand curve, a shift in the supply curve implies that the original supply curve has
changed, meaning that the quantity supplied is effected by a factor other than price. A
shift in the supply curve would occur if, for instance, a natural disaster caused a mass
shortage of hops; beer manufacturers would be forced to supply less beer for the same
price.
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Self-control test

1) The law of demand states that there is

positive relationship between price and quantity demanded

negative relationship between price and quantity demanded

positive relationship between income and quantity demanded

positive relationship between income and quantity demanded

2) When the price of good X increases, the demand for its substitute good

increases

decreases

remains constant

3) Among other factors, the position of supply curve for good X is determined by

the price of X

number of producers who produce good X

the number of consumers who consume good X

4) When the demand for good X increases, the equilibrium price of good X

increases

decreases

remains constant

5) When the supply of good X decreases, the equilibrium price of good X

increases

remains constant

decreases

6) When production technology for good X improves, the equilibrium price of good X

increases because demand increases

increases because demand decreases

decreases because supply increases

decreases because supply decreases

7) When consumers expect lower prices for good X in the future, the demand for good X

increases

decreases
 remains constant

8) Increase in equilibrium quantity of good X can be caused by

decrease in consumers´ income

increase in the price of good which is X`s complementary good

decrease in the factor prices that are used to produce good X