Sunday, August 29, 2010

Demand & Supply

One of the fundamental premises of classical economics is the rule of demand and supply. In a free market when demand is more and supply is less, prices go high and when demand is less and supply is more, the prices go down.  This works most of the time but not all the time. Here is when it doesn't works.

  • Free markets are hard to achieve. Typically we have less number of producers and high number of consumers in any market. This gives unfair advantage to producers to artificially keep the prices high simply because their number is small enough to organize. Real Estate, Sabzi Mandi, Auto Stand, etc are some of the places where producers will typically unite and charge high prices.  With GroupOn and other demand aggregator sites, what we now see in consumers uniting to create artificially lower demand to impact the prices. This would not be required in a free market.
  • The second factor is how many times the buying decision is taken. We don't change phone numbers often, which means even if the new plan from Airtel is very good, it will not create enough demand. If I have bought a house at some price, any changes is price later are irrelevant for me. The same is the case with home loan, because of the switching charges and no guaranty by the bank on the floating home loan rate. Only when the buying happens over and over again, it is possible for the demand/supply rule to be effective. If it doesn't happens often enough, the equilibrium is lost. Same is the case with representative democracy where we end up voting only once in five years.  Demand/Supply will not work if consumers just have to make this decision only once or twice. The markets will only be fair if consumer needs to choose over and over and not when they are stuck with their choice for lifetime or a big duration of time.
  • The third factor is the time of delivery of the product or service. If the product is only scheduled to be delivered, the decision of payment has already been made and the quality of service/product doesn't comes into picture, only its expectation. When an enterprise buys some software from other company, it is paying for the product as well as the maintenance charges which will happen only in the future. When we sit in an auto, we will know if his meter is bad or the driver is slow or reckless only when have made the buying decision. Or when buying a house, the house will be delivered only in the future which means actual cost of house will be known only in the future.  What this really means is that it is impossible for us to take an informed decision about the purchase or at least is fairly complicated decision to make, which gives the producer unfair advantage it terms of setting prices.
What I want to say is that their exist enough markets which appears to be free but are not, because they don't give consumers enough time/chances to revise their decisions and this gives unfair advantage to the producers, which means fair market theory fails and we need government intervention or group buying or really establish fair prices in these markets.

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