What is the law of supply and demand?
The law of supply and demand is a theory that explains the interaction between the sellers of a resource and the buyers of that resource. Theory defines what effect the relationship between the availability of a particular product and the desire (or demand) for that product has on its price. Generally, low supply and high demand increase the price and vice versa. PayPal is one of the perfect examples of supply and demand in action.
Key points to remember
- The law of demand says that at higher prices, buyers will demand less of an economic good.
- The law of supply stipulates that at higher prices, sellers will provide more of an economic good.
- These two laws interact to determine real market prices and the volume of goods traded on a market.
- Several independent factors can affect the shape of supply and demand in the market, influencing both the prices and the quantities we observe in the markets.
Law of supply and demand
Understanding the law of supply and demand
The law of supply and demand, one of the most basic economic laws, is related in one way or another to almost all economic principles. In practice, supply and demand pull against each other until the market finds an equilibrium price. However, multiple factors can affect both supply and demand, causing them to increase or decrease in various ways. It has been widely studied by Murray N. Rothbard.
Law of demand vs law of supply
The law of demand states that if all other factors remain equal, the higher the price of a good, the less people will demand it. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers buy at a higher price is less, because as the price of a good increases, the opportunity cost of buying that good also increases. As a result, people will naturally avoid buying a product that will force them to give up consumption of something else they value more. The graph below shows that the curve is a downward slope.
Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers provide more at a higher price, because selling more at a higher price increases income.
Unlike the demand relationship, however, the supply relationship is a time factor. Time is important to provide because suppliers must, but cannot always, respond quickly to a change in demand or price. It is therefore important to try to determine whether a price change caused by demand will be temporary or permanent.
Let’s say there is a sudden increase in demand and price for umbrellas during an unexpected rainy season; suppliers can simply meet demand by using their production equipment more intensively. If, however, there is climate change and the population will need umbrellas all year round, the change in demand and prices should be long term; suppliers will need to change their equipment and production facilities to meet long-term demand levels.
Offsets vs movement
For the economy, the “movements” and “offsets” in relation to the supply and demand curves represent very different market phenomena.
A movement refers to a change along a curve. On the demand curve, a movement indicates a change in both the price and the quantity demanded from one point to another on the curve. The movement implies that the demand relationship remains consistent. Therefore, a movement along the demand curve will occur when the price of the good changes and the quantity demanded changes according to the original demand relationship. In other words, a movement occurs when a change in the quantity demanded is caused only by a change in price, and vice versa.
Like a movement along the demand curve, a movement along the supply curve means that the supply relationship remains consistent. Therefore, a movement along the supply curve occurs when the price of the good changes and the quantity supplied changes according to the original supply relationship. In other words, a movement occurs when a change in the quantity supplied is caused only by a change in price, and vice versa.
During this time, a change in a demand or supply curve occurs when the quantity of a good demanded or supplied changes even if the price remains the same. For example, if the price of a bottle of beer was $ 2 and the quantity of beer requested increased from Q1 to Q2, then there would be a change in demand for beer. Changes in the demand curve imply that the original demand relationship has changed, which means that demand for quantity is affected by a factor other than price. A change in the demand relationship would occur if, for example, beer suddenly became the only type of alcohol available for consumption.
Conversely, if the price of a bottle of beer was $ 2 and the quantity offered decreased from Q1 to Q2, there would then be a change in the supply of beer. Like a change in the demand curve, a change in the supply curve implies that the original supply curve has changed, which means that the quantity supplied is effected by a factor other than the price. A change in the supply curve would occur if, for example, a natural disaster caused a massive shortage of hops; beer manufacturers would be forced to supply less beer for the same price.
How do supply and demand create an equilibrium price?
Also called the market compensation price, the equilibrium price is the price at which the producer can sell all the units he wants to produce and the buyer can buy all the units he wants.
At any given time, the supply of a good placed on the market is fixed. In other words, the supply curve in this case is a vertical line, while the demand curve is always sloping downward due to the law of decreasing marginal utility. Sellers cannot charge more than the market will bear based on consumer demand at that time. However, over time, suppliers can increase or decrease the amount they supply to the market based on the price they expect to be able to charge. Thus, over time, the supply curve is increasing; the more suppliers expect to be able to invoice, the more willing they are to produce and bring to market.
With an upward sloping supply curve and a downward sloping demand curve, it is easy to see that at some point the two will overlap. At this point, the market price is sufficient to induce suppliers to put the same quantity of goods on the market as consumers will be willing to pay at that price. Supply and demand are balanced or balanced. The precise price and quantity where this occurs depends on the shape and position of the respective supply and demand curves, each of which can be influenced by a number of factors.
Factors affecting supply
Production capacity, production costs such as labor and materials, and the number of competitors directly affect the amount that supply companies can create. Ancillary factors such as the availability of materials, weather conditions and the reliability of supply chains can also affect supply.
Factors affecting demand
The number of substitutes available, consumer preferences and variations in the price of complementary products affect demand. For example, if the price of video game consoles drops, the demand for games for this console may increase as more people buy the console and want games for it.