Understanding Market Dynamics

Market dynamics refer to the forces that change in the supply and demand curve and consequently, that influences the prices of a specific commodity or service in an economy.

It is our common knowledge that market prices are determined via demand and supply. If the demand for a product is more than the supply, the prices seem to go up. If the supply of the product is more than the demand, the prices go down. Based on the above simple economic principle, the consumers want to pay the lowest amount for the products or services, and the suppliers, on the other hand, buy at lower prices and sell at higher prices to want to maximise the return. Thus, the point of intersection of demand and supply determines the price of the product or service.

Equilibrium price:

The equilibrium price is the market price as the demand and supply meet the equilibrium price. In other words demand and supply match determines the price of the good or service. The equilibrium price is ever-changing, and the demand and supply factors keep changing. As the factors change, the equilibrium price changes as well.

Price discovery:

Free markets tend to find the correct price for a product or service. The market equilibrium is formed at the point where the demand and supply curves intersect. This process is called ‘price discovery’. The price, as determined by the intersection of demand and supply, forms the market price of the goods.

The overall concept is that production, or the supply of goods and services, is most important in determining economic growth as consumers will respond to the price set by the suppliers. For example, a business might supply 1000000 Android mobile phones if the price is Rs20000/- each, but if the price increases to Rs30000/-, they might supply 7500000 phones.

Supply-side economics:

The supply-side theory has three pillars which are tax policy, regulatory policy, and monetary policy. The macroeconomic theory of supply-side is postulating that economic growth can be most effectively fostered by lowering taxes, decreasing regulation, and allowing free trade.

Supply-side economics (also known as classical economic theory) refers to free-market economics which was defined and articulated by Adam Smith in his 1776 book ‘On the Wealth of Nations’. Smith determined that specialization took advantage of comparative advantages that made trade a net win for both parties.

Supply-side economics, also called trickle-down economics, is the theory that focuses on influencing the supply of labour and goods, using tax cuts and benefit cuts as incentives to work and produce goods. It was explained by the U.S. economist Arthur Laffer (b. 1940). This theory of economic growth was implemented by Pres. Ronald Reagan in the 1980s. The supporters of Reagonomics pointed out economic growth during the 1980s as proof of its efficacy. However, detractors point to the massive federal deficits and speculation that accompanied that growth.

Supply-side economics usually focuses on creating government projects to encourage the production of goods from a corporation. In contrast, demand-side economics focuses specifically on creating jobs for the unemployed, so consumers feel more comfortable spending.

Demand-side economics:

Demand-side economics holds that demand for goods and services drives economic growth. As the market demand works on factors like competitive products can affect the market demand for particular goods or services.

Market demand is the demand for a particular good in the market and aggregate demand is the total demand for goods and services in the economy.

According to Keynesian (John Maynard Keynes) economics or demand-side economics theory, aggregate demand is composed of four elements: consumption of goods and services; investment by industry in capital goods; government spending on public goods and services; and net exports.

Under the demand-side model, Keynes advocated for government intervention to help overcome low aggregate demand in the short term, such as during a recession or depression. This could reduce unemployment and stimulate economic growth.

 Central Bank intervention for price control under its monitory policy:

Inflation is a rise in prices increase in the price of raw materials, increase in taxes, decline in productivity, and increase in money supply. When inflation is rising the aggregate demand in the economy will be high and reduce the purchasing power of consumers over time. When inflation boils and prices rise too rapidly, restrictive or ‘tight’ monetary and fiscal policy tools are employed by the Central Bank to reduce the supply of money within an economy by lowering the prices of bonds and raising interest rates.  When money supply is reduced, consumption falls, prices fall and inflation slows down. Similarly, if prices begin to fall as is the case with deflation, ‘loose’ or expansionary monetary and fiscal policy tools are used. The Central Bank cuts the interest rate when the aggregate demand in the economy is low. Reduction of interest rates will pump money into the markets and increase the demand for goods and services. Hence, the Central Bank policy is more demand-related and is based on demand-side factors. However, when the unemployment rate is high economy will be in recession. In that case, the demand is low despite low-interest rates.

Dynamics of Securities Markets

The financial markets are running under the factor of speculation and investor sentiment results in an increase in volatility. Therefore, unlike quantifying in economic models, quantifying the dynamic forces prevalent in the security market is difficult.

Traders and other institutional investors understand the functioning of markets and can access market information and metrics that can be used to analyze and understand market trends. On the other hand, unprofessional participants in the financial market may be driven by incomplete information knowledge, and greed. It may lead to excessive speculation and volatility in the market.