Among the concepts in economics, few are as universally fundamental as supply and demand. Two forces are the invisible hands of market shaping, price determination, and consumer behavior regulation in general. Understanding these basics is essential if one is going to know how economies actually work. It may be influencing the price of your daily commodities or shaping global market trends, but in any financial decision we make, the roles are that of supply and demand.
This blog breaks down fundamental issues of supply and demand, delves into the interaction that forms market equilibrium and looks at concepts such as price elasticity and the demand curve. Whether you are a budding economist, an interested consumer, or just someone who wants to understand better the economic theory governing your everyday decisions, this comprehensive guide will ensure that you can approach these concepts with confidence.
The most essential feature of the law of supply and demand is a simple comparison between how much of a product is available (supply) and how many people want that product (demand). It's a simple mechanism that nonetheless explains well what happens to prices in markets.
These two forces are continually interacting in the formulation of prices in the marketplace for products and services.
Demand can be read in one of the most influential visual ways to learn sensibilities through reading the demand curve. It graphically depicts the relationship between price and the quantity demanded by consumers.
This inverse relation intuitively holds as well: the cheaper a good is, the more people will want to buy it. On the other hand, if the price increases, the number of consumers who will afford or wish to pay the cost to acquire it will decrease. For example, in case a cell phone price decreases, then the sales will rise; whereas the sales will fall with an increase in its price.
But demand doesn't come out of a vacuum. Consumer income, preferences, and other factors in the broader market may change demand. For instance, they could even push demand higher or lower for any given price.
The price also influences producers. The law of supply dictates that the higher the price, the more the producers are willing to offer for sale the commodity. Of course, the reason is simple: a higher price can result in higher profit margins, which would encourage the companies to produce more.
For example, if the price of crude oil increases upwards, the firms involved in the production of oil tend to increase supply in a bid to benefit from increased revenues. Conversely, if prices drop, the motive to produce lowers and supply decreases correspondingly.
This relationship is illustrated graphically as the supply curve. Since supply curves slope upward from left to right, a rise in prices increases the quantity supplied.
Market equilibrium is where the supply of the product equals its demand. In theory, at that equilibrium price, there would be no surplus-which is the extra product-and no shortage, which is the lack of product. Producers are selling precisely what consumers want to buy at that price.
For example, on holiday time, the toy companies estimate the demand for a new hot toy. They may over-estimate and produce too much of it. They then offer a discount to get rid of it. However, they may underestimate the demand for a new product and, consequently, cannot get enough stock, and therefore, demand because of a shortage can push up prices.
Another important concept that falls under the supply and demand umbrella is price elasticity. It refers to how sensitive the quantity demanded or supplied is to changes in price. Elasticity helps economists and businesses understand how their market flexes.
For instance, high-end luxury goods such as cars are generally inelastic in demand as people feel sensitive about these items at a change of price as these are not essential items. Conversely, products like gasoline or medicine are considered to be non-elastic commodities as they are always purchased regardless of the fluctuations in prices till and unless they are too excessive.
The price elasticity of supply represents the reaction of producers to a changed price. Examples of the supply of quickly and cheaply produced goods tend to be elastic, including cheap movies because they take little time and resources, whereas goods that take much time or are costly to produce, like rare metals or large-scale infrastructure projects, are inelastic.
Supply and demand are somewhat fluid concepts, with many factors affecting them, and being informed on what shifts these curves is necessary for the analysis of markets.
Here are a couple of actual examples of the power of supply and demand:
What is essential for making sense of economic activities most of the time, even in our everyday lives, is to understand the principles of supply and demand. These forces form the prices we pay for goods and services and influence business decisions as well as determine the kind of economic policy that governments ought to enforce.
Therefore, what you will learn in the chapters that follow will give you an understanding of how markets work but also how consumer behavior, economic theory, and real-world events interact to create the complex economy in which we live. The next time you read of a price increase or a product shortage, you will understand the dynamics behind it.
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