Price Changes Explained

How might the change in the price of a good be explained?

It is easy to see that a shift in demand or supply causes a change in the price of a good. Prices will increase if demand increases (moves to the right) or supply decreases (moves to the left). Prices will decrease if demand decreases (moves to the left) or supply increases (moves to the right). Demand for oil is highly price inelastic, as is supply. Any change in supply of oil will therefore have a very large effect on the price of oil.

Supply shocks such as the war in Iraq, or the breaking of a pipeline, will cause a dramatic increase in price as supply decreases. Recently, demand for oil from Newly Industrialised Countries such as China has increased, causing the demand curve to shift right, and oil prices to rise. Changes in oil prices have a large impact on the global economy, because oil is used as a raw material in the production of many products and the transport industry. So, if the price of raw materials increases then supply of most goods falls which pushes up prices of most goods. Demand for agricultural goods is also price inelastic, as they are necessities for the majority of people. Supply is also fairly price inelastic, as supply cannot easily be altered once crops are sown etc. Farmers always know the maximum that they can sell, as this equals the amount they have planted. However, in periods of bad weather, supply can be radically reduced, forcing prices up. Demand for agricultural products has increased recently with the rise in importance of biofuels, where products such as sugar cane are being used to produce ethanol rather than food. Again, this pushes up the price.

The price of stocks and shares on the stock market is determined through market forces. Confidence is a key determinant of share prices. Demand for shares tends to increase if people are feeling confident about the state of the economy and the future. Demand falls when events occur that shake people’s confidence, eg terrorist attacks, revelations of scandals at banks etc. Speculation is also an important factor. If people believe that share prices will rise, they will want to buy them at a lower price now and sell them at a higher price in the future. So, if people expect share prices to rise then demand will increase — which causes the price to rise, resulting in a self-fulfilling prophecy!

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