Businesses squander a considerable amount of money to figure out the degree of public demand for their services/products. To check if the manufactured product will be saleable, companies conduct consistent research studies. Inaccurate estimates can result in alarming consequences and losses.
Supply and demand are the “give and take” of microeconomics. They are the economic forces of the market that control what suppliers/manufacturers are willing to develop and what customers are willing and able to buy. The market will cease to exist if businesses do not offer a deliverable and customers do not purchase those deliverables.
Demand and supply work together to build a steady and competitive market. They are completely dependent on each other to nurture a distributor-consumer environment that ensures continuous and efficient selling and buying.
In economics, the law of demand and supply helps determine the prices of services/goods in the marketplace. Understanding the philosophies behind this law will help organizations look at the bigger picture of how the marketplace functions.
Even though demand and supply operate in close collaboration, they are different concepts that evolve in unique ways based on the changes in market conditions and trends.
Understanding Supply At Length
In economics, supply is the total amount of deliverables - or inventory - available to the customers in the market. It can refer to the physical commodities, including oil, laptops, and grocery, or abstract commodities, including time, labor, or energy.
Supply is not a static or single figure but a variable. The variations happen as manufacturing expenses differ by the supplier. If the prices are low, only limited manufacturers with low expenses can make profits. Conversely, when the prices surge and stay high, the sellers will supply the deliverables in bulk amounts to generate profits. In this case, even manufacturers with high expenses can be profitable; hence, everybody produces.
Supply relies on price and demand changes and swiftly keeps up with these. These changes can be temporary, seasonal, or permanent, and the suppliers must tweak their supply accordingly.
Let's understand supply with the example of jeans. Suppose the suppliers are offering the jeans at US$ 30. That said, if the customers can afford to foot US$ 35 for the same jeans, suppliers will scale up their production to adjust to the trend.
As the cost increases, the amount supplied rises and vice versa. Hence, price and amount are linearly associated with each other, representing a direct relationship. The supply curve of the above example will be an upward slope.
Critical factors affecting the supply include:
- Manufacturing capacity: An upsurge in the market demand leads to a rise in the output to deliver more supplies.
- Market rivals: Competitors can make it difficult for a firm to continue developing a supply of deliverables at a fair price if customers pick alternatives. They might reduce manufacturing or diversify to other products/services to experience a better market outcome.
- Tech advances: Investments in tech-based solutions boost the supply by trimming production time or cost.
- Availability of materials: The availability of cheap raw materials helps scale up manufacturing and the supply of commodities. If the resources are not readily available or are costly, the manufacturing will decline, thus reducing the supply to the market.
Understanding Demand At Length
Demand is the customers' potential and readiness to buy a particular amount of good/service at various price levels during a specific time frame. Similar to supply, demand fluctuates with the price.
While supply relates to the sellers' desire to generate profits, demand illustrates the customer side of purchasing decisions.
The fundamental economic theory explains that the lower the cost of an offering, the higher the demand. On the contrary, a higher cost for an offering translates to lower customer demand.
Besides, the demand for commodities will stay consistent up to a certain price level. However, beyond that level, purchasers will find the offerings extremely pricey and, thus, the demand for them will drop.
Demand can be classified into:
- Market demand: It stands for the demand for a particular good.
- Aggregate demand: It indicates the demand for all the deliverables.
As an example, let's consider a simple model of the demand for smartphones. If all manufacturers launch an identical smartphone at US$ 250, people who can afford it might purchase one per household. If the cost, however, falls to US$ 125, the quantity demanded could rise as customers might now prefer one for each family member. Similarly, the demand will increase if the smartphone price drops to US$ 50.
Simply put, price and required quantity exhibit an inverse relationship. Plotting the price-quantity relationship of the above example on a graph will give a downward-sloping demand curve.
Critical factors impacting the demand include:
- Buyer income: When consumers earn more, their purchasing capacity increases, and, hence, the demand for products/services increases.
- Availability of substitutes: A rise in the price of a particular commodity means greater demand for substitute commodities.
- Consumer preferences: Changes in trends impact consumers' preferences for a commodity. Popular products or services will witness explosive demand; however, that can rapidly shift when trends change.
Why Establishing Supply-Demand Equilibrium Is Essential
Supply-demand equilibrium is a market state where the supply equates to the demand. Graphically, a market achieves equilibrium at the intersection point of the market demand and market supply curves.
The equilibrium price is the price level that both the seller and buyer find reasonable and lucrative. In other words, it is the situation where the quantity of a commodity that customers want to purchase matches the quantity manufacturers want to sell. This common quantity is known as the equilibrium quantity.
If a market is at equilibrium, the product/service price will not change unless an external influence triggers shifts in the supply or demand, disrupting the equilibrium.
Attaining market equilibrium is crucial as it enables businesses to quote a product/service price that matches the customers' budget at a reasonable manufacturing cost to them. When that happens, the sellers will execute a demand-generation plan to create interest in their deliverables; hence, the supply and demand cycle stays afloat.
Supply-Demand Equilibrium- How To Establish?
The supply-demand equilibrium can be represented as:
QS = QD,
Where QS = Quantity supplied, and QD = Quantity demanded.
As such, the prices vary until the market fulfills the above equation. But how to bring equilibrium to the market? There are two situations:
Supply is Greater than the Demand (Surplus)
A situation where the market supply exceeds the market demand leads to a decline in the product/service price below the equilibrium level. When a surplus occurs, manufacturers will be left with excess stocks (which cost money to preserve and hold), which people are hesitant to purchase at the existing price. In the worst cases, they have to dispose of their additional output.
Surplus = QS - QD
For suppliers, this condition is not optimum from a profit standpoint. To clear these stocks, businesses will have to cut prices and production amounts at the opportune time. The process will continue as long as a surplus persists, again bringing back the market to equilibrium.
Demand is Greater than the Supply (Shortage)
Conversely, the product/service price advances above the equilibrium level when the market demand surpasses the market supply. When there is a shortage, many people will find it difficult to buy commodities they want as producers have run out of stock. At the existing price tag, suppliers will fail to meet the excess demand.
Shortage = QD - QS
To address this shortage, manufacturers will scale up their output quantity and quote a higher price for their offerings when they find the opportunity to do so. The trend will continue as long as the shortage remains, again bringing back the market to equilibrium.
Businesses must remember that markets are not necessarily in equilibrium at every point in time as various disruptions can trigger a temporary supply and demand imbalance.
With that considered, markets trend toward equilibrium with time and maintain the status until a disruption occurs to either demand or supply. The time a market takes to attain equilibrium relies on particular market characteristics and, above all, how often companies have the opportunity to change prices and manufacturing quantities.
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