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 pricing signals which result from the fluctuation of supply and demand for a given product or services. Economic and business models associated with market dynamics as goods and services are bought and sold. However, market dynamics can impact any industry or government policy.

There are dynamic market forces besides price, demand, and supply. Some emotions also drive decisions, influence the market and behaviors, and create price signals. The effect of these emotions drives the actions of investors, traders, and consumers.

How the Economics of Market Dynamics Work

Market dynamics form the basis for many economic models and theories, and policymakers differ in their opinion as to the best way to stimulate an economy. Is it better to lower taxes, increase wages, do neither, or do both? There are two primary economic approaches. One has a basis on supply-side theory, and the other has a demand-side base.

Key Takeaways

  • In a free or open economy, the market determines the price of a good.
  • The basis of supply-side economics is on the theory that the supply of goods and services is most important in determining economic growth.
  • Demand-side economics holds that the creation of economic growth is from the high demand for goods and services.
  • Pricing signals come from changes in either the supply of or demand for a product.
  • Economic models cannot capture some dynamics which affect markets and increase market volatility.

Dynamics of Supply-Side Economics

Supply-side economics is also known as "Reaganomics," or "trickle-down" policy made famous by the 40th U.S. President Ronald Reagan, is based on the theory that more significant tax cuts for investors, corporations, and entrepreneurs provide incentives for investments to supply more goods and produce economic benefits that trickle down to the rest of the economy.

The supply-side theory has three pillars which are tax policy, regulatory policy, and monetary policy. However, the overall concept is that production, or the supply of goods and services, is most important in determining economic growth. The supply-side theory contrasts with Keynesian theory, which considers that demand for products and services can drop and, in that case, the government should intervene with fiscal and monetary stimuli.

Dynamics of Demand-Side Economics

Opposite of the supply-side, demand economics argues that the creation of effective economic growth is from the high demand for products and services. If there is a high demand for goods and services, consumer spending grows, and businesses can expand and employ additional workers. Higher levels of employment further stimulate aggregate demand and economic growth.

Demand-side economists consider tax cuts for corporations and the wealthy not to be of economic benefit. No benefit comes because the additional funds do not go to the production of goods or services. Instead, they argue, money often goes to stock buybacks which boost the market value of the stock and to executive benefits.

Demand-side economists argue that increased government spending will help to grow the economy by spurring additional employment opportunities. Demand-side economists use the Great Depression of the 1930s as evidence that increased government spending stimulates growth at a greater rate than do tax cuts.

In a free or open market in which no entity can influence or set prices, the price of a good is determined by the market, which consists of buyers and sellers, collectively. A single body or group, therefore, is unable to have a significant effect on market dynamics.

Dynamics of Securities Markets

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 straightforward dynamics are, for the most part, efficient, and participants in these markets are assumed to make rational decisions. In financial markets, the human element of emotion creates a chaotic and difficult-to-quantify effect that always results in increased volatility.

In financial markets, some, but not all, financial services professionals are knowledgeable about how markets work. These professional make rational decisions which are in the best interests of their clients based on all of the available information. Savvy professionals, base their decisions on comprehensive analysis, extensive experience, and proven techniques. They also work to fully understand their client's needs, goals, time horizons, and ability to withstand investment risks.

Unfortunately, some market participants are not professionals and possess limited knowledge of the markets and the various events which can impact the market. This segment of nonprofessionals includes small-to-intermediate traders who seek to “get-rich-quick,” scam artists, driven by personal greed and investors who attempt to manage their investments rather than seek professional advice. Some in this category of experts are self-proclaimed professionals who are, at times, dishonest.

Greed and Fear in the Markets

Competent and professional traders determine entry and exit points of any investment or trade using proven quantitative models or techniques. They define the appropriate plan of action and follow it exactly. Through the practice of strict money management, the execution of trades happens without deviating from the well thought out, predetermined plan. Emotion seldom influences the decision-making process of these traders.

Conversely, for the novice investor or trader, emotion frequently plays a role in their decision-making process. After the execution of a trade, if it becomes profitable, greed may influence their next move. These traders will ignore indicators and, at times, not take profits turning a winning trade into a losing one. Fear is another emotion that can drive the decisions of these investors. They may fail to exit a trade at a predetermined stop loss. These are examples of irrational emotional behavior that is difficult to capture in economic models.

Real-World Example: Market Dynamics at Work

Consumer demand can at times be a powerful dynamic for the market. As explained in this study by The NPD Group, consumer spending is on the increase, particularly for luxury fashion items such as footwear, accessories, and apparel. According to the January 2019 NDP study, U.S. Luxury E-commerce Report sales of luxury fashion items have increased as new brands have emerged, and online retailer platforms have created a more competitive landscape while gaining market share due to buyer demographics and preferences. As demand for luxury apparel increases, manufacturers and brands will be able to raise prices, which will stimulate the industry and boost the overall economy.

According to Marshal Cohen, chief industry advisor, The NPD Group, “If we pay attention to what consumers are saying, these new market dynamics spell a great deal of opportunity across the entire luxury fashion market.”