Law of Supply and Demand - Explained
What is the Law of Supply and Demand?
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What is the Law of Supply and Demand?
The law of supply and demand reflects the relationship between demand and supply in that a change in one causes a change in the other. According to the law of supply and demand, when there is higher demand for a commodity, there is a rise in the supply of such commodity and vice versa. The law of supply and demand explains the interaction between the desire for a product and the supply of that product. For instance, if the supply of a product is how and the demand is high, it means such product is scarce and insufficient for the number of people that wants it, hence, it will lead to an increase in the price of the product.
Back to: ECONOMIC ANALYSIS & MONETARY POLICY
How is the Law of Supply and Demand Used?
The law of supply and demand is an economic theory that explains how demand and supply are connected and how these two concepts strive to find market balance or equilibrium price. Usually, when there is excess supply in the market and a low demand for the supplied products, there is a decrease in the price of goods. There are many factors that influence demand and supply. Supply and demand can rise for multiple reasons, so also can they decline. The law of supply and demand is connected to almost all economic principles, although there are exceptions.
How Do Supply and Demand Create an Equilibrium Price?
The impact of equilibrium price is that it allows suppliers sell their goods at a price which buyers are willing to pay. For instance, if a supplier is able to sell all units of products at a predetermined price and buyers are willing to purchase all units at the price, there is equilibrium. Equilibrium price is otherwise called a market-clearing price, supply and demand play a major role in the creation of equilibrium price in the market. Generally, businesses or producers find means to reach an equilibrium, they are often in search of ways to create a balance between the units of goods produced and the desire of consumers for the goods.
Factors Affecting Supply
There are certain factors that directly affect supply and determines whether there will be high or low supply. The capacity of a producer or company, the costs of producing specific items including cost of materials, labor, and equipment can affect supply. Other factors include the presence of competitors in the market. Also, if the production of an item is determined by weather, for instance, a company that manufactures sweaters, the supply of products will the determined by weather. The supply chain is another factor that affects supply.
Factors Affecting Demand
Demand on the other hand is also affected by many factors. The common factors that affect demand are;
- The cost of a product, that is, the price at which the product will be purchased.
- The availability of other alternatives in the market.
- The importance of the product, whether it is an inferior good or otherwise.
- The price of complementary products.
These and few others are factors that affect demand.
Do Supply and Demand Only Affect Prices?
The law of supply and demand is an economic theory that affects diverse economic principles and not just the concept of 'price.' For instance, supply and demand is an important gauge for measuring economic growth and it is important when calculating the gross domestic product (GDP) of a country for a particular time. The rate of employment and unemployed can also be determined. The law of demand and supply is also applicable to wages for labor, business growth, among others.
- Self Interest
- Cost-Benefit Analysis
- Enlightened Self-Interest
- Fisher's Separation Theorem
- Ratchet Effect
- Total Utility (Economics)
- Efficiency Principle
- Expected Utility
- Subjective Theory of Value
- Positional Goods
- Indifference Curve
- Time Preference Theory of Interest
- Marginal Benefit
- Diminishing Marginal Utility
- Sunk Costs
- Production Possibilities Frontier
- Law of Diminishing Returns
- Economic Efficiency
- Efficiency Theory
- Productive Efficiency
- Capacity Utilization Rate
- Allocative Efficiency
- Pareto Efficient
- Comparative Advantage
- Criticisms of the Economic Approach
- Behavioral Economics
- Normative Economics
- Positive Economics
- Invisible Hand
- Sunk cost