Market Dynamics: Definition and Examples

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 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 Takeaways

  • Market dynamics are the forces that impact prices and the behaviors of producers and consumers in an economy.
  • These forces create pricing signals that result from a change in supply and demand.
  • 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.
  • Economic models cannot capture some dynamics which affect markets and increase market volatility, such as human emotion.

Understanding Market Dynamics

Market dynamics are the factors that change the supply and demand curves. They form the basis of many economic models and theories. Because market dynamics impact the supply and demand curves, policymakers aim to determine the best way to use various financial tools to stimulate or cool down an economy. Is it better to raise or lower taxes, increase wages or slow down wage growth, do neither, or do both? How will these adjustments affect supply and demand and the general direction of the economy?

There are two primary economic approaches when it comes to changing the supply or demand in an economy with the ultimate goal of impacting the economy positively. One has a basis on supply-side theory and the other has a demand-side base.

Dynamics of Supply-Side Economics

Supply-side economics, also known as "Reaganomics," or "trickle-down economics" is a policy made famous by the 40th U.S. President, Ronald Reagan, based on the theory that more significant tax cuts for investors, corporations, and entrepreneurs provide incentives for investors to supply more goods to an economy, which results in other added 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

The opposite of supply-side economics is demand-side economics, which argues that the creation of effective economic growth comes 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 believe tax cuts in general can stimulate aggregate demand and move an economy that has significant unemployment back towards 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 incremental income generated may go back into stock buybacks that boost the market value of the stock or to 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 reevaluate them before making any investment or business decisions.

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

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. However, 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 professionals make rational decisions that 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 that 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.

The government has the most impact when it comes to creating demand on a national level due to its ability to affect 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 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, thus difficult to know how market dynamics will impact supply and demand.

Real-World Example

Consumer demand can at times be a powerful market dynamic. As explained in a 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 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 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.”

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