‘Supply and demand’ comes from microeconomics and is used in connection with many different programs and subjects.
Supply and demand is an economic model that seeks to explain and predict the price and quantity of goods being sold on a market with complete competition. Supply and demand also help determine price formation in markets.
The quantity offered on a market is defined as the quantity that sellers at a given price are willing to offer. Graphically, the supply curve can be plotted based on a tender function that expresses the relationship between price and quantity.
The ratio between price and quantity is proportional, which means that if the price increases by 5%, the quantity will increase by 5%.
There are also two different conditions that may be the basis for changes in the supply curve:
- The production cost of the item.
- Production capacity.
Companies will often tend to offer only if the market price exceeds the company’s production costs. If the company’s costs increase, there will be a tendency to offer less products or demand a higher price, which affects the equilibrium price.
Production capacity also affects the market price. If there is more demand than what the capacity of company, this refers to a higher equilibrium price. Conversely, companies with a high capacity level – at low demand – will still require a high price. Because, they will have higher costs here. If the supply of a product falls due to increased production costs, the equilibrium price will often increase as consumers now have to pay a higher price to obtain the limited number of products.
The demand on the market is defined as the quantity that buyers are willing to pay at a given price. Graphically, the demand curve can be shown on the basis of a demand function that expresses the relationship between price and quantity as a decreasing linear function.
There are two different effects that may cause changes in the demand curve:
- Substitution effect.
- Income effect.
The substitute effect implies that consumers tend to substitute different products for each other according to their prices. For example, if the price of milk rises, many will tend to shift the milk out with cheaper alternatives such as juice or water.
At the income effect, the consumer’s purchasing power gains more importance. If consumer purchasing power falls, they will tend to demand cheaper alternatives on many products due to the decline in their incomes.
These two curves, the supply curve and the demand curve, can be inserted in the same diagram and on the point where these curves intersect, the market price / equilibrium price appears. Here one will be able to find a situation that both buyers and sellers are willing to exchange at the same price. There may be changes in both demand and supply, which in turn leads to changes in the market price / equilibrium price.
This whole system leads to the concept of market economy, which is the term for the system where the free market forces form the market price of a commodity on the basis of supply and demand conditions of the given commodity. There are a number of disadvantages of the market economy that affect both the companies in the market and the consumers. The strong competition between companies may lead some companies to withdraw completely from the market. From a societal perspective, this results in waste of resources. Business owners lose money and the employees lose their jobs and income.
However, the benefits of the market economy in most cases outweigh the disadvantages. The high level of competition usually entails that companies optimize their production and utilize their resources more efficiently. In this way, prices can be kept down and the demand from consumers and production will increase.