Decision Making in Economic Analysis

An explanation of how decision-making is dealt with in economic analysis requires an examination of the main factors at play. These factors amongst others are looked at as a base for decision making. Supply and Demand are the most fundamental tools used in economic analysis. I will explain what demand is and how the demand curve is derived. I will also write about Supply and its relationship with Demand. I will examine equilibrium price (market clearing price) and how we can calculate or plot it. I will attempt to show how market surpluses and market shortages are caused and their effect on product prices. Factors of cost and the decisions regarding cost will be covered. I hope to covey how cost is correlated with price which in turn is dictated by market supply and demand configurations. Finally I will be discussing Marginal Analysis and its benefits for economic analysis. While there are many other factors involved in decision making these are the ones I have chosen to focus on for this essay.

Normally when the price of a good is decreased, the demand for that good will go up because its consumers can afford to buy more of it. This can be shown graphically.

Figure 1.1:

Figure 1.1 shows a graphical representation of the demand curve for Yorkie Bars. On the vertical axis Price (P) is represented. The Quantity (Q) is represented on the horizontal axis. At a price of Ђ2 only 4 bars were sold. When this price was brought down to Ђ1 the quantity demanded of it went up to 18. The demand curve is derived by plotting a line threw these two points.

Supply and its curve essentially have very similar characteristics to demand although supply slopes in the upwards direction. The supply curve tells us how much producers are willing to sell at each price they receive in the market. When demand and supply are represented on the same graph an economist can determine where the equilibrium price is and if the price being charged is leading to a market surplus or shortage.

Figure 1.2:

Figure 1.2 shows the demand curve with the supply curve intersecting it. Where the two lines intersect is known as the equilibrium. 5 is the most economic price to sell this product.

In figure 1.2 the graphical method of analysing price equilibrium can be seen. This can also be derived mathematically. When a product is sold at its equilibrium price there is no shortage or surplus in the market. When a price is above equilibrium a surplus will arise. If it is priced below there will be a shortage. However when a market is charging over or under the market clearing price then there will always be a pull on this price to rise or fall to the equilibrium price. To explain this, suppose the price were initially above the market clearing price. Then producers would be trying to produce and sell more then customers are willing to buy. This would in turn cause a surplus to grow. Producers would eventually have to reduce their price in order to clear. Hence the price would be pulled downward towards the market clearing price. The opposite would happen if the initial price were below the equilibrium price. In this case a shortage would develop as consumers wouldn't be able to purchase as much of the good as they would like at this price. In order to secure the item consumers may start to out bid each other for existing supplies. Producers will then react by increasing price and output. Here too the price will over time move towards equilibrium. This can be seen in the following illustration.

Figure 1.3

 Demand  Supply

Here the price Pe is the market clearing price. When a price of Pa is charged a surplus will arises between where Pa intersects the demand and supply curves. Likewise when price is Pb a shortage will occur between where Pb intersects the supply and demand curves.

The subject of cost