In every market, there are both buyers and sellers. Supply and demand is the most useful model for a competitive market, showing how buyers (citizens) and sellers (businesses) interact in that market. In fact, these two market forces demand and supply, and the relationship between them lie at the very centre of economics.
The demand for a product is the amount that buyers are willing and able to purchase at a certain price. You may want to take a round-the-world cruise or to rent a huge apartment that overlooks the ocean. However, you may not be able to afford any of these things. Therefore, economists would say that you have no actual demand for them. Even though you want them, you dont have the money needed to buy them. On the other hand, you may want the latest CDs by several of your favorite bands. And, at a price of between $12 and $15 each, you can afford them. Since you have both the desire for them and the ability to pay for them, you do have demand for CDs.
The supply of a product is the amount that producers are willing and able to bring to the market for sale when receiving a certain price. The amounts which firms are prepared to supply will depend upon the prices which people are prepared to pay. When farmers consider market prices to be too low, they will sometimes plough1 vegetables back into the ground or dump2 fruit crops3, rather than take these products to the market. In such cases, the vegetables and fruit were produced, but they were not part of the supply of these things because they were not offered for sale.
In classical economic theory, the market price of a good is determined by both the supply and demand for it. This relationship is thought to be the driving force in a free market. In 1890, English economist Alfred Marshall published his work, Principles of Economics, which was one of the earlier writings on how both supply and demand interacted to determine price.
Today, the supply-demand model is one of the fundamental concepts of economics. It concludes that in a competitive market, price will function to equalize the quantity demanded by consumers, and the quantity supplied by producers, resulting in an economic equilibrium of price and quantity. As demand for an item increases, prices rise. When manufacturers respond to the price increase by producing a larger supply of that item, this increases competition and drives the price down.
In market economy theories, demand and supply theory will allocate resources in the most efficient way possible. How? Let us take a closer look at the law of demand and the law of supply.
Price is one of the major factors that influence demand. Experience shows that, with very few exceptions, the quantity demanded of a good increases as the price decreases. The law of demand states: Other things being equal, more will be demanded at lower prices than at higher prices. The expression other things being equal is a very important part of the statement. There are some other factors influencing demand for a good, such as the prices of related goods, consumers incomes, or consumers tastes. If they change too, the effects of the fall in price become very uncertain.
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As it is true with demand, price is a major factor that influences supply. The law of supply states, More will be supplied at higher prices than at lower prices. Firms want to earn the maximum profit, so when the price of a good or service rises they are willing to supply more of it. When the price falls, they want to supply less of it. A very important factor that influences supply is the cost of production which includes:
Input prices As the prices of inputs such as labour, raw materials, and capital increase, production tends to be less profitable, and less will be produced. This leads to a decrease in supply.
Technology Technology relates to the methods of transforming inputs into outputs. Improvements in technology will reduce the costs of production and make sales more profitable so it tends to increase the supply.
Expectations If firms expect prices to rise in the future, they may try to produce less now and more later.
Price, therefore, is a reflection of supply and demand. The law of supply and demand predicts that the price level will move toward the point that equalizes quantities supplied and demanded. The equilibrium point must be the point at which quantity supplied and quantity demanded are in balance, which is where the supply and demand curves cross. This is the market or equilibrium price. This market price is arrived at by a gradual process. If trading takes place at prices other than the market price, there will be either a shortage or a surplus, which will cause the price to move until it settles at the equilibrium level.
Modern economic theory proposes that many other factors affect price, such as government regulations, monopolies, and modern techniques of marketing and advertising. Government regulates demand and supply, imposing ceiling prices (maximum prices) and floor prices (minimum prices) and adding its own demand to the demand of the private sector. For example, in the European Economic Community (EEC) and in many other parts of the world, governments guarantee minimum prices for certain agricultural products. These guaranteed prices are often higher than the prices the farmers would receive if they had to sell products on a free market. Or, in times of a severe shortage, for example in wartime, the government will fix the prices of basic foodstuffs at levels which pensioners and those on low incomes can afford to pay.
1plough v ,
2dump v ,
3crop n ,
