Basic Elements of Supply and Demand

~The Law of Supply and Demand~

 Supply and demand analysis demonstrates how a market mechanism
addresses the three issues of what, how, and Whom. Demands and supplies
are combined in a market. Customers create demand by allocating their
financial resources among the various goods and services that are offered,
while businesses provide these goods and services with the intention of
making the most profit possible.
Law of Supply and Demand in Economics:
What Is the Law of Supply and Demand?
 What Is the Law of Supply and Demand?

> The law of supply and demand describes how changes in

the price of a resource, commodity, or product affect its
supply and demand. It is based on two basic economic
principles.
 What Is the Law of Supply and Demand?

> Demand decreases and supply increases as the price rises. On the
other hand, demand increases while supply contracts as prices
decrease.
 What Is the Law of Supply and Demand?

> Levels of supply and demand for varying prices can be plotted on
a graph as curves. The intersection of these curves marks the
equilibrium, or market-clearing price at which demand equals
supply, and represents the process of price discovery in the
marketplace.
Understanding the Law of Supply and
Demand
 Understanding the Law of Supply and Demand

> It should go without saying that in any selling transaction, the

pricing should match supply and demand so that both the buyer and
the seller are satisfied. For thousands of years, people have watched
how supply, demand, and price interact in a (more or less) open
marketplace.
 Understanding the Law of Supply and Demand

> Many medieval philosophers made a distinction between a "just"

price based on costs and equitable returns and one at which the sale
was transacted. Enlightenment economists studied and
summarized this relationship, and their work is the foundation for
our understanding of price as a signaling mechanism matching
supply and demand. Modern critics of market pricing for specific
commodities also draw this distinction.
 Understanding the Law of Supply and Demand

> Crucially, supply and demand don't always react to changes in price in
the same way. Price elasticity is the measure of how much a product's
supply or demand is impacted by changes in price. Demand for products
with a high price elasticity of demand will fluctuate more widely in
response to price changes. On the other hand, because individuals find it
difficult to live without fundamental requirements, their price will be
relatively inelastic, meaning that demand will fluctuate less in response to
price fluctuations.
 Understanding the Law of Supply and Demand

> Based on supply and demand curves, price discovery presupposes a

market where buyers and sellers are free to engage in transactions at any
price. The supply and demand curves can be shifted or have their shapes
changed by a variety of factors, including economic cycles, provider
market power, taxes and regulations, and the availability of substitute
commodities. However, the commodities impacted by these outside
variables continue to be susceptible to the basic principles of supply and
demand as long as buyers and sellers maintain agency. Let's now examine
how supply and demand react to variations in price in turn.
The Law of Demand
 The Law of Demand

>If everything else is equal, the law of demand states that a

product's demand fluctuates inversely with its price. Put
another way, demand is inversely correlated with price.
 The Law of Demand

>Since consumers may only spend a certain amount of money

on any particular good or service, greater costs lower the
quantity that is required. On the other hand, when a product
gets cheaper, demand increases.
 The Law of Demand

>Naturally, there are exceptions. One is Giffen goods, typically

low-priced staples also known as inferior goods. Inferior goods
are those that see a drop in demand when incomes rise because
consumers trade up to higher-quality products. But when the
price of an inferior good rises and demand goes up because
consumers use more of it in place of costlier alternatives, the
substitution effect turns the product into a Giffen good.
 The Law of Demand

>At the opposite end of the income and wealth spectrum, Veblen
goods are luxury goods that gain in value and consequently
generate higher demand levels as they rise in price because the
price of these luxury goods signals (and may even increase) the
owner's status. Veblen goods are named for economist and
sociologist Thorstein Veblen, who developed the concept and
coined the term "conspicuous consumption" to describe it.
The Law of Supply
 The Law of Supply

>The law of supply relates price changes for a product with the
quantity supplied. In contrast with the law of demand the law
of supply relationship is direct, not inverse. The higher the
price, the higher the quantity supplied. Lower prices mean
reduced supply, all else held equal.
 The Law of Supply

>Higher prices give suppliers an incentive to supply more of

the product or commodity, assuming their costs aren't
increasing as much. Lower prices result in a cost squeeze that
curbs supply. As a result, supply slopes are upwardly sloping
from left to right.
 The Law of Supply

>As with demand, supply constraints may limit the price

elasticity of supply for a product, while supply shocks may
cause a disproportionate price change for an essential
commodity.
Equilibrium Price
 Equilibrium Price

>The equilibrium price, which is also known as a

market-clearing price, is the point at which supply
and demand combine to create a market equilibrium
that is agreeable to both buyers and sellers.
 Equilibrium Price

>Supply and demand in terms of the amount of the commodities are

balanced at the intersection of an upward-sloping supply curve and a
downward-sloping demand curve, meaning that neither excess supply
nor unsatisfied demand remains. Numerous factors affect the shape
and position of the corresponding supply and demand curves, which
determine the level of the market-clearing price.
Factors Affecting Supply
 Factors Affecting Supply

>In industries where suppliers are not willing to lose money,

supply will tend to decline toward zero at product prices below
production costs.
>Price elasticity will also depend on the number of sellers, their
aggregate productive capacity, how easily it can be lowered or
increased, and the industry's competitive dynamics. Taxes and
regulations may matter as well.
Factors Affecting Demand
 Factors Affecting Demand

>Consumer income, preferences, and willingness to substitute one

product for another are among the most important determinants of
demand.
>Consumer preferences will depend, in part, on a product's market
penetration, since the marginal utility of goods diminishes as the
quantity owned increases. The first car is more life-altering than the
fifth addition to the fleet; the living-room TV more useful than the
fourth one for the garage
 Why Is the Law of Supply and Demand Important?

>The Law of Supply and Demand is essential because it helps

investors, entrepreneurs, and economists understand and
predict market conditions.
MUST REMEMBER!
 According to the law of demand, a resource's or
product's degree of demand will increase when its
price decreases and decrease when its price
increases.
In contrast, the law of supply states that although
lower prices tend to decrease the supply of an
economic good, higher prices tend to increase it.
 Supply and demand are balanced at a market-
clearing price, which is graphically represented as
the point where the supply and demand curves
intersect.
 The product's price elasticity is the extent to which
changes in price are reflected in variations in supply
and demand. Basic needs have somewhat inelastic
demand, which means that price fluctuations have
less of an impact on it.