SUPPLY AND DEMAND

The concept of supply and demand is arguably the most important in economics. Few have not heard it before, but what does it really mean. Frankly, supply and demand is a very easy concept to understand. First, the law of demand, which states that the lower something's price it, the more people want it. Now, this is not practically true (for example, nobody wants to buy really outdated cars, even though they're cheap.) We must add that, only given no other factors to consider is this law true.

As just about any other thing in economics, demand can be represented in a graph. The following demand curve shows the relationship above. As the price goes up, demand comes down and vice versa. As demand goes up, price comes down. A demand curve like this can be created by getting a variety of products, plotting them on the graph (their price and the amount of the product purchased) and fitting a line to these points.

Fig 1.2.1-demand curve

There is also a law of supply. The law of supply states that the higher something's price is, the more it will be supplied. The concept of supply involves getting many factors of production: resources, labor, etc., getting these things together to make a product which is then demanded. The law of supply is because people want to charge the highest price possible for the least amount of production possible. As prices increase, so do the expectations for profits. As people expect more profits from a product, they naturally produce more of that product. They produce this high-priced product rather than a low-priced one. Of course, if all products' prices rise evenly, than no change would happen. Again, this model assumes there are no other factors considered.

Fig 1.2.2-demand curve

A market-wide analysis of these trends can be built by combining individual graphs. The supply and demand curves of each individual is different, but what is important in an economy is that something is being sold to someone, so the to get a good picture of the market, we combine the add the individual demand and supply curves. (So person A buys 10 of something at 5 money units each, but person B buys only 6; adding everyone in an economy yields say, 1000000 purchases of the product at 5 monetary units).

Note that the previous discussion took place under the condition that no other factors are considered. A constant graph shows that price affects supply and demand in precisely defined ways. Real life, as always, is different from simple theory. There are certain factors that does not only cause movement on the graphs (meaning movement occuring on the line, i.e. the price goes up or down and the supply and demand changes, following the graph exactly), these factors actually shift the line itself. Basically everything in the world is a shift factor. There are many important shift factors, however, like people's overall income and their ever-changing preferences of one product over another.

Supply, demand, and prices always work together in a real life economy. We can put both supply and demand on the same graph to illustrate this point of how they work together with price.

Fig 1.2.3-demand curve

Note the point at which the supply line and the demand line meet. That is the point of equilibrium, the perfect point of balance. However, the economy is never completely balanced. Anywhere outside the balanced point, there is a disparage in numbers between supply and demand (remember, supply is directly related to price while demand is inversely related). Thus, market forces must push things towards the equilibrium point. The first law of supply and demand states: when demand is greater than supply, prices rise and when supply is greater than demand, prices fall. These forces that push markets towards equilibrium also depend on how great the difference between supply and demand is. The second law of supply and demand, then, states: the greater the difference between supply and demand, the greater the forces on prices are. Naturally, then, the third law would say: when supply is the same as demand, prices do not change.

These theories apply to the real economy very well. When there's is an excess of supply and no demand for it, then suppliers have to drop the price until people do want to buy all their extra stuff. The suppliers are desperate to get all the excess products off their hands. However, when there's great demand and no supply (there's scarcity), people are willing to pay any price, so long they get the desperately needed, but rare, product. Thus, the market for any product tends to push its price towards equilibrium. Of course, perfect equilibrium is never reached as we've demonstrated earlier; the supply and demand curves are constantly shifting. The market adjustment is always going on. To get a good picture of how supply and demand on markets work on in an economy, look at the following picture:

Fig 1.2.4-the production process

Supply and demand comes into play in all markets. The factor market, firms buy factors of production like labor and natural resources. They then produce them into marketable goods for the consumer to buy in the goods market. Individuals also contribute to the goods market.