What is the Law of Supply and Demand?
The law of supply and demand is a theory that explains the interaction between a seller of a resource and a buyer of that resource. This theory explains the interaction between the existence or availability of a product and the demand for that product on the price of the product.
Generally, low supply and high demand increase prices and vice versa. Meanwhile, high supply and low demand will reduce prices.
A brief description
- The law of demand says that at higher prices, buyers demand less of an economic good.
- The law of supply says that at a higher price, the seller will supply more of the economy’s good.
- These two laws interact to determine the actual market price and the volume of goods traded on the market.
- Several independent factors can influence the shape of market supply and demand, which can affect the prices and quantities we observe in the market.
Understand the Law of Supply and Demand
The law of supply and demand is the most basic of economic laws, where it binds almost all economic principles in some way. In practice, supply and demand oppose each other until the market finds a price balance.
As we know that there are many factors that can affect supply and demand, which causes supply and demand to increase and decrease in several ways. It was studied extensively by Murray N. Rothbard.
The Law of Demand vs. Supply Law
The law of demand states that, if all other factors remain the same, the higher the price of a good, the less people will demand that good.
In other words, the higher the price, the lower the quantity demanded. The number of goods that buyers buy at the higher price is less because when the price of the good rises, so does the opportunity to buy that good.
As a result, people naturally avoid buying products, forcing them not to consume anything they value more. The graph below shows that the curve is slope downward.
Like the law of demand, the law of supply shows the quantity to be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied.
Producers supply more at a higher price because selling the higher quantity at a higher price increases revenue.
However, unlike the demand relationship, the supply relationship is a time factor. Time is important to provide because suppliers must — but not always — react quickly to changes in demand or prices. So it is important to try and determine whether the price change caused by demand will be temporary or permanent.
Say there is an increase in demand for umbrellas and the price of umbrellas suddenly increases in an unexpected rainy season; suppliers can only accommodate demand by using their production equipment more intensively.
However, if there is climate change, and the population will need an umbrella throughout the year, changes in demand and prices will be expected over the long term; suppliers must change their production equipment and facilities to meet long-term levels of demand.
Shift vs movement
In an economy, “movements” and “shifts” in relation to the supply and demand curves represent very different market phenomena.
Movement refers to changes along a curve. On the demand curve, movement shows the change in price and quantity demanded from one point on the curve to another. These moves imply that the demand relationship remains consistent.
Hence, a movement along the demand curve occurs when the price of a good changes and the quantity demanded changes according to the initial demand relationship. In other words, a movement occurs when a change in quantity demanded is caused only by a change in price, and vice versa.
Like movement along the demand curve, movement along the supply curve means that the supply relationship remains consistent.
Hence, a movement along the supply curve occurs when the price of the good changes and the quantity supplied changes according to the original supply relationship. In other words, a movement occurs when a change in a given quantity is caused only by a change in price, and vice versa.
Meanwhile, a shift in the demand or supply curve occurs when the quantity of a good demanded or supplied changes even though the price remains the same. For example, if the price for a bottle of energy drink A is IDR 10,000 and the quantity of energy A demanded increases from Q1 to Q2, then there will be a change in the demand for energy drink.
Shifts in the demand curve imply that the original demand relationship has changed, meaning that quantity demand is affected by factors other than price. A shift in the demand relationship will occur if, for example, energy drink A suddenly becomes the only type of energy available for consumption.
Conversely, if the price for a bottle of energy drink is IDR 10,000 and the quantity supplied decreases from Q1 to Q2, then there will be a change in the supply of this drink. Like a shift in the demand curve, a shift in the supply curve implies that the original supply curve has changed, meaning that the quantity supplied is affected by a factor other than price.
A shift in the supply curve would occur if, for example, a natural disaster caused a shortage of hop mass; State drink producers will be forced to supply less of their product at the same price.
How do supply and demand balance prices?
Also called the market clearing price, the equilibrium price is the price at which the producer can sell all the units it wants to produce and the buyer can buy all the units it wants to produce.
At a certain point in time, the supply of goods brought to market is constant. In other words, the supply curve in this case is a vertical line, whereas the demand curve always slopes downward because of the decreasing law of marginal utility.
Product sellers cannot charge the market more than the market can bear, based on the concept of consumer demand. Over time, however, suppliers may increase or decrease the quantity they supply to the market based on the price they predict will be charged.
So over time the supply curve slopes upward; the more suppliers expect to charge extra, the more willing they are to produce more and to shower the market with their products.
With the supply curve sloping up and the demand curve sloping down, it is easy to imagine that at some point the two will intersect. At this point, the market price is sufficient to encourage the supplier to bring to market the same amount of good that the consumer is willing to pay at that price. Supply and demand are in balance, or in balance.
The right price and quantity occurs based on the position and shape of the supply and demand curves, each of which is influenced by several factors.
Factors Affecting Supply
Production capacity, production costs such as labor and raw materials, and the number of competitors directly influence how much of a business supply can be made. Supporting factors such as weather conditions, availability of materials and reliability of the supply chain are also a set of factors that can affect supply.
Factors Affecting Demand
The number of substitutes available, changes in prices for complementary products, and consumer preferences can influence demand. For example, if the price of a motorbike for brand A goes down, then the demand for that motorbike can increase because people are more likely to buy it because the price has dropped and want to own it.