One of the more important concepts in all economics is supply and demand.
Chances are you probably have at least some familiarity with the terms.
Perhaps you’ve heard them used in conversation, a segment on the evening news, or maybe you’ve
taken a class in microeconomics.
If you live in the United States or any other country whose economic system resembles a
market economy, then you’ve experienced first-hand supply and demand at work.
Recall that in a market economy a nation’s government generally doesn’t get involved
in setting prices for markets.
Instead, markets rely on supply and demand to determine how to allocate resources and
make decisions regarding price.
Now that you know some of the theory behind supply and demand lets define them.
Supply represents how much of a good or service a seller is both willing and able to provide
at various price levels.
Now there are two important components to this definition.
The first is willingness, which refers to a desire.
So in order for a firm to be considered one who factors into supply they must have the
desire to provide a good or service to consumers.
The second component is ability, which refers an actual ability to provide a good or service.
If a firm has a desire to provide a good or service, but lacks the financial means necessary
to do so, then it would not be considered according to this definition.
Now being that firm’s are run by people like you and I, and we all respond to incentives,
sellers` respond to markets in somewhat predictable ways.
As the price that the seller can charge for a good or service increases, they are willing
to provide more of that good or service.
But as this price decreases, than sellers are less willing to expend the resources to
offer the good or service.
This is because a firm’s profit margin decreases if they’re forced to reduce prices.
At a certain point, firm’s find it unwise to provide goods or services and it’s likely
that better opportunities exist for the firm.
However if the price a seller can charge increases, then firm’s will likely enter the market
since they have a greater chance at earning profit.
This movement of the quantity that a seller will provide at various price levels is called
a supply curve, and is represented by an diagonally upward sloping line.
But without its counterpart supply would be virtually meaningless.
So lets talk about demand.
Demand represents how much of a good or service a buyer is both willing and able to purchase
at various price levels.
Again, the presence of both willingness and ability is necessary for there to be true
demand.
For example, lets say I wanted to purchase a brand new car but my credit is poor and
I lack the cash needed to complete the transaction.
You would say that although I have the willingness or desire to purchase a new vehicle, I lack
the ability to do so.
Now as consumers we obviously respond to incentives as well.
Naturally, our incentive is acquire as many goods and services as we can without giving
up our scarce resources.
So we will purchase more of something as its price decreases, while we will purchase less
of something as its price increases.
This is exactly why retailers run sales promotions, because they realize that doing so will increase
demand for goods and services.
Now the idea that buyers will demand more goods as the purchase price decreases is characterized
by the demand curve.
A downward sloping line that looks a bit like this.
It’s this tug of way balancing act that takes place between supply and demand that
explains how prices are set.
Although each group, sellers and buyers, would rather acquire as much money or spend as little
as possible this wouldn’t work.
Because the other party is necessary to complete the transaction.
Although buyers would likely purchase a large amount of goods at low prices, sellers wouldn’t
provide them.
And likewise, although sellers would be clamoring at the chance to sell goods and services at
premium prices, buyers may not be willing to purchase them.
The point at which both parties compromise and the supply and demand curves intersect
is called the market price.
At this price, both parties are willing and able to sell and purchase goods at similar
prices.
We experience this on a small scale when we go to the store and make a decision to purchase
a tablet computer or a new car.
On a larger scale, if a sellers products go unpurchased, this could be a reflection that
buyers don’t have adequate demand at the offered price.
Again, it’s this interaction between buyers and sellers that helps us make decisions on
resource allocation as well as pricing.
One thing I’ll add is supply and demand is a helpful in interpreting, understanding,
and articulating how markets operate, but they don’t provide tactical application
for a firm trying to set prices.
With that said, an understanding of supply and demand is important to grasping some of
the more advanced concepts in economics and understanding how we allocate resources.