Law of Supply and Demand

The law of supply and demand refers to one of the core concepts in economics explaining the relationship between demand, supply, and price of products and services. It integrates the concepts of the law of demand and the law of supply. 

In simple terms, while all other factors remain constant, the law of demand holds that when the price rises, demand falls. At the same time, the law of supply states that when the price increases supply increases. The direct relationship between the price and supply creates an upward sloping supply curve. At the same time, the inverse relationship between price and demand results in a downward sloping demand curve.

• The laws of supply and demand are basic concepts helping businesses analyze the best-selling price, the ideal supply rate, and the readiness of a market for a new product.
• The law of demand explains that when the price increases demand decreases.
• The law of supply explains that when the price increases seller increases the supply to obtain maximum profit.
• Equilibrium prices showcase the price at which supply and demand are equal and satisfying in the market.

The law of supply and demand gives insight into the process of price and quantity determination in a competitive market through buyer and seller interaction. For example, the consumer often chooses products and services which come in affordable price tags with desired utility. In contrast, the seller wants to sell their products and services at the maximum possible price.

It is where the equilibrium price comes into significance. It is the price at which supply equals the quantity demanded in the market.  When an item is in low supply, its demand is great, which increases its value, hence its price. Producers of such commodities tend to increase supply to optimize profits, up to a point where the market is saturated with the product, and its value reduces due to too much supply.

The theory of supply and demand do not operate in a vacuum but are subject to other external forces that might influence one. Nevertheless, the four fundamental concepts explaining the correlation between demand and supply are a way of explaining what demand and supply are in an easy-to-understand format.

• Demand increases, and supply remains the same: In a competitive market, this will cause an increase in the price. The shortage of products increases the value of the product.
• Demand decreases, and supply remains the same: In this situation, the price reduces. If the demand continues to decline, there will be a surplus of the product in the market, subsequently dampening the product's value.
• Supply increases and demand remains unchanged: The easy availability of a product causes a decrease in its price, manifesting an oversupply scenario if the demand remains intact for long.
• Supply decreases and demand remains unchanged: When supply decreases, and there is no increase or decrease in demand, the price will increase.

These four basic laws are often affected by external factors such as government intervention. As a result, while the majority of products follow the law, some do not. These are usually Giffen goods, Veblen goods, and essential goods.

The laws of supply and demand example can find in the electric cars market. Barely a decade or so ago, very few cars or models in supply were purely electric. Those that were (or which were hybrids) commanded high prices. Hence, the demand was also less.

As more and more people have started embracing electric vehicles mainly due to their environmentally friendly attributes, the demand started rising, the firms have drastically ramped up the production of the cars, and subsequently introduced lower-priced better-performing versions, even though battery supply bottlenecks are causing hindrance to the production. Furthermore, government subsidies also made it cheaper to manufacture and purchase vehicles. As a result, the overall global market for EV increased significantly from 2010 to 2020.

The future prediction of an increase in demand for EVs globally made it easier for the manufacturer to use economies of scale to carry out expensive research and development to introduce usable, stable and provided excellent real-world experiences. Furthermore, with announced launches of new EV models spiking, automakers and suppliers are increasing their global footprints in target markets by localizing the production of vehicles and components. Such measures ensure the supply chain strengthening process.

For businesses, it is vital to consider the supply and demand scenario when planning to enter a particular market. Understanding it in addition to other factors that could influence supply and demand will help to have a positive impact on the selling price of the product, which in turn affects a seller's bottom line. The point would be to find out the probable economic equilibrium. If this equilibrium does not lead to profit-making, starting such a business would be risky.

Many firms have gone under simply by investing a lot of capital in markets where the demand for their products may not be there. Lack of demand means having meager sales even after spending a lot in marketing, setting up factories, and more. Business experts can find out what demand is for a product before penetrating that market and check for the possibilities that will cause a positive shift in the demand or supply curves hence manipulating the theory of demand and supply.

This has been a guide to the Law of Supply and Demand and its Definition. Here we explain the four basic laws of supply and demand and why it is vital with examples. You may also have a look at the following articles to learn more –

• Aggregate Supply
• Price Elasticity of Supply
• Elastic Demand