Supply and demand is “one of the most fundamental concepts of economics” and “the backbone of a market economy,” according to Investopedia. If supply and demand is so important, how come we don’t know about it?
Glad you asked because we’re here to deliver. Buckle up for our crash course in supply and demand.
Supply: What the market has
First, let’s figure out what these two terms mean individually. Supply is the availability of goods ready for consumers to, well, consume. “Supply” isn’t necessarily limited to tangible goods either; supply can also refer to services or labor.
Supply is almost always analyzed in conjunction with demand. Another important thing to note is that supply is closely tied to price. We’ll talk more about the relationships between these three terms in a bit.
Separately speaking, though, a few factors can affect the supply of a good in the market: the price of similar goods, the cost of raw materials to produce the good and the cost of the labor and energy to manufacture the good.
For example, let’s think about strawberries. In the summer months, farmers are able to supply more strawberries because they are in season. Because the berries naturally ripen at this time, the farmers don’t have to shell out major cash for fertilizers or pesticides to make the crops grow like they do in the off-season. This means lower production costs for the farmers, with the ability to supply more fruit while the berries are in-season.
Cheers to that. Sangria, anyone?
Demand: What you want
On the other hand, demand is how much of a certain good or service that the consumer wants. Demand is used as a gauge to determine our wants and desires. How mysterious. Demand isn’t, however, a Magic 8 Ball blindly guiding us, it is affected by the size of the population, consumer preferences and price. These three, in turn, influence our demands.
With population, it’s the everyday case of mo’ people, mo’ wants. Now, that could either mean a greater distribution of wants or a higher concentration of people wanting a specific good (therefore, driving up demand).
Quite simply, people can change their minds. Who’s to say that the goods and services you have a huge demand for Friday evening are going to be the same come Monday morning? As consumer preferences fluctuate, so does the demand for goods and services.
For example here, look no further than your beach trips this summer. Are you going out to buy a bikini and sunblock in January? Not unless you’re going on some kick-ass vacation.
Price is also an obvious contributing factor in the demand equation. The higher the price of a good, the lower the demand is at that price (proving that there is still a frugal, quarter-hoarding college student in all of us).
Price: Finding the sweet spot
With consumers trying to make purchases at dirt-cheap prices and suppliers trying to make a sizable profit off of sales, it takes trial and error to make sure everybody is happy. Setting the price for a good is how we get supply and demand to play together nicely in the sandbox.
If prices are too high, demand is low and suppliers can’t sell enough products to make a profit. Vice versa, if prices are too low, demand increases but at the expense of the supplier potentially not being able to cover production costs.
Supply and demand intersect at the equilibrium price. When this happens, the market for the specific good is operating efficiently. Goods that are being supplied are exactly meeting the consumer demand, and there is no economic waste.
Hold the “Hallelujah” chorus, though. Hate to break it to you, but marketplace equilibrium is a cookie-cutter image that can only be reached theoretically. In the real world, the market is in a state of perpetual flux, reacting to constant changes in supply and demand.
Why does it matter?
While we might never see marketplace equilibrium in all its glory, it’s important to remember that these same forces of supply and demand have huge implications in capitalist markets.
These seemingly simple terms are the cogs that turn the capitalist economy. As you remember, capitalist economies favor competition. With consumers and producers constantly trying to get the best deals and maximize value, this causes the market, rather than the government, to dictate the distribution of scarce goods. That’s ok, though, because market competition will allow prices to fluctuate in order to move closer towards the economic unicorn of market equilibrium.
So the next time Uncle Jerry tries to tell you you know nothing about economics, school him with some facts on supply and demand.
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