Contents
- Law of Demand and Supply
- What is Demand
- What is Supply
- Elasticity of Demand and Supply
- Market Equilibrium
Law of Demand and Supply
The law of demand and supply is a fundamental principle in economics that demonstrates how price fluctuations can affect the balance between the quantity of goods (or services) offered in the market and what consumers are willing to purchase. When the price of a good decreases, there is usually an increase in demand for it, while supply may decrease, as lower prices often lead to reduced profits for sellers. Conversely, when the price increases, supply may rise, but demand generally falls, as consumers' purchasing power decreases. As a result, a point of equilibrium is formed in the market, where the price of a good allows producers to earn profits while consumers can afford to buy it.
What is Demand
Demand represents the desire and ability of consumers to purchase goods or services. This indicator is subject to changes influenced by various factors, such as:
- Price of the good;
- Technological changes;
- Government regulation;
- Seasonal fluctuations;
- Trends;
- Availability of the good on the market;
- Number of potential buyers;
- Price forecasts;
- Income levels of the population;
- Competition among producers;
- Inflation expectations.
A decrease in the price of a good typically leads to an increase in the volume of demand. However, there are exceptions — for example, the Giffen effect and the Veblen paradox, where price increases lead to increased demand for essential goods or luxury items, respectively. There are two types of demand: actual and potential. Actual demand reflects actual purchases, while potential demand shows consumers' possibilities in the future.
What is Supply
Supply is the readiness and willingness of sellers to provide goods to the market. The volume of supply depends on various factors, such as:
- Production costs;
- Market competition;
- Price and demand forecasts;
- Seasonal changes;
- Economic and political news;
- Government regulation;
- Taxes;
- Prices of similar goods.
When there is an oversupply in the market, prices begin to fall, which may lead producers to reduce their production volumes. Conversely, when demand exceeds supply, prices may rise.
Elasticity of Demand and Supply
The elasticity of demand and supply shows how these quantities change in response to price fluctuations. The elasticity of demand determines how consumer behavior changes when the price of a good changes. If a price decrease leads to a significant increase in demand, this indicates high elasticity. Goods with high elasticity include cars and electronics, while medications and staple foods have low demand elasticity.
The elasticity of supply demonstrates how producers respond to price changes. For example, ice cream producers can quickly increase production in response to higher demand during the summer months, while the supply of movie tickets remains fixed regardless of price changes.
Market Equilibrium
Market equilibrium occurs when the volume of demand matches the volume of supply, establishing an equilibrium price that satisfies both buyers and sellers. There are two main types of market equilibrium:
- Stable equilibrium: quickly restores itself after temporary changes.
- Unstable equilibrium: leads to new demand and supply ratios, where prices change significantly.
For example, in the lead-up to holidays, the demand for certain products, such as fish and seafood, increases, leading to rising prices and production volumes. However, after the holidays, when consumer interest declines, sellers may offer discounts on leftover products to stimulate sales.