What is the Law of Supply and Demand?
Supply and Demand, also known as the law of supply and demand, are two primary forces in the market. The concept of supply and demand is an economic model to represent these two forces. This economic model discloses the equilibrium price for a given product. It is a price point where the amount consumer demands for goods mees the price suppliers are willing to accept to produce the desired quantity of that good. The supply and demand graph shows why prices for an apartment rises quickly in the market when there is a lot of demand but little supply or how prices for good like oil can fall when refiners discover new deposits of oil, enhance production, or release millions of barrels of crude oil held in reserve. Supply and demand graphs not only represent price but also represent a decrease in wages when there is high unemployment, or how the interest rate affects the supply of money.
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What is the Law of Demand?
The law of demand describes the relationship between the quantity demanded and its price. According to Alfred Marshall, the law of demand states that the quantity demanded decreases with rise in price and increases with fall in price. Hence, it represents an inverse relationship between quantity demanded and price.
Assumptions of Law of Demand
No change in the taste and preference of the consumer.
No change in customs
Income of the consumer remains constant.
No substitutes of the commodity are there
No change in the price of other related goods
Law of demand does not hold those goods which confer social distinction.
No possibility in change in the price of the product being used
No change in the quality of the product
The habits of consumers remain unchanged.
The law of demand works only in these conditions. If there is a change even in one of these conditions, it will stop working.
What is the Law of Supply?
The law of supply states that other things being constant, the supply of commodities rises i.e. expands with rise in price and falls i.e contracts with fall in price.
In other words, the law of supply states that higher the price of the product higher the supply and lower the price of the product lower the supply.
The law of supply suggests that supply changes directly with change in price. Hence, a higher quantity of goods are supplied at a higher price and vice versa.
Assumptions of Law of Supply
Important assumption of law of supply are as follows:
No change in the price of the factor of production.
No change in production technique.
No change in transportation cost.
No change in cost of production
Scale of production is constant. i.e. fixed.
No speculations about the future changes in the price of the product.
Prices of other related goods remain constant i.e. no change.
No change in government policies related to the price and production of the commodities.
No change on the firm’s goal.
Exception To The Law of Supply
According to the general rule, quantity supplied increases with rise in price and decreases with decrease in price. However, in certain cases, the positive relationship between quantity supplied and price may not hold true.
The law of supply does not apply to agricultural products as their production depends on climatic conditions.
In the case of perishable goods like vegetables and fruits, suppliers are willing to sell more even if the price of these goods is falling.
Rare and precious articles also do not fall under the law of the supply category. Even if the price of rare articles like paintings of Monalisa increases, the quantity supplied of such goods cannot be increased.
Production and supply in backward countries cannot be increased with rising in prices due to the shortage of resources.
Demand Supply Curve
Let us now discuss the demand and supply curve along with their graphical representation:
Demand Curve And Its Slope
The demand curve is the graphical representation of the relationship between different quantities of commodities at different possible prices. The concept of demand curve includes:
Individual Demand Curve
Market Demand Curve
Let us understand the Individual And Market Demand Curve in detail.
Individual Demand Curve
The individual demand curve is a curve representing different quantities of commodities that one particular buyer is ready to buy at a different possible price of the commodity. In the individual's demand curve diagram given below, the quantity of the commodity is shown on the horizontal axis and price on the vertical axis. The curve in red represents the individual demand curve.
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In the above diagram, the demand curve slopes downward. It shows the inverse relationship between price and quantity demanded. The 4 units of quantity are demanded when the price is 40 per unit while only 2 units of a commodity are demanded when the price increases to 80 per unit.
The demand curve slopes downward from left to right indicating the inverse relationship between the price of the commodity and the quantity demanded. Higher price leads to falling in quantity demanded whereas a fall in price leads to a rise in quantity demanded of a commodity.
Market Demand Curve
Market Demand Curve is defined as the horizontal summation of the individual demand curve.
It represents the various quantities of commodities that all buyers are ready to buy at different possible prices at a given point in time.
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The figure given above shows the market demand curve. Here Consumer 1 and Consumer 2 are two individuals in the market. Figure (1) is Consumer 1’s demand curve, Fig (2) is Consumer’s 2 demand curve, and Figure (3) is the market demand curve. Here, when the price is 1 per unit of good X, Consumer 1 demand is 2 units and Consumer 2 demand is 1 unit. Accordingly, total market demand is 1 + 2 = 3 units. Whereas when the price is 2 per unit market demand is 1 + 0 = 1 unit. The market demand curve slopes downward as it represents the inverse relationship between the price of the commodity and the quantity demanded.
Supply Curve
The supply curve is the graphical representation of the relationship between different quantities of commodities offered for sale at different possible prices of that commodity. It represents the positive relationship between the price of a commodity and its quantity supplied. The concept of supply curve includes:
Individual Supply curve
Market Supply Curve
Let us now discuss Individual And Market Supply Curve in detail below:
Individual Supply Curve
Individual supply curve is a curve representing different quantities of commodities that one particular producer or supplier is ready to supply at a different possible price of the commodity. In the individual supply curve diagram given below, quantity of commodity supplied is shown on X-axis and price on Y-axis. SS is the supply curve.
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In the above diagram, the supply curve slopes upward. It is drawn as a straight line representing that more commodities are supplied at higher prices. In the above diagram, we can see that if the price is Rs.30 per unit, the firm is ready to sell 5 units of commodities. On the other hand, if the price increases to Rs.40 per unit, the quantity supplied increases to 10 units. Hence, the individual supply curve is representing the positive relationship between the price of a commodity and its quantity supplied i.e higher quantities are supplied at higher prices and vice versa.
Market Supply Curve
The market supply curve is a horizontal summation of the individual supply curve representing different quantities of commodities that all the producers or suppliers in the market are ready to supply at a different possible price of that commodity.
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In the above diagram, we can see that when the price is Rs. 30 per unit, market supply is (5 + 10) = 15 units whereas when the price increases to Rs. 40 per unit, the market supply increases to (10 + 15) = 25 units of commodities.
Conclusion
Supply and demand are two important topics to understand as it helps us to know how the demand and supply of commodities changes with change in price. Also, it helps us to understand how the economy works. The Covid-19 pandemic enables many people to understand how quickly the economy changes. These two terms will be the most fundamental concepts in economics.
FAQs on Supply and Demand
1. What is the law of supply and demand in economics?
The law of supply and demand is a fundamental economic principle that describes the relationship between the availability of a product (supply) and the desire for it (demand). The law of demand states that, all else being equal, as the price of a product increases, the quantity demanded falls. Conversely, the law of supply states that as the price of a product increases, the quantity supplied by producers rises. The point where these two forces meet is called the equilibrium price.
2. Can you give a real-world example of supply and demand?
A classic example is the market for new smartphones. When a popular brand releases a new model, demand is very high, but initial supply is limited. This imbalance allows the company to set a high price. Over time, as the supply increases and the initial excitement fades (demand stabilises), the price often decreases. Similarly, older models see a drop in price as demand for them falls and supply remains plentiful.
3. What is the difference between an individual demand curve and a market demand curve?
The primary difference lies in their scope. An individual demand curve graphically represents the quantity of a good that a single consumer is willing to buy at different prices. In contrast, a market demand curve represents the total quantity of that good that all consumers in the market are willing to buy. It is calculated by the horizontal summation of all the individual demand curves.
4. How does a supply curve differ from a demand curve?
The main difference is the relationship they illustrate, which is reflected in their slope. A demand curve has a downward slope from left to right, showing an inverse relationship: as price decreases, quantity demanded increases. A supply curve has an upward slope, showing a direct relationship: as price increases, quantity supplied also increases.
5. What are the key factors that can cause a shift in the demand curve?
A shift in the demand curve, meaning a change in demand at all price levels, is caused by factors other than the item's own price. Key factors include:
- Changes in consumer income.
- Shifts in consumer tastes and preferences.
- The price of related goods (both substitutes and complements).
- Consumer expectations about future price changes.
- The total number of buyers in the market.
6. What happens to the price of a product if demand increases but supply stays the same?
When demand increases while supply remains constant, a shortage occurs because more consumers want the product than what is available at the current price. This excess demand puts upward pressure on the price. As the price rises, producers are incentivised to supply more, and some consumers will drop out, until a new, higher equilibrium price is established.
7. Why is the 'ceteris paribus' assumption crucial for understanding the laws of supply and demand?
'Ceteris paribus' is a Latin phrase meaning 'all other things being held constant.' This assumption is crucial because it allows economists to isolate the relationship between just two variables: price and quantity. For the law of demand, it assumes that income, tastes, and prices of other goods do not change. Without this, it would be impossible to determine if a change in quantity demanded was a result of a price change or another factor, making the analysis unclear.
8. Why doesn't the law of supply apply to agricultural goods or rare items?
The law of supply has exceptions where a higher price does not lead to a higher quantity supplied. This occurs for several reasons:
- Agricultural Goods: Their supply is heavily dependent on climatic conditions, seasons, and harvest yields, not just price. A farmer cannot instantly produce more wheat just because the price goes up.
- Rare Articles: For items like a famous painting or a rare antique, the supply is fixed. No matter how high the price gets, more cannot be produced.
- Perishable Goods: Sellers of goods like fruits and vegetables may be willing to supply more at a lower price to sell their stock before it spoils, which contradicts the law of supply.
