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What is Supply and Demand?
Supply and Demand are two of the main elements of one of the basic rules for a economy with a free market. These two make the Supply & Demand curve, which is the number one rule to define price and the quantities produced and consumed.
It is one of the basics that you have to know if you want to understand economics.
The supply is the quantity of a product or a service available in the market, it is the quantities that the supplier will make available in the market. However the supplier should never produce or offer the service if there is no demand, the demand is essential because it is the need for the existence of a product or a service.
The demand is the quantity of a product or a service that the clients need or want, it is the term for the quantities searched in the market by the potential buyers.
The supply and the demand always depend on one simple thing, Price. In order to have quantities supplied or demanded, the price has to be attractive.
The supply is the group of people or enterprises that offer something. It is the supplier of the product, that can vary from a bicycle to a "work hour"(Labour Market).
- In a simple flea market the supplier is the seller that is offering a bunch of products.
- In the Labour Market the supplier is the worker that is offering himself to do something, to work.
The supplier has one main goal, maximize its revenue and they will want to avoid producing too much or less than the optimal point of the market. In the supply and demand simple curve the Supply is considered as one element, even if there are one million suppliers the market only considers "The Supply".
Example Non-Straight Line
Equation of the Supply curve
The simple equation of a Supply Curve is:
If Elasticity is 1, you get Q=P, so the quantities supplied will be equal to the value in Price.
Other equations may include other variables like these:
- Q=E*P+B, B is the minimum quantity produced, even when the Price is 0. If B is negative, the minimum price for production will be P=-B/E, since Q=0.
- Q=E*P2-P, this is used in non straight curves. You can find an example in the picture.
- P=B+C*Q, which is equal to Q=(P-B)/C, in this equation C has a similar effect as elasticity.
Explanation for the Supply Curve
Reasons for increasing Quantity:
- If the prices are higher there are more suppliers trying to sell the product.
- As salaries rise there are more people wanting to work.
Reasons for decreasing Quantity:
- Lower prices lead to less suppliers in the specific markets.
Reasons for an increase in Price:
- In a normal free market, one main reason for the prices rising is the lack of product quantities, but in the supplier point of view, prices rises if he expects to increase revenues.
- The expansion of the market leads to higher numbers in quantities and prices.
Reasons for a decrease in Price:
- The supplier would never want to decrease the products price. In economics the supplier lowers prices to increase quantities, but the basic Supply does not consider other variables. The reason for a decrease in price is almost always due to other variables like demand or externalities.
Elasticity (Economic View)
The elasticity in economics, and specially in the Supply and Demand, is the measurement of how changing one variable may change another. In the simple curves of Supply and Demand the Price elasticity measures the change in Quantities after a change in Price.
If elasticity is 0, a change in price will lead to a zero change in Quantities. That may happen with a product like water, people always need to drink water even if the price doubles.
Elasticity is 1 when there is an exact change in quantities and price, that is if the price changes by one, the quantities also change by 1.
The effect of Elasticity in Supply
The supply curve above shows a change in quantities of 10, as prices rise 1 unit. The elasticity in that case is "10", it is considered a "normal" elasticity for supply when the number is between 0 and infinite. Here you can see other examples of Supply curves:
- Negative Elasticity, this happens when the supplier offers less when the price rises, that may happen in the luxury goods market. In order to make a product more desirable, there may be a change to a higher price and lower quantities, so it is considered an exclusive.
- Perfectly Elastic/Infinite Elasticity, the smallest change in price can change quantities from maximum possible to zero. The supplier may act this way if there is a maximum price imposed he can charge and under that price it is not profitable producing.
- Perfectly Inelastic/Zero Elasticity, the Supply can charge any price, and the quantities will always be the same. One of the best examples in drinking water, it does not matter the price, people will always need to consume a determined quantity. Another example is if the Labour market is composed by just one worker eager to work, he will work the same time for any price.
The simple word to describe the Demand is "Consumers", it is the people or enterprises that want to consume the product. The demand can be:
- The person that wants to buy a bicycle.
- The Enterprise that is looking to hire a person.
- The client that wants to buy a coffee.
The simple way to see demand is to consider a product like a simple bicycle or other product that is simple to buy and sell in the market. Products like water or food are harder to exemplify, products like these have a strict demand, nobody will buy less of these products than the needed to survive.
Explanation for changes in the Demand Curve
The demand curve moves negatively in quantities as the prices get higher. These are simple reasons for the changes in the Demand curve.
Reasons for an increase in Quantity:
- Prices are getting lower, so more people are available to buy the product.
Reasons for a decrease in Quantity:
- If the prices are too high, people prefer to spend the money somewhere else.
Reasons for an increase in Price:
- If there are only a few products or resources, the richer people that are available to pay more will pay more than the others, so price for the product will increase.
- In a market like Labour, the enterprises will pay more for good workers if they are scarce.
Reasons for a decrease in Price:
- The excess of products leads to a decrease in Price in order to achieve a larger potential number of buyers.
Elasticity on Demand function
The elasticity of the demand is the same as in the Supply but in a contrary tend. The Demand will want more if the price is lower, so a elasticity of "-1" will be the simple way of the Demand curve, if the price lowers by 1, the quantities demanded will increase by 1. So instead of considering strange the negative elasticity, it is rare to find a positive Elasticity.
- Positive Elasticity, this may happen in markets like low quality products, if the prices get too low, the consumer may distrust the quality of the product and will want to buy less.
- Perfectly Elastic/Infinite Elasticity, the demand may act this way if there are substitute goods, with similar prices, that way if the price lowers or gets higher, the consumer may prefer other product.
- Perfectly Inelastic/Zero Elasticity, the example used in Supply can also be used in the Demand. The drinking water is consumed at a strict quantities, even if the price varies.
Example of Supply and Demand
The Market equilibrium is achieved when in the same graph the two curves meet. That is the optimal point and the market equilibrium, where the supply and demand functions are both satisfied.