The law of supply and demand refers to one of the core concepts in economics explaining the relationship between demand, supply, and price of products and services. It integrates the concepts of the law of demand and the law of supply.
In simple terms, while all other factors remain constant, the law of demandThe Law of Demand is an economic concept that states that the prices of goods or services and the quantity demanded are inversely related when all other factors remain constant. In other words, when the price of a product rises, its demand falls, and when its price falls, its demand rises in the market.read more holds that when the price rises, demand falls. At the same time, the law of supplyThe law of supply in economics suggests that with other factors remaining constant, if the price of a commodity increases, its market supply also goes up and vice-versa.read more states that when the price increases supply increases. The direct relationship between the price and supply creates an upward sloping supply curveSupply curve represents the relationship between quantity and price of a product which the supplier is willing to supply at a given point of time. It is an upward sloping curve where the price of the product is represented along the y-axis and quantity on the x-axis.read more. At the same time, the inverse relationship between price and demand results in a downward sloping demand curveDemand Curve is a graphical representation of the relationship between the prices of goods and demand quantity and is usually inversely proportionate. That means higher the price, lower the demand. It determines the law of demand i.e. as the price increases, demand decreases keeping all other things equal.read more.
- The laws of supply and demand are basic concepts helping businesses analyze the best-selling price, the ideal supply rate, and the readiness of a market for a new product.
- The law of demand explains that when the price increases demand decreases.
- The law of supply explains that when the price increases seller increases the supply to obtain maximum profit.
- Equilibrium prices showcase the price at which supply and demand are equal and satisfying in the market.
Explanation
The law of supply and demand gives insight into the process of price and quantity determination in a competitive market through buyer and seller interaction. For example, the consumer often chooses products and services which come in affordable price tags with desired utility. In contrast, the seller wants to sell their products and services at the maximum possible price.
It is where the equilibrium price comes into significance. It is the price at which supply equals the quantity demandedQuantity demanded is the quantity of a particular commodity at a particular price. It changes with change in price and does not rely on market equilibrium.read more in the market. When an item is in low supply, its demand is great, which increases its value, hence its price. Producers of such commodities tend to increase supply to optimize profits, up to a point where the market is saturated with the product, and its value reduces due to too much supply.
The 4 Basic Laws of Supply and Demand
The theory of supply and demand do not operate in a vacuum but are subject to other external forces that might influence one. Nevertheless, the four fundamental concepts explaining the correlation between demand and supply are a way of explaining what demand and supply are in an easy-to-understand format.
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- Demand increases, and supply remains the same: In a competitive market, this will cause an increase in the price. The shortage of products increases the value of the product.
- Demand decreases, and supply remains the same: In this situation, the price reduces. If the demand continues to decline, there will be a surplus of the product in the market, subsequently dampening the product’s value.
- Supply increases and demand remains unchanged: The easy availability of a product causes a decrease in its price, manifesting an oversupply scenario if the demand remains intact for long.
- Supply decreases and demand remains unchanged: When supply decreases, and there is no increase or decrease in demand, the price will increase.
These four basic laws are often affected by external factors such as government intervention. As a result, while the majority of products follow the law, some do not. These are usually Giffen goodsGiffen goods are the goods whose demand curve doesn't conform to the 'first rule of demand', i.e., price and quantity demanded of Giffen goods are inversely related to each other, unlike other goods, where price and quantity demanded are positively related. Therefore, they are inferior goods without a substitute. It is named after the Scottish statistician, Sir Robert Giffen.read more, Veblen goodsVeblen Goods is a category of luxury goods whose demand increases with the increase in price. It behaves the opposite to the demand and supply theory.read more, and essential goods.
Real World Examples
The laws of supply and demand example can find in the electric cars market. Barely a decade or so ago, very few cars or models in supply were purely electric. Those that were (or which were hybrids) commanded high prices. Hence, the demand was also less.
As more and more people have started embracing electric vehicles mainly due to their environmentally friendly attributes, the demand started rising, the firms have drastically ramped up the production of the cars, and subsequently introduced lower-priced better-performing versions, even though battery supply bottlenecks are causing hindrance to the production. Furthermore, government subsidiesA subsidy in economics refers to direct or indirect financial assistance from the government to an individual, household, business, or institution to promote social and economic policies.read more also made it cheaper to manufacture and purchase vehicles. As a result, the overall global market for EV increased significantly from 2010 to 2020.
The future prediction of an increase in demand for EVs globally made it easier for the manufacturer to use economies of scaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. read more to carry out expensive research and development to introduce usable, stable and provided excellent real-world experiences. Furthermore, with announced launches of new EV models spiking, automakers and suppliers are increasing their global footprints in target marketsA target market consists of different groups of individuals, households, and organizations towards which a company aims to offer its products and services.read more by localizing the production of vehicles and components. Such measures ensure the supply chainA supply chain refers to a process beginning with the procurement of raw materials and the production of finished goods and ending with their distribution and sale.read more strengthening process.
Why is it Important?
For businesses, it is vital to consider the supply and demand scenario when planning to enter a particular market. Understanding it in addition to other factors that could influence supply and demand will help to have a positive impact on the selling price of the product, which in turn affects a seller’s bottom lineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more. The point would be to find out the probable economic equilibriumEconomic equilibrium refers to a situation wherein specific market forces remain balanced, resulting in optimal market conditions in a market-based economy. The term is often used to describe the balance between supply and demand or, in other words, the perfect relationship between buyers and sellers.read more. If this equilibrium does not lead to profit-making, starting such a business would be risky.
Many firms have gone under simply by investing a lot of capital in markets where the demand for their products may not be there. Lack of demand means having meager sales even after spending a lot in marketing, setting up factories, and more. Business experts can find out what demand is for a product before penetrating that marketMarket penetration is calculated as how much the customers are using the product or service compared to the total market for that product or service.read more and check for the possibilities that will cause a positive shift in the demand or supply curves hence manipulating the theory of demand and supply.
Frequently Asked Questions (FAQs)
What is the law of supply and demand in economics?
It is a core concept in economics that describes the relationship between producers and purchasers of a product or service. For example, sellers show interest in producing and supply more when the price is high and vice versa as price declines.
What are the four basic laws of supply and demand?
When the supply remains constant, a rise in demand results in a higher equilibrium price and higher quantity, and a fall in demand results in a lower equilibrium price and lower portion. At the same time, when the demand remains constant, an increase in supply causes a decrease in prices and vice versa.
What is an example of the law of supply and demand?
A seller sets the price of its product at $5.00 in line with competitive pricing and enjoys a satisfying share of demand in the market. After a year, he doubled the price when no other competitors did. The result was no one wanted high-priced products, and demand declined.
Recommended Articles
This has been a guide to the Law of Supply and Demand and its Definition. Here we explain the four basic laws of supply and demand and why it is vital with examples. You may also have a look at the following articles to learn more –
- Aggregate Supply
- Price Elasticity of Supply
- Elastic Demand