The concept of demand and supply in an economy


What Is the Law of Supply and Demand?

  • The law of supply and demand is a theory that explains the interaction between the sellers of a resource and the buyers for that resource.
  • The theory defines the relationship between the price of a given good or product and the willingness of people to either buy or sell it. Generally, as price increases, people are willing to supply more.
  • The theory is based on two separate “laws”, as follows:
    1. Law of demand
      1. The law of demand states that if all other factors remain equal, the higher the price of a good, the fewer people will demand that good.
      2. 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.
      3. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more.
    2. Law of supply
      1. The law of supply demonstrates the quantities sold at a specific price.
      2. This means that the higher the price, the higher the quantity supplied.
      3. Producers supply more at a higher price because the higher selling price justifies the higher opportunity cost of each additional unit sold.
  • Supply and Demand Curves
    • At any given point in time, the supply of a good brought to market is fixed.
    • In other words, the supply curve, in this case, is a vertical line, while the demand curve is always downward sloping due to the law of diminishing marginal utility.
    • Sellers can charge no more than the market will bear based on consumer demand at that point in time.
    • Over longer intervals of time, however, suppliers can increase or decrease the quantity they supply to the market based on the price they expect to charge.
    • So over time, the supply curve slopes upward; the more suppliers expect to charge, the more they will be willing to produce and bring to market.

Equilibrium Price

  • Also called a market-clearing price, the equilibrium price is the price at which the producer can sell all the units he wants to produce, and the buyer can buy all the units he wants.
  • With an upward-sloping supply curve and a downward-sloping demand curve, it is easy to visualize that the two will intersect at some point.
  • At this point, the market price is sufficient to induce suppliers to bring to market the same quantity of goods that consumers will be willing to pay for at that price. Here, Supply and demand are balanced or in equilibrium.
  • The exact price and amount where this occurs depend on the shape and position of the respective supply and demand curves, each of which can be influenced by several factors.


Additional Information

Factors Affecting Supply

Supply is largely a function of production costs, including:

  • Labour and materials
  • The physical technology available to combine inputs
  • The number of sellers and their total productive capacity over the given time frame
  • Taxes, regulations, or additional institutional costs of production.
  • Competitors and Supply chains

Factors Affecting Demand

These include:

  • Consumer preferences among different goods
  • The existence and prices of other consumer goods
  • Changes in conditions that influence consumer preferences
  • Changes in incomes can also be important in either increasing or decreasing the quantity demanded

Importance of concept of Supply and Demand

  • The Law of Supply and Demand is essential because it helps investors, entrepreneurs, and economists understand and predict market conditions.
  • For example, a company launching a new product might deliberately try to raise the price of its product by increasing consumer demand through advertising.
  • At the same time, they might try to further increase their price by deliberately restricting the number of units they sell to decrease supply