Demand and Supply Theory
Supply and demand are arguably the most basic concepts of economics and backbone of any market economy. Essentially, they are the roots of any market that deals with buying and selling; thereby, forming the demand and supply theory. Before getting deeper, we need to define demand and supply. Demand refers to the amount of goods or services that a buyer is ready and capable to buy. The quantity demanded is the sum total of a product or service that people are ready to buy at a specific price. Demand relationship refers to the relationship that exists between the price of a commodity and quantity of the commodity demanded (Nicholson & Snyder, 2008). Supply refers to the quantity of products and services the market can offer. The quantity supplied is the amount of commodity or service producers are prepared to supply at a specific price. The supply relationship refers to the correlation between price of a commodity or service, and the quantity of goods or service supplied to the market. Therefore, price is a reflection of the interaction of demand and supply (Sampat, 2007). One may wonder, in what way the two relate to have power to dictate the marketplace. This happens because consumers and suppliers respond differently, when price fluctuates, meaning that if prices go high, the consumers are less eager to buy commodities, but the suppliers are very much eager to sell them. The laws of demand and supply will demonstrate this principle. This paper will analyze the theory of supply and demand, and give real world examples that will illustrate this theory further.
As indicated earlier, price influences demand and supply following the laws of demand and supply. When the price is high for a commodity, the supply is also high, because the supplier’s main intention is to maximize their profits; thus, produce more goods at this period in order to cash in on the high price. Comparatively, at this moment, the demand for the commodity will be low, because the consumers’ main objective is to save as much as possible, meaning that consumers will buy only things that are essential, as they wait for the price to reduce. The inverse happens, when the price of a commodity is low, demand will increase, and supply will reduce because of the reasons above. The above principles cover the laws of demand and supply. The relationship that exists between demand and supply will define the forces that decide the way the resources are allocated in the market. They do this in the most proficient way possible. In order to understand how it happens, the law of demand should be explored and defined in more detail (Nicholson & Snyder, 2008).
The Law of Demand
The law of demand states that if all factors remain constant, the higher the price of a commodity is, the lower the demand will be. This means that the quantity of a specific commodity that buyers purchase at a price that is high is generally less due to the fact that the price is high, and so is the opportunity cost of that specific commodity. It is normal for people to avoid purchasing a commodity that will in return consume a lot of money that will lead them to forgo purchasing something else that they deem has more value. In other words, the higher the price is, the lower the quantity demanded will be. The amount of a good that buyers purchase at a higher price is less, because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more (Sampat, 2007). The diagram below indicates that the law of the demand curve is a downward slope.
A, B, and C are points along the demand curve. Each point reflects a relationship between the price of a commodity and the quantity demanded. For example, at point A, the price is at its highest point, but if you look at the quantity demanded, it is at its lowest point. This curve demonstrates the negative relationship that exists between a high price and the demand. At point A, the quantity demanded is low, while at point C the quantity demanded is high, all in relation to the price. One may wonder what the determinants of demand are; a few factors that affect demand are highlighted as following.
This is probably the most significant determinant of demand. As income of consumers increases, their demand for commodities also increases; the vice versa also applies. However, there are exceptions, when it comes to the essential goods and services. For example, if the income of consumer increases, the demand for him/her to buy salt will not necessarily increase, it will probably stay the same.
Tastes and Preferences
Consumer preferences and desires have a major impact on the consumer’s demand. Personal tastes and preferences influence the demand for the commodity. For example, the consumer, who prefers vanilla ice cream flavor and the price of the strawberry flavor falls, will still buy the vanilla-flavored one.
As illustrated in the demand curve, the higher the price is, the lower the quantity demanded will be. However, prices of other related goods and services also have their influence on the demand for a specific product. Some goods and services are substitutes for one another, meaning that if price of one of the goods or services falls, the demand for the other one will also fall, as it also becomes less attractive to the consumers. A good example is the case of holiday spots for tourists; the people, who would decline to go to Kenya, will also decline going to Malaysia.
Another factor of the related commodities is for goods that are complementary to one another. If the price of one of the complementary good falls, the demand for the other will increase. A good example is if the price of gasoline goes up, the demand for cars will go down.
There are still more factors that affect demand; therefore, the list is not exhaustive. For example, if a person leaves home, while it is sunny, and all over sudden is in the middle of a storm, he/she will likely purchase an umbrella. This type of situation leads to the different type of demand management that does not comply fully with the law of demand. Such situations call for a different type of management economics. This situation falls under the seasonal demand, which means that consumers only need some commodities at certain the times of the year. For example, Christmas cards are sold during the Christmas period. This means that even if the prices are at their lowest in the middle of the year the demand will still be low. Other type of situations includes negative demand and no demand, where the demand for a product is negative due the fact that consumers are not aware of the commodity or service. Such situations require proper marketing of the product or service to the market in order to increase demand (Nicholson & Snyder, 2008).
For a company to be successful, the demand patterns have to be studied keenly on the different segments of the market, so that they can react appropriately on the different demand cycles.
The Law of Supply
The law of supply states that if all factors remain constant, the higher the price of a commodity is, the higher the quantity supplied will be. Therefore, when the price of a commodity is high, the suppliers tend to produce more commodities, so that they can reap maximum profit. The law of supply curve shows an upward slope in relation to the increase of price and supply as illustrated below.
Like in the demand curve, each point reflects a direct relationship between the price and quantity supplied. At point C, the price is the highest and the quantity supplied is the highest as well; while at point A, the price is the lowest and the quantity supplied is the lowest. Several factors affect supply, although they may change over a period, they include:
As indicated above, a higher price will prompt suppliers to supply more.
Technology reduces the use of manual forms of production meaning lower costs and improved products. This will increase suppliers’ capability to supply commodities; thus, increasing supply. Lack of technology increases the cost of production.
Prices of Other Goods and Services
Some commodities and services exhibit inter-dependency of supply. This means that if the price of one commodity increases, the inter-dependent commodity that has not changed its price, will become less attractive. A good example is gas heaters and gas bottles.
Costs of factors of production
These are the resources that are used in the production process. They include labor costs, capital costs, land costs, and entrepreneurial casts. These factors directly affect the ability of suppliers to bring products to the market. If these factors increase, the suppliers tend to shift to other products that cost less to produce.
The supply relationship, as shown in the illustration, depends mostly on the factor of time. Supplier’s reaction to the price change and needs of the market is fundamental; this helps them to know if demand for the certain commodity is temporary or permanent. A good example is the case of expected demand for umbrellas, because of an upcoming rainy season. This will require the suppliers to accommodate the demand because it is expected. However, if the climate changes and umbrellas are required all year round, this will necessitate the suppliers to change their production facilities in order to accommodate the long-term demand for umbrellas.
When demand and supply are equal, the economy is at equilibrium. This is the point, where demand and supply intersect, meaning that the commodities supplied are equivalent to the consumers’ demand. There is no excess or shortage. This is the point, which all markets try to reach.
In the real world scenario, equilibrium point cannot and has never been reached. Fluctuations in demand and supply lead to either excess in supply or excess in demand. This is known as disequilibrium.
Demand and supply theory also includes shifts and movements of the demand and supply curves. Movement refers to the change of both the price and quantity of a commodity along the demand or supply curve. A shift in a supply and demand curve refers to the change of the quantity of goods demanded or supplied, but the price remains constant. The figures below illustrate the two phenomena.
In conclusion, the demand and supply theory is the backbone of any market economy. Understanding the determinants and being able to predict the future will ensure that consumers and suppliers are both happy. It should always be the priority for markets and governments to ensure that the demands and supply curve are at equilibrium or just about. Fluctuations in demand and supply will always make it impossible, but this should always be the priority.