Eco360_Supply_Demand_Simulation

Supply and Demand Simulation Objective The Supply and demand simulation is designed to apply real world business concepts to gain a better understanding of how a company analyzes supply and demand to optimize decision making. The simulation sample industry of rental property management can be used as a learning tool to identify the causes that change aggregate supply (AS) and aggregate demand (AD) and the shifts in supply and demand that impact surplus, shortages, and revenue. The primary goals are to maximize revenue and reduce vacancies through cause analysis followed by adjusting rental rates accordingly to compensate for shifts in the market (TATA, n.d.). Changes in AS/AD The aggregate supply (AS) is the economy’s gross production of goods and services to meet the total aggregate demand (AD), or the demand for final goods and services during a specific period. Economic changes frequently occur and determine whether to increase or decrease rental rates during a short-run cycle. For instance, a population increase will increase demand therefore presenting an opportunity to increase rental rates. Consequently, changes in preferences toward purchasing homes versus renting will decrease the demand. As identified in the simulation, the equilibrium will also change as the AD curve shifts. Rental price adjustments are then necessary to eliminate any potential surplus or shortage unless feasible to maximize profits with a marginal vacancy level. Shifts in Supply and Demand Shifts in supply and demand must be carefully monitored to avoid a surplus or shortage situation. A surplus of rentals will drive down rates, whereas, a shortage of rentals may induce an increase in price. The optimal decision is to ensure capacity demands and price per rental unit achieve equilibrium. Applying decision making toward addressing the shifts required forecasting statistics and surveys to predict the direction of change. For example, if the demand increases and supply remains constant the right shift in demand will cause an increase in rental rates while simultaneously decreasing supply. In contrast, as the demand decreases and supply does not change, the result is a left shift on the demand curve. Prices will drop along with surplus until equilibrium between the new demand curve and the original supply curve is achieved. Key Points Understanding the concepts of supply and demand becomes less complicated once change factors have been identified and adjustments in quantity and price are made to compensate for any market shifts that would create surplus and shortage. The simulation demonstrated four key points that can predict the affect of shifts in supply and demand. Law of Demand The law of demand states that ‘the quantity of a good demanded is inversely related to the good’s price” (Collander, 2006). A typical example demonstrated in the simulation that applies the demand is competition from neighboring towns may produce a lower quantity of demanded apartments if rates remain uncompetitive. By lowering the rental rate the potential imbalance between quality demanded and quantity supplied is eliminated. In this case, the quantity demanded rises as price falls, other things remain constant. Law of Supply As prices increase for a particular good or service, the larger the quantity will be offered for sale. Reviewing the impact of increased population on supply and demand would assume and increase demand along with the likelihood of a price and supply increase. If people are willing to pay more for a particular good, the supply of that good will increase with expectation to maximize profits. Equilibrium The two components of equilibrium comprise of price and quantity. At prices below equilibrium the quantity demanded exceeds the quantity supplied creating a shortage. As prices increase the quantity demanded decreases. If the price rises higher than the amount people are willing to pay for a product there will be a surplus of supply. The principle of equilibrium is to attain a market price that equals the quantity demanded and quantity supplied. Price Ceiling A price ceiling is an imposed government mandate to control the amount a rental management company can charge for rent. A price ceiling is above the equilibrium price does not have any affect on supply and demand. However, when a price ceiling is below equilibrium will generally cause an excess demand and lead to a market shortage. AS/AD Illustration The apartment rental industry is affected by AS/AD changes much in the same manner as other industries. Using the auto industry for example, a reduction in consumer expectations or confidence would temporarily reduce demand and therefore, create a new equilibrium, or a lower price on vehicles to prevent a surplus. The graph below illustrates the affect of the change by the shifting AD curve. The shift downward and left indicates that a decrease in demand resulting in a decrease in output and a reduction in price creating a new equilibrium (intersects at blue AS and red AD). Thus, auto dealers would likely reduce prices to sell off surplus inventory and manufacturers would reduce production until demand increases. Summary The simulation covers many circumstances that connect consumer demand, specifically how pricing of goods and services are determined compared to the actual amount of output. The importance of gathering data and making accurate estimations can make a difference between making a profit and losing money. Completing the simulation was a simple process of making adjustments dictated by changes and shifts in the market. References Collander, D. C. (2006). Thinking like an economist (6th ed.). New York: McGraw-Hill. TATA (n.d.). Applying supply and demand concepts [Simulation exercise]. Retrieved February 13, 2008, from https://mycampus.phoenix.edu/secure/resource/vendors/tata/UBAMsims/economics1/supply_demand/economics1_supply_demand_frame.html