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Back to Basics: Supply and Demand

October 15th, 2015

 

Everything in our economy is determined by one relationship. Every price point, every amount produced, and every single decision has factored in the affiliation between two ideas.

 

You may be wondering what these two very influential factors are. They are none other than supply and demand, of course!

 

The relationship between supply and demand has been around long before anyone ever realized it. A farmer would not spend the money to raise six cattle if there was only a need for two.

 

Thus, the farmer has successfully factored supply and demand into his business model.

 

Together, supply and demand determine the price of every commodity. This relationship tells a business how much of its product to produce and how much to sell it for.

 

Supply and demand is the basic foundation of a free market economy.

 

Now, let us examine each principle more closely.

 

According to “Brief Principles of Macroeconomics,” the law of demand states “the quantity demanded of a good falls when the price of a good rises.”

 

Basically, consumers tend to want less of a product if it is priced higher than they feel it should be.

 

According to the aforementioned work, the law of supply states “the quantity supplied of a good rises when the price of a good rises.”

 

In other words, a business can produce more of a commodity the higher that commodity is priced.

 

The relationship between supply and demand is considered to be negative because as one goes up, the other will go down.

 

So, how does supply and demand determine the price of a good?

 

When quantity supplied equals quantity demanded, the market price of a commodity has reached its equilibrium price. A business can sell the most of its product at the equilibrium price.

 

Most companies spend a lot of time on research and development to find out what this price is for each of its products. The equilibrium price is the price point in which a company maximizes its profits.

 

When supply and demand are not at this point one of two things happen. There is either excess supply, or excess demand.

 

If there is excess supply, the price of that commodity may decrease in order to rid the company of the extra good.

 

If there is excess demand, it means that there is not enough of a good to satisfy the demands of every customer.

 

If either of these phenomena occur, one could say that market for that good is at disequilibrium.

 

In each situation, either the consumer or the producer is not benefitting from the transaction. This is why businesses strive to find the equilibrium price of a particular good.