The concepts of supply and demand form the basis of every initial Economics 101 lecture, as well the basis of a market-based economy. Markets are made up of sellers and buyers, and sellers provide supply to meet buyers’ demand. Supply refers to the amount of products or services offered by the market, while demand refers to the amount buyers are willing to purchase at a certain price. Both supply and demand can be represented visually as curves on a graph – supply slopes upward, while demand slopes downward.
Law of Demand
In microeconomics – the field of economics concerned with the decision-making patterns of individual buyers and businesses – the law of demand states that when the cost of a product or good increases, demand for that product or service decreases and vice versa, when all other factors are equal. This means that there’s an inverse correlation between price and the demand For example, when the price of coffee goes down, consumers buy more coffee, but when the price goes up, they buy less. The law of demand’s “all other factors” refers to income, taste and substitution and complement price, all of which potentially affect consumer behavior; in contrast, the law of demand is only concerned with price and quantity.
When demand is represented visually on a graph, price is on the Y vertical axis and quantity is on the X horizontal axis. When price is high, demand is low, so the curve begins at the top of the Y axis. As price decreases, demand increases, causing the curve to fall as it moves outward along the X axis. The downward-sloping demand curve reflects the maximum price that a consumer would pay for a product or service – also known as the reservation price – as well as the maximum amount of a product that a consumer would pay for a certain price. Demand curves also show consumer surplus, or the difference between the maximum cost a consumer is willing to pay and the actual market price, according to Thomas McGahagan at the University of Pittsburgh.
Law of Supply
In contrast, the law of supply indicates that as the price of a product or service increases, the quantity of that product of service will also increase – again, when all other factors are equal. When a business makes more profits, it’s more likely to produce more goods or offer more services in the hopes of making more profits – in other words, indicating a positive relationship between price and supply. The law of supply is based on several assumptions. It assumes that the market is competitive, that the marginal benefit (the profit a seller makes from producing and selling one more product or service) is greater than the marginal cost which is the cost of producing and selling one more product or service. Lastly is the law of diminishing returns, in which the marginal cost of production increases beyond the marginal benefit.
When supply is represented visually on a graph, with price on the Y axis and quantity supplied on the X axis, supply generally curves upward. This upward slope represents increasing marginal costs with an increase in production. When prices are low, quantity is low, but as price and profits increase, supply increases, as well, creating an upward curve. Supply curves can also be flat or even vertical. If the marginal cost stays the same, a flat curve results. Similarly, if there’s a finite amount of a good, such as a limited-edition product, a price increase won’t result in a corresponding increase in quantity, creating a vertical curve.