In economics market is a wonderful tool operated by an invisible hand in a competitive world. It involves different buyers, sellers and other economic actors who come together at one place and trade in a given good or a service by reinforcing efficient allocation of resources. Supply & demand of goods or services is what the economics all about. This concept of supply and demand is the basic concept which lays the foundations of whole story in economics. Supply and demand is an economic model of price determination in a market economy.
SUPPLY refers to the total amount of a specific good (or a product) available in the market place at a given point of time. This is how much the economy can offer to buyers of the good.
DEMAND refers to the total amount (quantity) of a good that buyers (or consumers) desire in an economy. Quantity demanded of a product is the amount of that product people are willing and able to buy at a specified price.
The terms supply and demand are usually studied in economics as a relationship between price and quantity of the concerned good. Demand relation specifies the relation between the price and quantity demanded by the buyers in the economy while supply relation specifies the relation between the price and quantity supplied by producers or the intermediaries.
In any market, it is assumed that the demand & supply mechanism will allocate the resources in the most efficient way possible. Let’s dig a little bit more into the wonders of supply and demand and the law governing these concepts.
The law of demand states that keeping other factors constant (ceteris paribus), when the price of a good falls, the quantity demanded by the buyers for that good rises. Similarly, as the prices of the good rises, the quantity demanded for the good falls. The reason behind this law is a whole new story.
When the price of the good 1 increases, the opportunity cost for the consumer also increases as to buy the same good the consumer has to shell out more money. Since resources are limited while wants are unlimited, the consumer will have to forgo the consumption of the commodity (say good 2) he prefers more in order to buy good 1. This is what a rational consumer would not do.
The relation between demand and price of a commodity can be explained through the following graph:
The diagram clearly shows a negative relation between the amount of good 1 demanded by consumers and its price. Higher the price of the good the lower will be its quantity demanded. This downward sloping curve is known as the demand curve which is the graphical representation of the price and quantity demanded of a particular commodity.
According to the law of supply, when the price of the commodity rises then the quantity supplied by the producer rises. Similarly, a fall in the price of the commodity leads to a fall in the supply of that commodity. The reason behind this law is that at a higher price a rational supplier in the market economy would prefer to sell higher amount of the commodity as this will increases his revenue. This supply relationship can be explained through following graph:
Clearly the slope of the graph is upwards. This shows the positive relationship between price and quantity supplied. The graphical representation of price and quantity supplied at a point of time is known as supply curve.
Now here are some of the factors that determine or affect the demand of a commodity by the consumer in the economy:
Let’s go through some of the theoretical assumptions of law of demand:
There are many instances when law of demand fails to work i.e. there is no inverse relationship between price and demand. Some of the cases are as follows:
As in the case of law of demand, we need to make some assumptions for the law of demand in order to carry out theoretical analysis of supply and demand.
In economics, it is vital to understand the difference between shifts and movements as both explain two different market phenomena:
1. MOVEMENTS ALONG THE CURVE: A movement along the curve refers to change along the curve. On demand curve, movement denotes a change in the price and quantity demanded from one point to other on the curve without any change in the demand relationship.
Similarly, on supply curve, movement means that supply relationship remains constant.
The movement in any curve occurs when a change in quantity supplied is caused only by change in the price, and vice versa.
2. SHIFTS OF CURVE: Shifts in demand or supply curve occurs when changes in quantity supplied or quantity demanded of a good change by factors other than price of that good.
In the above figure, price of commodity is P*, and if the quantity demanded for the commodity in consideration increases from Q1 to Q2 due to any factor other than the price of the commodity, then the demand curve shifts Rightwards from D1 to D2, while the price remains the same.
The above diagram shows a shift in supply curve towards left due to a factor other than the price of the commodity. The price P* is same as before the shift. The supply curve shifts from S1 to S2.
A shift in the curve may be upwards or downwards as shown.
An equilibrium in economics is a state when the supply and demand are balanced and there will be no change in the values of economic variables in the absence of any external force.
At the equilibrium point, allocation of goods is most efficient as the amount that the suppliers are willing to supply at the given price is exactly equal to the amount that the consumers are willing to buy.
As is shown in the diagram, equilibrium occurs at the intersection of demand and supply curves. At this intersection point, the equilibrium price is P* and the equilibrium quantity is Q*.
In reality, markets never remain at equilibrium as the prices keep fluctuating in relation to fluctuations in demand and supply.
Disequilibrium is a state where some forces (external or internal) cause markets to get out of balance i.e. prevents the market from achieving equilibrium.
In economics, excess supply or economics surplus is a situation in which the quantity supplied by supplier is more than the quantity demanded by the consumer. In this case price is above the equilibrium level determined by supply and demand. In this case goods are not being efficiently allocated as price is set too high.
At price P1, the quantity of a good supplied by the suppliers is denoted by Q2 and the quantity demanded by consumers is denoted as Q1. Clearly Q1 < Q2. Too much is being produced and too less is being consumed.
In economics, excess demand or shortage is a situation where demand of a good exceeds its supply in a market. In this economic situation, price of a good is so low that the production of the good has become less lucrative and thus supply is low. On the other hand, low price of the good increases the demand of that good.
In the above figure, at price P1, quantity demanded is Q2 and quantity supplied is Q1. Clearly, Q2 > Q1.
Excess demand, like excess supply, is a case of market condition when there is inefficient allocation of goods among economic agents.
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