The modern market is based on the following elements: prices, supply and demand, competition. A decrease in the level of the latter, as a rule, most often negatively affects the quality of goods and services. Product prices are directly related to production volumes. Supply and demand also depend on each other. For example, the more popular the product, the more often it will appear on the shelves.
High demand causes prices to rise over time. In other words, the added value of products is growing. However, a decrease in demand does not always lead to a decrease in the price level. The cost of goods generally falls rarely. This phenomenon is known in economics as the “ratchet effect.”
Let's see why this process was named that way. As you know, the ratchet wheel can only move in one direction. Approximately the same with prices in a market economy. They can grow, but it is quite difficult to reduce them. They are not always reduced even by a drop in demand.
A number of objective economic phenomena reflect the ratchet effect. The graph of the price level and real production shows a declining curve. That is, the relationship between the two isinversely proportional. The lower the price level, the more products will be produced, since the amount of goods created depends on the level of demand for them.
There are three factors that can help you understand the ratchet effect more deeply. The first of them is connected with real cash funds of consumers. This is the so-called "we alth effect". The purchasing power of the population decreases with an increase in prices. As a result, consumers, acquiring more expensive goods, become poorer. This leads to the fact that the population begins to save on their expenses. Conversely, an increase in costs can be caused by a decrease in prices. The next factor is the interest rate effect. It grows along with prices. Rising rates cause a reduction in certain consumer spending and certain types of investment. The third factor is the effect of import purchases. The higher the prices for domestic goods, the more profitable it is to buy their foreign counterparts. However, in order for the economy to develop, it is necessary that exports exceed imports.
What are the reasons for such a phenomenon as the ratchet effect? And why prices are easy
rising but struggling to decline? The main reason is limited competition. In such conditions, prices can be dictated by large firms, which benefit from increasing profits. They determine the cost of certain goods and try, if not to raise it, then at least to maintain it at the current level. But how in this case to make a profit with a decrease in demand? This questionlarge firms solve by cutting supply and jobs at their production facilities. It is worth suggesting that, if competition were not severely limited, as it is in our time, then prices would depend mainly only on the balance between supply and demand. The ratchet effect would probably be negligible. However, this situation is disadvantageous for monopolists and large firms. These organizations find mechanisms that allow them to maintain their profits even in the face of falling demand for the goods they produce and sell. When there is no macroeconomic balance, the ratchet effect is especially pronounced.
