Market Dynamics

What are Market Dynamics?

Market dynamics refer to the forces that impact the prices and the behaviors of producers and consumers. The forces result in the creation of pricing signals. A fluctuation in the demand and supply of a given product or service creates pricing signals.

Market dynamics can affect any industry, economy, business model, or even government policy. Price, demand, and supply are influenced by dynamic forces, but they may not always be rational. It means that the emotions of investors or other qualities, such as risk aversion, can also drive the actions that investors, consumers, and traders take.

Market Dynamics in Economic Models

Many economic models and theories are formed by market dynamics. Policymakers have different opinions over what is best to stimulate an economy or achieve economic growth. There are two primary economic approaches: the supply-side and the demand-side approach.

Dynamics of Supply-side Economics

Supply-side economics is based on a theory of incentivizing investors to invest more in order to increase the output in an economy. The basic principle is that the most important determinant of economic growth is the supply of goods and services or production.

Supply-side economics includes tax policy, monetary policy, and regulatory policy. It is a proponent of significant tax cuts and easily available credit for investors and entrepreneurs. The market participants supply more goods and provide economic benefits (in terms of employment generation, etc.) that subsequently trickle down to the rest of the economy.

It is also known as the trickle-down policy, or Reaganomics, since it was popularized by former US President Ronald Reagan.

Dynamics of Demand-side Economics

Demand-side economics is diametrically opposite to supply-side economics. It functions on the principle that high aggregate demand in the economy is the most basic driver of economic growth. It says that effective wealth creation can only occur in a market characterized by high demand for goods and services. It leads to an increase in consumer spending, which generates profits for a business.

Businesses can then expand and generate employment opportunities. It also argues that high levels of employment and higher wage rates can stimulate aggregate demand, while lower wage rates or tax cuts for corporations do not provide any economic benefit. This is because additional funds saved due to tax cuts or low wage rates are not invested in the business but instead are utilized for stock buybacks and paying executives.

It is also known as Keynesian economics, after economist John Maynard Keynes who first proposed the theory.

Dynamics of Securities Markets

Economic models made for physical goods or services are more easily quantifiable as opposed to those for financial markets. In financial markets, the factor of speculation and investor sentiment results in an increase in volatility and makes it difficult to quantify the dynamic forces prevalent in that market.

Financial professionals, such as traders and other institutional investors, understand the functioning of markets and can access to market information and metrics that can be used to analyze and understand market trends. Based on such facts, they can be expected to make rational investment-related decisions. They may also advise their client to make rational decisions.

However, it may not be true for all participants in the market. Non-professionals in the financial market may be driven by incomplete information and knowledge, and greed. It may lead to excessive speculation and volatility in the market.

Additional Resources

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Economic Indicators
• Products and Services
• Institutional Investors
• Aggregate Supply and Demand
• See all economics resources