Demand and Supply of Gold and Factors Sides of The Market

Question: Discuss about the Demand And Supply Of Gold And Factors That Affect The Demand And Supply Sides Of The Market. Answer: Introduction Price of a commodity is the main determinant of the market demand for that commodity. Demand depends inversely on price, that is, as the price of a good rises, the demand for it falls and vice-versa. However, there are certain commodities for which the demand and price are directly related, that is, the demand increases with increase in price and vice-versa Giffen goods. Prices of other related goods like substitute goods and complementary goods also affect the demand. Income of the individual is another major determinant of the demand for a product. The demand for a normal commodity increases with increase in the income of the individual. But for an inferior commodity, the demand falls with increases in income. Other determinants of demand are tastes and preferences of consumers and expectations about the future. The market demand curve is downward-sloping which reflects the inverse relationship between the demand for a commodity and its price. Price changes lead to shifts along th e demand curve whereas changes in any of the other parameters lead to shifts of the demand curve. (Varian, 2005) The supply of a product depends on a variety of factors. Besides price which shares a direct relationship with supply, the prices of inputs that determine the cost of production also affect the supply. Other factors are technology, prices of other goods, price expectations and the number of producers in the market. In a demand-determined market structure, demand for a particular product determines the supply. The market supply curve is a graphical representation of the relationship between price and quantity supplied and since these are directly related, the curve is upward-rising. (Pindyck and Rubinfeld, 2005) The market equilibrium is established when the demand for a particular commodity is exactly equal to the supply of the same and the corresponding price is called the equilibrium price. (Mankiw, 2006) The Market For Gold The demand for gold depends on a lot of factors ranging from individual perspectives to macroeconomic parameters. The primary determinant of the market demand for gold is the price. When the price of gold falls, the demand for gold will go up. Similarly, when the price of gold rises, the demand will fall. The relative rise and fall in the demand depends on the price elasticity of demand for gold which is generally high given that gold is a luxury commodity. This implies that when the price of gold reduces by a small amount, the demand will go up considerably. The relationship is illustrated in the following diagram: FIGURE 1 In Figure 1, the DD curve represents the market demand curve for gold. As the price of gold increases from P* to P, the amount of gold demanded in the market falls from Q* to Q along the demand curve. However, gold is often used as an investment commodity and also as a future security. In such cases, sometimes the price of gold and the quantity demanded can reflect a positive relationship. This is because when the price of gold rises, people anticipate that the price will rise even further. Hence, they hoard gold as much as possible in the present period to avoid paying higher costs in the future. Moreover, if used as an investment commodity, the gold can be sold off at a higher price later. Similarly, when the price of gold falls, people reduce their purchase in anticipation of further fall in the price to avoid incurring losses. (Folger. 2016) The demand for gold is dependent on the availability of substitutes such as silver, platinum, etc. When the price of platinum increases it pushes up the demand for gold. This is because platinum is a substitute for gold when used in the form of jewellery and also otherwise when the price of platinum increases people will want to substitute their purchase of platinum jewellery with gold jewellery. This is shown in the following diagram: FIGURE 2 In Figure 2, when the price of platinum increases, the demand for gold increases and this is represented by an outward shift of the demand curve from DD to DD. (Dorgan, 2015) Though there is no such complementary good for gold, the making charge for gold jewellery may be considered as a complementary service which might affect the demand for gold however insignificantly. When making charges increase by a considerable amount the demand for gold may fall because people might not want to pay such high charges. This is shown in the following diagram: FIGURE 3 As shown in Figure 3, as making charges increase, the demand for gold falls which is represented by the shift of the demand curve from DD to DD. However, there is no complement of solid gold. (Pettinger, 2011) The demand for gold again depends on the income of an individual. As income increases, individuals will purchase more of gold jewellery for ornamental purposes as well as for investment and hence the market demand for gold will increase considerably as an aggregate effect. This is represented by an outward shift of the market demand curve for gold. Again, as income falls the market demand for gold will also fall and the market demand curve will shift inward. The demand for gold depends hugely on the income of individuals at every level mainly because it is considered the safest investment option given that the value never falls except under certain unlikely macroeconomic shocks. The supply of gold does not depend on individual consumers and producers in the gold market. The supply of gold is determined by macroeconomic parameters according to the various requirements of an economy. It is varied according to fiscal and monetary adjustments and changes with policy changes. The supply of gold is determined by the government and the central bank. The import or export of gold at the national level depends on international parameters and is determined according to market conditions. The supply of gold is relatively price inelastic it does not vary much with prices. However, when the supply of gold increases due to non-price factors, the supply curve shifts outside. (Wagner, 2010) The equilibrium is established where the demand for gold equals the supply of the same. Conclusion Expectations about the future are a very significant determinant of the demand for gold. If consumers expect prices to go up further in the future, they might end up buying more of gold at present or they might stop purchasing gold completely. This is a subjective issue and depends on individual perspectives. Since gold is often used as an investment good, the behaviour of demand and supply in the gold market can sometimes reflect considerable deviations from conventional economic theory. The gold market can be segregated into different sections according to the use of the gold, as jewellery for consumers, as an investment good for investors or gold security reserved by the central bank. (Haugon, 1984) References Mankiw, G 2006, Principles of Microeconomics, South Western Educational Publishing, USA. Pindyck, R Rubinfeld, D 2005, Microeconomics, Pearson Education, USA. Varian, R 2005, Intermediate Microeconomics: A Modern Approach, W.W. Norton Company, USA. Folger, J 2016, What Drives the Price of Gold, viewed 20 August 2016, https://www.investopedia.com/financial-edge/0311/what-drives-the-price-of-gold.aspx. Pettinger, T 2011, Factors affecting the price of gold, viewed 20 August 2016, https://www.economicshelp.org/blog/3099/economics/factors-affecting-the-price-of-gold/. Dorgan, G 2015, The Six Major Fundamental Factors that determine Gold and Silver Prices, viewed 20 August 2016, https://snbchf.com/swissgold/gold/gold-silver-prices/. Wagner, H 2010, The Truth About Worldwide Gold Supply and Demand, viewed 20 August 2016, https://www.investinganswers.com/investment-ideas/commodities-precious-metals/truth-about-worldwide-gold-supply-demand-1668. Haugom, H 1984, Supply and Demand for Gold, viewed 20 August 2016, file:///C:/Users/user/Downloads/b14460762.pdf.