Economic Phenomenon Analysis with Examples for Demand and Supply Model

In the next part, the researcher can describe all possible reasons of market failures and also determine the gold price by considering the analysis of demand, supply, and market failure. Also, he will try to find the negative externality that arises for the use of the personal car.

Investigation of Market Failure by using Demand and Supply analysis

Demand refers to the desire of buyers and a price that the buyers are willing to pay for a particular services and goods. Supply is an economic phenomenon that refers to the entire goods and services which are available to customers at a specific price. Considering these two, one can say that market equilibrium occurs where demand and supply coincide with each other (Frank, 2010).

In figure 1, market equilibrium is shown. In the horizontal axis, quantity is shown and in the vertical axis price is shown.

Figure: 1

In this figure, P* and Q* are the equilibrium price and quantity respectively.

Causes of Market Failure

Sometimes it can be seen that free market cannot allocate the scarce resources in an efficient manner. It occurs due to some reasons like negative externalities, monopoly power, etc. which are explained below.

Allocative and productive inefficiency

When the markets cannot allocate and produce possible scarce resources in an effective manner, then there may be a chance of market failure (Krugman, 2014).

Missing markets

When the markets fail to form, there is a chance of market failure; because it cannot meet the willingness for public goods (highways, lights on road etc.)

Negative externalities

This term refers to the cost that suffers the third party resulting from economic deals. In any economic deals, the first party and the second party are customers and producers and the third party may be any individual or any company who are affected by the externalities.

In this case, producers, as well as consumers, fail to determine the effects on the third party for the actions taken by them. For example, pollution is created by the industries and it affects the individual or the society.

Information failure

The markets may not serve all possible information during market deals. So, another party may not have an interest in the transaction. This will lead to a market failure.

Inequality

Sometimes, the markets also fail to manage the huge gap among earners. This is known as “Income-gap”. In market deals, both producers and consumers are benefited with profits and incomes respectively. But the main problem is that benefits are concentrated among very few people which leads to market failure.

Instability in markets

The unstable market situations also lead to market failure. Sometimes it can be seen, stable market equilibrium cannot be established in volatile market structure (Share market, foreign exchange markets etc.).

Monopoly Power

Monopoly power is another reason of market failure. Monopolists have full control over price. They set the price according to the objective of profit maximization. This high prices may create market failure (Sunderasan, 2012).

To determine the gold price, the researcher should determine the market failure.

Determination of gold price

By considering the trading, mining, recycling and selling the metals, it is highly important to understand the pricing of the metals. But this is not so easier to value the metals. In this part, according to the question, the researcher will determine the “Gold”. To determine the gold price, some questions should be answered, those are: what is called “fixing”, who sets the price of gold, what are future price and sports price, etc.

What are Fixings?

The fixing is done in a daily basis and it is an agreement among individuals on the similar sides in any market to sell or buy gold at a fixed price or managing the market states that is how the price is determined by the intersection of supply and demand. Throughout the process when orders are adjusted, there is ups and downs in the price level of gold. This process will continue until the orders are fulfilled and the price level is “fixed”. In March 2015, the London Gold Fix had discontinued and then replaced by LBMA price of gold. ICE Business Administration is known as IBA and had selected as administrator of LBMA price of gold (Shafiee and Topal, 2010).

An electronic auction method is organized by IBA to evaluate the LBMA gold price. It is administered and traded in an independent manner. Sometimes the auction is physically and electronically settled and it is conducted in dollars with anonymous and aggregated offers as well as is being published in real time. The LBMA price of gold is set two times in a business day in US dollars.

Figure: 2

Source: (MALI, 2014)

Factors that help in determining the gold price

Gold is used as a consumer good. By examining previous data, it can be suggested that UK has more interests in gold among all metals and it has indicated that the demand of gold in the UK has increased over the years. When an economic progress of the country is in boom then it increases the disposable income of people and demand for gold among people is rising day by day. Being a luxury material, the Gold’s income elasticity of demand is greater than 1 and it describes that a rise in income increases demands gold among people. A higher income will lead to higher demand of gold which increases the demand for gold at a higher rate (Parsons, 2010).

Investment of gold is also considered in this section. For profitable investment purposes, Gold can be used as the very important metal. The retention rate of gold also remains high during inflation. So, suppliers, producers or individual use this metal in their investment purposes. Individuals store gold for bad times. From 2006, the gold price moved up as investment demand was keep rising.

Another factor can be the value of the dollar which can determine the price of gold. In international trade, US dollar is used as supreme currency. There is a negative relationship between gold value and dollar value. In September 2014, the dollar index of US had increased by 2 units, and thus, buying of gold was considered as ‘strong dollar’ because many options of purchasing were there (MALI, 2014).

Many countries control the exchange rate in terms of dollars for its huge worldwide demand. Generally, individuals are confident enough and have higher tendency to buy USD assets. But the negative side of USD assets is that those are over exposed than gold. So, households preferred gold for investment. People were more confident about gold because paper currencies are more volatile in nature.

Figure: 3

Another determinant is interest rate which affect the gold price. The positive side of gold is that this metal does not have to bear any interest rate, but it affects the global interest sometimes during fluctuations. The gold price will fall when the interest increases because investors will choose another option of investment by selling gold to gather reserves. When the rate of interest starts falling, there is a tendency that price of gold will increase and this will lead to increase the holding of gold than cash because gold holding will lead very low cost (Baur, 2014).

The gold price may be affected for inflation too. By holding investment, this metal works to prevent the rate inflation. The paper currencies are volatile in nature and the value is decreasing over the years but the gold value is increasing day by day. In the long run, investment of Gold is considered as a stable investment option because Gold is associated with low risk compared to paper currencies. Even after 50 years, the paper currencies can retain its value but in reality, the situation is not the same. So, individual and households try to invest gold rather than the paper currency which affect the price of gold. In this context, it can be said that investors are motivated to invest more in gold during hyperinflation and less in paper currencies as gold serves hedge against inflation (Yaacob and Ahmad, 2014).

It is known that Gold is often used as the substitute of the stock market. Although the purchasing of shares has many positive sides as shares give a higher return and help to increase the growth. But in an economic recession, the value of shares has decreased. Hence, risk-averse investors will prefer to buy gold instead of shares because invest in gold will give a positive return and this is safe for them. This speculative nature is also a helpful measure to determine the gold price.

Variations in Gold supply affects the price of gold. According to the law of supply, the gold price can be determined that is a sharp rise in production of gold, the price is of gold will fall and vice versa. In this context, it can be said the supply of gold is stable in the economy.

The countries who have effective supply generally have lower prices and vice versa. The variations in price will occur due to variations in gold demand and supply. Thus, it can be concluded that the law of supply and demand used as a major factor in determining the prices of gold worldwide.

Negative Externalities due to the uses of personal cars

 Two kinds of externalities can be seen: negative externality and positive externality. This term refers to the cost that suffers the third party resulting from economic deals. In any economic deals, the first party and the second party are customers and producers and the third party may be any individual or any company who are affected by the externalities. It considers that when manufacturing firms are using some old technologies, then the third party may be negatively hampered. Rationally, these costs are not included in the economic cost. Thus, one should identify the costs properly (Acharya and Bisin, 2011).

Figure: 4

The effects of negative externality are not only on the owner, but it also affects those who are generally not associated with the externality of goods producing. The results of these externalities are situations resulting in market failure. Negative Externalities are triggers of third party effects.  Negative Externalities generally takes place out of market i.e. they affect people not involved directly with the production or consumption of goods or services. Spill-over costs are the other name by which they are known.

When demand for cars increases, there is also an increasing supply of cars by different firms in the market. High demand of cars will produce large scale pollution which negatively affected the society as well as those people like street shopkeepers, individuals who are going to work etc. Air pollution that is made daily by the cars’ smokes which adversely affect the health of people (Baofu, 2012).

There is a larger probability of a rise in urban flooding which is made from negative externality. Urban flooding in every year may arise due to the high desire for roads by personal cars. This reduces the soaking capacity of the areas where the cars are used most and thus, in rainy season frequent flooding in urban areas can be seen.

Congestion is another negative externality arising from the personal use of the car.Congestion is not limited to road network but negative externality arises by congestion due to personal cars is also evident in busy transport networks as well as crowded areas.There is the classical excess in demand situation compared to supply for the personal cars by households where each household wants its own personal car. When there is an increase in income, there is a large demand for personal cars which is a luxury good, since people want to buy more cars as income increases. As space on the busiest platforms and on the crowded trains is limited and small the demand for cars also increases (Nagler, 2013).

The congestion which is made by personal cars can increase the problems for commuters and this can cause increasing problems like people cannot reach their destination on proper time due to congestion on roads. Traffic congestion is another negative externality that is faced by other individuals on the road (Centemeri, 2009).

In a free market structure, individuals are taken into account their own benefits and the consumption level will take place where MPB=MPC. Consumers’ net benefit is maximized under this condition.

However, this is not the socially optimal level of road space should be attained at MSB=MSC. The main reason behind it that there are negative externalities which are linked with the higher utilization of roads. The overuse of limited space in a free market creates a complete deadweight loss for society.

Cars create noise as well which is a direct effect. Noise pollution is another types of a negative externality that can arise from the high use of cars. It can be seen that a large number of cars and they honk in traffic in a daily basis and this traffic is disturbing for the individuals that the people work on the both sides of the road.

In this context, it can be said that government can reduce the negative externalities in many ways like it can impose a tax on noise pollution or air pollution, can charge costs from car owners. This remedies can be discussed below.

To reduce the negative externalities, the government can charge costs of creating congestion. This can be an effective measure because when individual cars made more traffic, they have to pay a large amount to the government. This is one of the best policy from demand side to reduce congestion on limited size roads. This policy was implemented by Singapore for the first time and they also took some effective measures on road pricing (Chen, 2010).

Advanced methods of electronic toll collection can be helpful to reduce the uses of personal cars. These useful measures have also been implemented in Rome and London and it can be seen that there was a noticeable improvement in congestion among these countries.

Another way of pricing on congestion can be the rationing of road space. Road size rationing an effective method that stringent rules for car drivers and it is the better option than congestion pricing (NAGLER, 2011).

Conclusion

In conclusion, the researcher can that demand and supply analysis is seen in determining the price of gold. There are various factors like investment in gold, stock and share prices, consumption of gold, interest rate, inflation etc. which play a crucial role to determine the gold price. Gold price is determined in terms of USD as in exchange rate market, countries are comfortable to take it. The researcher also comes to know about the term “Externality”. Here, market failure analysis can be used to discuss the negative externality (Centemeri, 2009). The negative externality can be seen in the higher use of personal cars as it creates smokes which lead to air pollution. It also leads to noise pollution because cars are honking in the traffic.  But there are some solutions to overcome the negative externalities by imposing a tax, road size rationing etc.

References

Colander, D. (2006). Microeconomics. Boston, Mass.: McGraw-Hill.

Frank, R. (2010). Microeconomics and behavior. New York: McGraw-Hill Irwin.

Slavin, S. (2008). Microeconomics. Boston, Mass.: McGraw-Hill.

Zhang, W. (2015). Reflections on economics: market failure or market theory failure?. China Economic Journal, 8(2), pp.109-121.

Acharya, V. and Bisin, A. (2011). Counterparty risk externality. Cambridge, Mass.: National Bureau of Economic Research.

Baofu, P. (2012). Future of post-human semantics. Newcastle upon Tyne: Cambridge Scholars Pub.

Baur, D. (2014). Gold mining companies and the price of gold. Review of Financial Economics, 23(4), pp.174-181.

Centemeri, L. (2009). Environmental Damage as Negative Externality: Uncertainty, Moral Complexity and the Limits of the Market. e-cadernos CES, (05).

Chen, S. (2010). The Game Analysis of Negative Externality of Environmental Logistics and Government Regulation. AMR, 113-116, pp.263-266.

Krugman, P. (2014). Microeconomics. [Place of publication not identified]: Worth Pub.

MALI, P. (2014). FLUCTUATION OF GOLD PRICE IN INDIA VERSUS GLOBAL CONSUMER PRICE INDEX. Fractals, 22(01n02), p.1450004.

Nagler, M. (2013). The Strategic Significance of Negative Externalities. Managerial and Decision Economics, 35(4), pp.247-257.

NAGLER, M. (2011). NEGATIVE EXTERNALITIES, COMPETITION AND CONSUMER CHOICE*. The Journal of Industrial Economics, 59(3), pp.396-421.

Shafiee, S., and Topal, E. (2010). An overview of the global gold market and gold price forecasting. Resources Policy, 35(3), pp.178-189.

Sunderasan, S. (2012). Externality. New York: Nova Publishers.

Yaacob, S. and Ahmad, S. (2014). Return to Gold-Based Monetary System: Analysis Based on Gold Price and Inflation. Asian Social Science, 10(7).

Parsons, J. E., (2010). Black gold and fool's gold: speculation in the oil futures market. Economia, 10(2), pp. 81-116.