Supply and demand are both very important to economic activity. Supply is the total amount of a particular good or service available at a given time to consumers at a given price. Demand is a representation of a consumer's desire to purchase goods and services; it acts as a measurement of a consumer's willingness to purchase a specific good or service at a given price.
These two economic forces influence each other; they are both important for the economy because they impact the prices of consumer goods and services within an economy and the quantities produced and consumed.
Key Takeaways
- Supply and demand are both keys to understanding the economy because they reflect the prices and quantities of consumer goods and services within an economy.
- According to market economy theory, the relationship between supply and demand balances out at a point in the future; this point is called the equilibrium price.
- Economists and companies analyze the relationship between supply and demand when making strategic product decisions.
Price and Quantity Produced and Consumed
Consumers may exhaust the available supply of a good by purchasing a given good or service at a high volume. This leads to an increase in demand. As demand increases, the available supply also decreases.
While an increased supply may satiate available demand at a set price, prices may fall if supply continues to grow. But if supply decreases, prices may increase. Supply and demand have an important relationship because together they determine the prices and quantities of most goods and services available in a given market.
According to the principles of a market economy, the relationship between supply and demand balances out at a point in the future. This point–at which supply is equal to demand–is called the equilibrium price.
At the equilibrium point, the market price for a given good ensures that the quantity of goods supplied is equal to the number of goods demanded. At this point, prices are perfectly set to interest consumers to purchase goods; at the same time, ensuring that companies produce neither too much nor too little product.
Both economists and companies analyze the relationship between supply and demand when making strategic product decisions. The assumption behind a market economy is thatsupply and demandare the best determinants of an economy's growth and health.
Demand usually decreases due to decreases in disposable income, the availability of substitute goods at a lower price, an increase in the price of a complementary good, or changes in preference.
Consumer Behavior Influences Demand
One way that companies or economists might analyze this relationship is to create graphs that chart the equilibrium price of certain goods and services in order to determineproduct development and their production schedule.
Consumer behavior dictates which products are produced and sold because consumers create the demand that companies attempt to meet. As a result, companies may study consumer behavior in an attempt to understand the current demand and predict future demand. It is vital that companies maintain the capacity to produce enough of a good or service that they can satisfy consumer demands.
Supply and demand are two sides of the same market coin. Generally, supply is how much of something is available or will be produced at a certain price. Demand is how much of something people want to purchase or consume at a certain price.
One way to develop a more precise relationship between the two is to consider how the price of something affects its supply and its demand. Generally when the price of a good goes up, so does the supply, since firms are willing to create more when they can sell at higher prices.
But when the price of a good goes up consumers will, at the same time, generally demand less. It is the interaction of supply and demand that determines how much will be produced and consumed and at what price, converging to a state known as equilibrium.
How Do Supply and Demand Affect the Economy?
If supply increases, then prices go down, if demand remains unchanged. The opposite occurs if supply decreases. If demand increases, then prices go up, if supply remains unchanged. The opposite occurs if demand decreases.
What Happens If Demand Is Higher Than Supply?
If demand is higher than supply, then prices increase because there is not enough of a good or service for everyone demanding it, so people are willing to pay more to obtain that good or service. As prices go up, this gives producers an incentive to sell more of their goods or services, so they increase production, which increases supply, which brings the prices down.
What Is Inelastic in Economics?
Inelastic in economics refers to the phenomenon that a specific product or service is fairly immune to changes in price; meaning that if the price goes up or down, the demand for that product will remain the same.
The Bottom Line
Supply and demand are both important components of the economy and go hand in hand; one is not more important than the other. They both work in tandem and influence the prices of goods and services as well as determine how much of goods and services are produced and consumed.
When demand increases, so do prices, if supply stays the same. This eventually leads to an increase in production (supply increasing), which brings down the price. If supply increases, prices go down, if demand stays the same. This eventually leads to a decrease in production (supply decreases).
