The Modern market is based on the following elements: price, supply and demand, competition. The decrease in the level of the latter, as a rule, most often negatively affects the quality of goods and services. Product prices are directly linked to production volumes. Supply and demand also independent from each other. For example, how in demand a product is, the more often it will appear on the shelves.
High demand creates higher prices. In other words, the incremental cost of production is increasing. However, reducing demand does not always lead to lower prices. The value of the goods actually drops rarely. The phenomenon in Economics known as the ‘ratchet effect".
Let's look at why this process was named that way. As is known, the ratchet wheel can only move in one direction. About the same prices in a market economy. They can grow, but you can reduce them quite difficult. They do not even necessarily reduce the demand.
A Number of objective economic phenomena reflects the ratchet effect. Schedule of price level and real production shows a declining curve. That is, the relationship between these two indicators is inversely proportional. The lower the price level, the more products will be produced, because the amount of the benefits depends on the level of demand for them.
There are three factors that can help to understand the ratchet effect deeper. The first relates to the real cash users. This so-called “wealth effect”. Purchasing power with increasing prices decreases. In the end, the consumers, buying expensive goods, poorer. This leads to the fact that the population starts to save on their costs. Conversely, the increase in expenditure can be due to a decrease in prices. The next factor – the interest rate effect. It grows together with the prices. Growth rates causes the reduction of certain consumer spending and certain types of investment. The third factor – the effect of imports. The higher prices for domestic goods, the better to buy their foreign counterparts. However, in order to get the economy moving, it is necessary that the export exceeded the import.
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What are the causes of such phenomena as the ratchet effect? And why is the price easily Grow, but with difficulty reduced? The main reason – the limited competition. In such circumstances, prices can dictate large firms, which are profitable to obtain all the large profits. They determine the cost of certain goods and try if not pick it up, then at least to maintain at current levels. But in this case, to obtain a profit while reducing demand? This question of a large firm resolve by reducing the supply and jobs in their facilities. We have to assume that if the competition was severely limited, as in our time, the prices would depend mostly only on the balance between supply and demand. The ratchet effect probably would be negligible. However, this situation is disadvantageous monopolies and large firms. These organizations find the tools to preserve their profits even in the face of falling demand for the goods they produce and sell. When there is no macroeconomic equilibrium, the ratchet effect is particularly bright.
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Alin Trodden - author of the article, editor
"Hi, I'm Alin Trodden. I write texts, read books, and look for impressions. And I'm not bad at telling you about it. I am always happy to participate in interesting projects."
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