What are market dynamics?
Market dynamics are forces that will impact prices and the behaviors of producers and consumers. In a market, these forces create price signals that result from the fluctuation of supply and demand for a given product or service. Market dynamics can impact any industry or government policy.
There are dynamic market forces other than price, demand and supply. Human emotions also drive decisions, influence the market, and create price signals.
Key points to remember
- Market dynamics are the forces that affect prices and the behaviors of producers and consumers in an economy.
- These forces create price signals that result from a change in supply and demand.
- The basis of supply-side economics rests on the theory that the supply of goods and services is most important in determining economic growth.
- Demand-side economics argues that the creation of economic growth comes from the high demand for goods and services.
- Economic models cannot capture certain dynamics that affect markets and increase market volatility, such as human emotion.
Understand market dynamics
Market dynamics are the factors that alter the supply and demand curves. They form the basis of many economic models and theories. Since market dynamics impact supply and demand curves, policymakers aim to determine how best to use various financial tools to stimulate or cool an economy. Is it better to raise or lower taxes, raise wages or slow wage growth, do neither, or both? How will these adjustments affect supply and demand and the general direction of the economy?
There are two main economic approaches when it comes to altering the supply or demand in an economy with the ultimate goal of having a positive impact on the economy. One is based on the theory of supply and the other on demand.
Dynamics of the supply-side economy
The supply-side economy, also known as “reaganomicor “trickle down economy” is a policy made famous by the 40th US President, Ronald Reagan, based on the theory that deeper tax cuts for investors, corporations and entrepreneurs induce investors to provide more of goods to an economy. , which results in other additional benefits that trickle down to the rest of the economy.
The supply theory has three pillars which are tax policy, regulatory policy and Monetary Policy. However, the general concept is that the production, or supply of goods and services, is most important in determining economic growth. The theory of supply is opposed to Keynesian theorywhich considers that the demand for products and services may fall and, in this case, the government should intervene with fiscal and monetary stimuli.
Dynamics of the economy on the demand side
The opposite of supply-side economics is demand-side economics, which holds that the creation of economic growth stems from the strong demand for products and services. If there is a high demand for goods and services, consumer spending increases and businesses can expand and employ additional workers. Higher employment levels further stimulate aggregate demand and economic growth.
Demand-side economists believe that tax cuts in general can boost aggregate demand and bring an economy that is experiencing high unemployment back to a full-employment scenario. However, tax cuts specifically for corporations and the wealthy may not end up stimulating the economy. In this case, the additional funds may not increase the demand for goods or services. Instead, it could be argued that the additional revenue generated can be reinvested in share buybacks that increase the market value of the stock or in executive benefits, but do not end up materially stimulating the economy. .
Market dynamics are not constant but always fluctuating, so it is necessary to constantly reassess them before making investment or business decisions.
Demand-side economists argue that increased government spending will help the economy grow by creating new job opportunities. They use the Great Depression 1930s as evidence that increased government spending stimulates growth at a faster rate than tax cuts.
Securities Market Dynamics
Economic models and theories attempt to account for market dynamics in a way that captures as many relevant variables as possible. However, not all variables are easily quantifiable.
Models of markets for physical goods or services with relatively simple dynamics are, for the most part, efficient, and participants in these markets are expected to do rational decisions. However, in financial markets, the human element of emotion creates a chaotic and difficult to quantify effect that always results in an increase volatility.
In financial markets, some, but not all, financial services professionals know how markets work. These professionals make rational decisions that are within the the best interests of their clients based on all available information.
Knowledgeable professionals base their decisions on comprehensive analysis, extensive experience and proven techniques. They also strive to fully understand their clients’ needs, goals, time horizons and ability to withstand investment risk.
Unfortunately, some market participants are not professionals and have limited knowledge of the markets and the various events that can impact the market.
This segment of non-professionals includes small-to-mid-size traders looking to “get rich quick”, scam artists, driven by personal greed, and investors trying to manage their investments rather than seeking professional advice. Some in this category of experts are self-proclaimed professionals who are sometimes dishonest.
Greed and fear in the markets
Skilled and professional traders determine the entry and exit points of any investment or trade using quantitative models or techniques. They define the appropriate action plan and follow it to the letter. Thanks to the practice of strict money management, the execution of transactions occurs without deviating from the well-thought-out and predetermined plan. Emotion rarely influences the decision-making process of these traders.
Government has the most impact when it comes to creating demand at the national level because of its ability to influence various factors, such as taxes and interest rates.
Conversely, for the novice investor or trader, emotion frequently plays a role in their decision-making process. After executing a trade, if it becomes profitable, greed can influence their next move.
These traders will ignore indicators and sometimes fail to take profits by turning a winning trade into a losing trade. Fear is another emotion that can drive the decisions of these investors. They may not exit a trade at a predetermined time stop loss. These are examples of irrational emotional behaviors that are difficult to capture in economic models, hence difficult to know how market dynamics will affect supply and demand.
Consumer demand can sometimes be a powerful market dynamic. As explained in a study by The NPD Group, consumer spending is on the rise, especially for luxury fashion items, such as shoes, accessories and clothing.
According to the January 2019 NPD study, sales of luxury fashion items have increased as new brands have emerged and online retail platforms have created a more competitive landscape while gaining market share due to demographics and buyer preferences.
As the demand for luxury clothing increases, manufacturers and brands will be able to raise prices, which will boost the industry and boost the overall economy.
According to Marshal Cohen, Senior Industry Advisor, The NPD Group, “If we pay attention to what consumers are saying, these new market dynamics provide many opportunities across the luxury fashion market.”
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