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The Law of Demand Expository Essay


Introduction

There are two types of social equilibrium that is dynamic and static equilibriums, abnormal and normal equilibriums the first is active, the second is passive.the first is unstable and the second is stable Equilibrium is the spot where consumers and producers exchange services and goods at a quantity and cost that signify a balance among the consumer’s desire to forfeit less cash and the producer’s desire to get more cash.

It is the point at which everybody prepared to pay the price of the market gets their demand satisfied, while anybody prepared to manufacture at the price of the market gets a buyer for the service or good. [Roger 2001]

A market can be defined as an area where services and goods are exchanged. One can imagine a bustling lane complete of sellers and buyers or a stock trade full of citizens selling and buying stocks. These are touchable manifestations of a market.

Economics can be defined as a communal discipline which checks the distribution, consumption and production of services and goods. Microeconomics can be defined as a tool that examines the performance of fundamental elements in the financial system including personalized agents or markets, that is, firms and consumers, sellers and buyers. [William and Alain 2006]

Macroeconomics can be defined as a tool that addresses problems affecting the whole economy. That is, inflation, economic growth, unemployment and fiscal and monetary policy. Demand is a connection amidst two variables quantity and price demanded, with all other additional factors that may influence demand held steady. [Esther1998]

How the Sonnenschein-Mantel-Debreu Theorem in General Equilibrium affect the law of demand and the law of demand

The demand law In money matters can be defined as a microeconomic commandment which states; ‘As the price of a service or good increases, consumer demand for the service or good will decrease and as the price of a service or good decreases, consumer demand for service or good will increase. When all the other factors remain unchanged. [Irvin 2011]

Below is a graph illustrating the law of demand?

The Law of Demand graph.

Source: (Rick Kash 2002)

From the graph it can be seen clearly that when the price increase from P3 to P2 the demand falls from Q2 to Q3 consequently when the price decreases from P1 to P2, the demand increases from Q2 TO Q1. According to Investopedia, law of demand shows the consequences that price variations have on consumer actions.

For example, a consumer will purchase more burgers if the price of the burgers falls. Relatively a consumer will purchase less burgers if the burgers price goes up or increases.

That is the greater the amount sold, the smaller the price should be in order for it to get purchasers or buyers. For instance, if the price of milk goes up automatically the demand of milk goes down [Rick Kash 2002] .The Sonnenschein–Mantel–Debreu Theorem is named after four economists who are Gerard Debreu, Rolf Ricardo Mantel, and Hugo Freund Sonnenschein.

As a result of general economics. It states; ‘The surplus demand function for an economy is not limited by the usual reasonableness restrictions on individual demands in the economy’.For example, if in a country’s economy the price of a commodity like petroleum goes high the demand for this particular commodity is not affected by restrictions of the individual demand this is because the customers will still use the commodity. [Lain and Henry 1998]

On the other side if the price of petroleum goes down the demand for the same commodity is not affected by restrictions of the individual demand for the same commodity because the amount regularly consumed remains. Thus microeconomics reasonableness assumptions do not have the same macroeconomics results. The implications of the theorem are mostly manifested in the interdependent markets. The economic equilibrium cannot be exceptional or stable.

According to the theorem, the Walrasian aggregate excess demand function inherits only certain properties of individual excess functions. Policy-makers did not favor forms of monetarism and supply-side economics, the New Classical economics is the dominant neoclassical theory.

The theory says that the existing expectations in the financial system are correspondent to what the prospect state of the financial system will be. This contradicts the thought that administration policy influences the decisions of public in the financial system [David 2006]

According to Investopedia the thought is that rational expectations of the company in a financial system will incompletely have an effect on what happens to the financial system in the prospect. Because he believes that the price will rise in the future.

According to Sonnenschein Mantel Debreu Theorem (Sonnenschein 1973, Mantel 1974, Debreu 1974) they show that under assumptions under which general equilibrium theory has been developed, there are no limitations on the behavior of data aggregates either within a cross section or intertemporally. General equilibrium theory is an overarching organizing framework for economics.

Without any limitations on the distribution of individual qualities, the Sonnenschein-Mantel-Debreu Theorem implies that general equilibrium theory imposes only extremely limited restrictions on combined data. Interactions methods bring the possibility that common types of combined behavior come out from widely changeable collections of individual’s qualities.

Many comprehensive phenomena, externalities or other types of market short comings naturally exist which do not lie under the purview of general equilibrium theory [Bryant 2010].

General Equilibrium theory plays several roles in monetarism theory, According to the monetarist the money supply function is where the money stock comes from given the money stock, the demand for money, would settle on the speed of distribution. [James 1969].

The monetarists take the money stock to be an exogenous variable resolute independently in the money supply function; the rise in the monetary content influence the increase in money stock, that is, bank treasury and money in vigorous movement or in the money multiplier while in the theory by Keysian money is taken to be an induced unpredictable or a lively or sovereign variable. [Roger 1999]

Therefore, according to this the returns increases, there would be a rise in demand for money thus the money seems to be formed from the variation of income. The monetary influence has full power on money supply through the stored requirement, interest pace and credit policy.

A chain reaction would result from a change in the money of substitutions causing rates, interests, prices, employment, and production to change; income change results from monetary change. [Keizo Nagatani 1981].

One implied suggestion of monetarism is “lender of last resort” which is a Federal Reserve function, that is, a savior of institutions and as a stabilizer of monetary markets through the refinancing of money market entities and banks as a provider of reserves.

Monetarism drawn in, first a theory cycle, and then as a result of these a suggestion for the behavior of financial policy. Specifically, price increases was alleged to be reasonable according to the rate of increase of the cycle, and the money supply, or more accurately it is revolving points according to the changes [Laidler 2004, pg 395].

In this increase rate as an conceptual mode the demand for money was a difficulty reasonably agreeable realistic to price theory , as an practical subject it seemed to be a stable function finely described by a small number of parameters [Friedman 1959].

Laidler different from Friedman who described money as a long lasting consumer he looked at it as a ‘buffer stock’ also different from the approach adopted by Friedman and Keynesian, the Walrasian equilibrium, he also embraced disequilibrium.

Manchester monetarism, Laidler, had in reality never assumed the Keynesian is-lm model that he had used to express it nor market clearing. The ordinary rate of joblessness is the point that would be positioned out by the systems of general equilibrium equations by Walrasian. According to Laidler “What markets do in our theories, money does it in the world [Sylee 1990].

General Equilibrium Theory views the properties and process of liberated market economies. The ground is a response to a sequence of questions at first written by an economist by the name Leon Walras regarding the process of markets. Frank Hahn stated it in the subsequent way: ‘Does consistency come from the search of personal importance through a structure of interrelated deregulated markets, without chaos, and how is it attained? [Friedman 1968, Pg 8]

Role played by General Equilibrium Theory in Monetarism and Rational Expectations Theories and the light shed on Rational Expectations by the said Theorem

The role played by general equilibrium theory plays several roles in the rational expectations theory, a predominantly low value for shares in a corporation may indicate to an ignorant agent that better knowledgeable agents are not selling the stock or buying the stock.

The view of rational expectation equilibrium is commonly acknowledged extension of the general equilibrium to economies with unevenly knowledgeable agents.

In rational expectations, representation agents maximize expected utility with respect to an updated probability distribution that combines their initial information with the additional information conveyed by the prices, but not with respect to an exogenously given probability distribution [Laidler and David 1984].

General equilibrium theory’s outlook is that wages and prices are either very sluggish in responding to change or rigid in overall demand and hence fail to complete their customary market payment functions.

In the Keynesian analysis, in production and employment increases or decreases in overall demand in the short run such as occur in a business cycle expansion or contraction are reflected mainly in changes in the real economy, while proponents of the rational expectations equilibrium theory retain that, balance by adjustments in prices and wages is given by supply and demand even at the level of the overall economy are constantly. [Peter 2009]

Employees and businessmen even if rational regarding the markets where they themselves operate are uninformed about all additional markets and accordingly prone to make mistakes on how much labor to supply or produce in response to a variation in demand.making these mistakes and then making a correction give growth to cyclical engagements. [Roger 1999]

Reduced forms of models are required by the general equilibrium theory when the analysis of equilibria are being done ,without or with rational expectation requirement for the absolute requirement of markets, agents , e.t.c, that is, as it is required by general equilibrium theory.[Bryant 2010]

According to the general equilibrium theory when markets are complete, and when agents are risk averse then they are tough on changes in fragile modeling options concerning the prior choice of the uncertainty to be included in to model.

The objection of insurance then depends on the authoritative outcome of completeness insisted by the in effective theorem. Full insurance restores the efficiency of the market equilibria dynamic, possibly generated by arbitrary beliefs, in the presence of extrinsic noise. [Peter 1986]

General equilibrium model insists on the hypothesis that agents expect future prices rationally. In general, equilibrium form, rational expectation hypothesis is common knowledge among the agents of the economy, where the competitive rational expectations mechanism functions smoothly.

Agents with full expectations, make use of all the information. In general equilibrium theory assumptions are made that the economic representation and also agents that rationally there was common information to all agents and were to fully exploit this knowledge. This assumption was to explain the model [Emilio 2003].

General equilibrium theory under certainty is able to show that agent’s choices are compatible in a perfectly competitive market when they pursue their self-interest different from the certainty environment, without this assumption.

In a dangerous surrounding, the rational expectations hypothesis it is important to understand the agent’s actions and also the rational expectations equilibrium.

The rational expectations theory is required to show some parameters anticipated on the up coming prices taken by the agent according to his behavior. [Ben 1998]

Without this assumption or related one it would be difficult determine the relevance in a perfectly competitive market, the agent’s decisions in accordance to the rational expectations theory.

The economy do not waste information and expectation are determined by the structure of the whole system. [Robert and Thomas 1988.]

Expectations of financial variables would be subject to mistakes, without being for recognized for sometime as a significant portion of most justifications for changes in the point of business actions expectations of the company, or generally, the individual probability circulation of result have a tendency of been distributed, for the similar information determine the forecast of the hypothesis or the objective possibility of circulation of results. [Michael 1992]

According to the theory, information is limited, and is not wasted by the economic system. The means by which expectations are created depends particularly on the organization of the appropriate structure describing the financial system a community forecast does not have any significant consequence on the function of the economic arrangement unless it is in relevant to the inside information.[Rodney and Michael 1982].

General equilibrium theory has shed light on the rational expectation theory by the several ways, for instance, People consider rational expectations, to keep the economy at equilibrium.

More convectional outcome relating to the potential responsibility and extent of state economic involvement in large-scale policy were re-establish after the rational expectations were given in combination with the hypothesis instead of those of faultlessly working markets that had at all times been the easy perception of the Keynesian perspective. [Davidson 2002]

It helps in shedding light on whether or not the financial system is able to convey to any type of harmonized equilibrium at all. The financial system produces a some insight on how large-scale policy operates and specifically regarding the function it plays in destabilizing or stabilizing the financial system, bringing it nearer to or taking it further away from a rational expectation equilibrium fully employed.[Hyman 2008]

Rational expectation is sensible only if the populace is able to learn macroeconomics associations from the experience of staying in the financial system and the traditional consistency theorem in statistical assumption do not signify that these connections are actuality learnable for the reason that they are self referential in the nature of macroeconomic study.

That is, statistical hypothesis assures that, under relatively general circumstances people are supposed to be able to consistently estimate connections from observing an extended enough sequence of data brought about by those relationships [Bryant 2010].

In macroeconomics the connections come about, when people change their expectation of price increase due to recent experience and hence affecting the actual rate of inflation.

[Frydman and Phelps 1983].It also helps understand whether or not the effort to find out about a system whose properties meet the rational expectations equilibrium is possible.

Light is also shed on the time varying temperament of the rational equilibrium theory within general equilibrium stochastic form [Sargent 1993].

In conclusion, all the theories, that is, the general equilibrium theory, rational expectation theory, and the monetarist theory are all connected or related.

Rational expectation theory puts together a variation of the expectation hypothesis with a monetary rule view and the general equilibrium hypothesis view. [Esther 1998]

References List

Bryant, W. D., 2010. General equilibrium theory and evidence. Hackensack N. J. world scientist Publishers. Singapore, Singapore.

David, C. C., 2006. Post Walrasian macroeconomics, beyond the dynamic stochastic general equilibrium model. Cambridge University, Cambridge.

Davidson, P., 2002. Financial Markets, Money, and the Real World. Edward Elgar, Cheltenham.

Emilio, B., 2003. Financial markets theory, Equilibrium, efficiency and information. Springer, London.

Esther, M. S., 1998. The evolving rationality of rational expectations: an assessment of Thomas Sergeant’s achievements. Cambridge university press, Cambridge.

Esther, M. S., 1998.Changing perceptions of economic policy: essays in honor of the seventieth birthday of Alec Cairncross. Malden publishers. London. Pg 162

Hyman, P. M., 2008.Stabilizing an unstable economy. McGraw-Hill Publishers, New York.

Irvin, B. T., 2011.Macroeconomics for today. Southwestern publishers. Mason, Ohion.

James, T., 1969. ‘A general equilibrium approach to monetary theory’. Journal of Money, Credit and Banking, Vol.1, pg 15-29.

Keizo, N., 1981, Macroeconomic dynamics. Cambridge University press. Cambridge, UK.

Laidler and David, E. W., 1984. ‘Misconceptions about the real bills doctrine a comment on sergeant and Wallace ‘, Journal of Political Economy. Pg. 149-155.

Lain Begg and S. G. B. Henry, 1998. Applied economics and Public Policy. University of Cambridge, Cambridge. Pg 63

Marc, R.T., 1984. An institutionalist guide to economics and public policy. Armonk, N.Y Publishers, Sharpe.

Michael, T. Belongia, 1992.The business cycle: theory and evidence: proceedings of the Sixteenth Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis. Kluwer Acad. Publ., Boston. Pg 112

Peter Flaschel, 2009. The Macro dynamics of capitalism elements for a synthesis of Marx, Keynes and Schumpeter. Heidelberg Springer, Berlin. Pg 14

Peter Wallace Preston, 1986. Making sense of development: An introduction to classical and contemporary theories of development and their application to Southeast Asia. Routledge and Kegan publishers, New York, London. Pg 226

Robert, E. L. and Thomas, J.S., 1988. Rational expectation and econometric practice. University of Minnesota press, Minneapolis.

Roger, G., 2001. Sunspot multiplicity and economic fluctuations. MIT Press, Cambridge, UK.

Roger, E. A., 1999. The macroeconomics of self-fulfilling prophecies. MIT Press. Cambridge, UK.

Sylee, 1990. The monetary and banking development of Singapore and Malaysia. Singapore University press, Singapore.

William O. W. and Alain T., 2006. The Blackwell dictionary of modern social thought. Malden Publishers. Oxford, London.

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