Understanding Supply and Demand In Economics

Supply and Demand are fundamental economic concepts. The two describe how changes in the price of a commodity, product, or resource impact its supply and demand.

Demand and supply are dependent on people, processes, and technology. Let us first understand these terminologies individually and then the relationship between the two.

Table of Contents

• What is Demand?
• Types of Demands
• Factors affecting demand
• What is Supply?
• Types of Supply
• Factors affecting supply
• Relationship between Supply and Demand

What is Demand?

Demand is the consumer’s desire for a good or service. Consumers are interested in purchasing that product for a particular price. Demand can increase or decrease based on several factors. Let us first consider three examples to understand the change in demand. 

1. Suppose an automobile company launches a limited edition luxury model of a famous car. Since there is less availability and the high popularity, the demand for this car will increase. Consumers will buy this car for the quoted price.
2. After a season of popularity, flared neon pants are out of trend. The demand will decrease since they are no longer as popular as before.
3. The restaurant became popular after it was highly talked about by one of the most popular food critics in the city. However, this restaurant has only 20 tables available. The demand will soar.

Types of Demands

Demand is of two types: Market demand and aggregated demand. 

1. Market demand is the total of what everyone within a particular industry wants. It is determined by consumers’ willingness to pay a certain price for a particular good or service. With an increase in demand, the prices will go up and with a decrease in prices, demand will decline.
2. Aggregate Demand/ Effective Demand/ Domestic Final Demand (DFD) is a microeconomics term that describes the total demand for goods produced in an economy. It is the demand for the GDP of a country. DFD specifies the amount of service or goods purchased at any possible price level.

Factors Impacting Demand

The following factors impact the demand in any market:

1. Price of the product

One of the most influential reasons for fluctuation in demand of a product is its price. If the price is too high, the demand will decrease; if the prices are low, demand will increase. This is based on the affordability of a consumer. It will remain in demand if they can afford to purchase their product. To understand this, we must know about the price elasticity of demand (PED). 

PED is the ratio of the percentage change in quantity demanded with the percentage change in price. If the PED coefficient is less than one, the price change less affects the demanded quantity. If PED is greater than one, prices are higher than the quantity demanded.

2. Income of Consumers

This is another important factor that impacts demand. If an economy comprises most less-earning individuals, low-cost products will be more in demand. This is because more people can afford it. The demand will automatically decline when the product prices in such an economy get too high. If more high-net-worth individuals are in an economy, even highly-priced products will remain in demand.

3. Availability of Alternatives

Any good or service remains in excessive demand only if it is unique to its market. Once there are alternatives or substitutes in the market, the demand for a particular product will go down, and so will its price. This will, however, also depend on the prices, quality, and quantity of those available alternatives.

Also Read – What is Consumer Equilibrium?

4. Number of Consumers

Suppose, in India; people do not eat pork and beef. Due to this, the demand of these items will always stay low in the Indian market. However, the demand for chicken meat will increase since Indian people prefer it. This example indicates that if a good/service has more consumers, its demand will remain high. If it has fewer consumers, then the demand will remain less. 

5. Consumer Expectation

This is evident in the stock market. If the buyer speculates an increase in the prices of a particular share, they will purchase it. In case they speculate a decrease in the price, they will plan to buy it in the future. Another real-life example was related to the situation of Indian markets after 21 days lockdown was announced in the country. People expected a shortage of goods, so household products were sold in massive quantities at that point. Similarly, people tend to skip buying certain products that are expected to go low in price during the sale season. Based on the price expectation, the demand also fluctuates in the market. 

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What is Supply?

Supply represents the capability or willingness of a seller to provide a particular good/service in the market. To ensure this, companies have a dedicated logistics and supply chain department. In general, supply is based on the demand and price of a product. Let us consider some examples to understand supply:

1. Product A is in high demand in the market and people are willing to pay any price to purchase it. This will motivate sellers to supply more quantity since they can make higher profits.
2. Weather is unfavourable for the production of tomatoes. This will hamper the supply of the demanded quantity of tomatoes even if consumers are willing to pay higher prices.
3. Product A is low in demand in a certain market. This will force the company to decrease the product supply in that market.

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Types of Supply

The following are the five types of supply:

1. Market supply

It is the total amount of a good/ service that producers are capable or willing to deliver over a given time period. Suppose, in a market, there are many cashmere sellers. One may be able to supply it during a particular season. Others may be short of it for the time being. Another seller is getting the stock next week. The summation of these individual supply curves will constitute the market supply curve.

2. Short-Run Supply

The current supply is based on the organization’s capital expenditure on fixed assets. To fulfill the supply, firms must adjust their fixed costs to a level that will minimize the average total cost of production. The organization will shut down production when the market price goes lower than the minimum average variable of the cost of that product.

3. Long Run Supply

It refers to the supply of goods when every input is variable. In the long run,  organization will only be able to earn ordinary profit, hence there will be zero economic profit. This allows new firms to enter if they see positive economic profits, and older firms will exit the market if they face losses. This entry and exit average will keep the number of firms consistent in the market.

Factors Impacting Supply

The following factors impact the supply of a product:

1. Product Prices

As shown in the supply curve, when the price of a commodity increase, its supply increases as well. Vice-versa, supply will decrease automatically when the price of the commodity goes down. This is also understandable since most businesses manufacture products to earn profit and hence, higher prices motivate them to increase the supply.

2. Availability of Raw Material

Suppose a restaurant is popular for its onion rings. However, the market is short of onions due to the destruction of the crops. Due to this, the supply of onion rings will also go down. The supply will automatically go down if the raw material required to produce the product is insufficient. If there is sufficient raw material, then the supply will continue.  

3. Producer’s Expectations

If the product manufacturer believes that the prices of his products will increase in the foreseeable future, then he will increase production to ensure supply. Similarly, if the producer anticipates a decline in the prices and demand of a product, they will cut short the supply of the product.

4. Costs of Input

Suppose the prices of one or more materials used in a product have increased. This will force the producer to plan out the supply of that product. In the worst-case scenario, the producer might decide to stop the supply of that product. 

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Relationship Between Supply and Demand

The following points summarize the relationship between the supply and demand of goods and services in a market:

• When the supply of any product increases, the price of that product will decrease, and demand will rise due to low prices.
• If the demand for a product is too high, the supply will be short in the market. This will, in turn, increase the prices of that product. However, with exorbitant prices, the demand will fall since people will not want to pay such high prices. In turn, the price will be decreased to sell that product or service.
• Supply and demand need to be in equilibrium. The supply of goods should be almost the same as the quantity demanded.