What is the Law of Supply and Demand and how was it built?

Table of Contents

Definition of The Law of Supply and Demand

The law of supply and demand is the law of a market economy that through the adjustment of the market, the equilibrium price (also known as the market price) and the equilibrium quantity of goods purchased and sold (the quantity supplied equals the quantity demanded) will be determined.

Law of Supply and Demand

See also: What is weighted average cost of capital (WACC)? Formula of WACC

The basis of the law of supply and demand

The law of supply and demand is built on the following basis:

The demand is the solvable need of social for a certain product or service in the market at different prices and period. Personal needs are the needs of an individual or family.

When there is demand by all individuals or families for a good in an aggregate economy, there is market demand. Quantity demanded is the quantity of a good that buyers are able and willing to buy at a given price and in a given period of time.

The size of demand depends on the following factors: commodity prices, income, tastes, prices of related goods, number of consumers, expectations; in which the price of goods is a particularly important factor.

The supply of a product or service is the total number of products or services that economic actors offer to the market at different prices during a given period of time.

Supply includes both sales and inventory. The supply of a good offered for sale at prevailing market prices, due to production, level of technology, certain government regulations, expectations of price and weather is called the quantity supplied.

The sum of all the quantity supplied by all sellers in an economy is called the market supply.

The size of supply depends on factors such as price, technology, input prices, tax policy, number of producers, producer expectations about the market.

Identify and Apply the Law of Supply and Demand

When a good is sold in a market where the quantity demanded of the good is greater than the quantity supplied, the price of the good will tend to increase. A group of consumers with a higher ability to pay will push up the market price.

Conversely, the price will tend to fall if the quantity supplied exceeds the quantity demanded. This price and quantity adjustment mechanism helps the market move gradually to an equilibrium point where there will be no more pressure to cause changes in price and quantity. At this equilibrium, the producer will produce approximately the amount that the consumer wants to buy.

Applying the law of supply and demand helps managers make a decision to continue investing or conduct a certain production and business activity on the basis of the balance of supply and demand in the market.

When the supply is less than the demand in the market, there are many customers willing to pay for the goods, and the sales opportunity still exists, management may be inclined to expand or maintain production. Conversely, when supply is greater than demand, there are many goods produced but there are not enough buyers, managers may tend to reduce the output.

That is also the reason why managers have to regularly study consumer needs, tastes, preferences, predict changes in demand, discover new needs to improve  the quality and appearance, and also use appropriate formulas, designs and promotion to stimulate the demand.

See also: What is GDP? How is GDP calculated?

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