Supply and demand are the backbone of economics and are the two main forces that determine the prices of goods and services in a market. Anyone who wants to understand the fundamentals of economics needs to become familiar with these two factors, as they influence not only pricing but also product availability, consumer behaviour and business decisions.
This article aims to explain in a simple way the concept of supply and demand, to show how these forces work in real-life situations and to give examples that make these principles easier to understand.
What is Demand?
Demand is the quantity of a good or service that consumers are willing to buy at a given price and at a given time. Simply put, the more people who want to buy a product, the greater the demand for it.
Demand is influenced by several factors, such as:
- The price of the good or service: The lower the price, the more consumers are willing to buy the product.
- The disposable income of consumers: The higher the income of consumers, the more likely they are to buy more goods and services.
- Market preferences and trends: Consumer preferences can change based on trends, fashion or even cultural changes.
- The population and its structure: More consumers mean more demand, while the age distribution of the population can influence preferences for certain products.
- Οι τιμές των υποκατάστατων αγαθών: Εάν ένα υποκατάστατο προϊόν είναι φθηνότερο, οι καταναλωτές μπορεί να προτιμήσουν αυτό, μειώνοντας τη ζήτηση για το αρχικό προϊόν.
The demand curve
In economics, the demand curve shows the relationship between the price of a product and the quantity that consumers are willing to buy. In its usual form, the demand curve is sloping from left to right, which means that as the price of a product decreases, demand increases. Conversely, as the price increases, demand decreases.
For example, if the price of a coffee in a café is €1, 100 coffees may be sold per day. If the price increases to 2 euros, demand may drop to 50 coffees. Demand is directly affected by the price.
What is the Offer?
Supply, on the other hand, is the quantity of a good or service that producers are willing to offer on the market at a given price. The higher the price of a product, the more producers are likely to produce, as they expect higher profits.
Factors affecting supply are:
- The cost of production: The lower the cost of production, the more advantageous it is for producers to produce more goods.
- Technology: Improving technology can increase efficiency and reduce production costs by increasing supply.
- The prices of the factors of production: If the prices of raw materials or labour increase, supply may decrease.
- Expectations for the future: If producers expect prices to rise in the future, they may limit their supply now to sell at higher prices later.
- The number of producers: The more producers there are in the market, the greater the total supply of a product.
The Supply Curve
The supply curve shows the relationship between the price of a product and the quantity that producers are willing to offer. Unlike the demand curve, the supply curve is upward sloping from left to right. This means that as the price of a good increases, the more producers are willing to supply the market.
For example, if the price of coffee is €1, cafés can produce 100 coffees a day. If the price increases to EUR 2, cafés will have an incentive to produce more coffees, as they will have a higher profit margin.
The Interaction of Supply and Demand
The interaction of supply and demand determines the price and quantity of goods in a free market. The point at which supply and demand meet is called the equilibrium point, and this determines the 'market price' of a product.
- Balance Point: At the equilibrium point, the quantity that consumers are willing to buy equals the quantity that producers are willing to offer. At this point, the market 'clears', i.e. there are no shortages and no oversupply.
Let's take the example of coffee again. If a café sells coffees for EUR 1 and consumers are willing to buy 100 coffees, but the café can only produce 50 coffees, there is a shortage. In this case, the price will rise until the producers can meet the demand. Conversely, if the café produces 200 coffees, but only 100 consumers are willing to buy, there is an oversupply, and the price will probably fall.
Elasticity of Demand and Supply
The concept of elasticity refers to how the quantity of demand or supply of a product changes in relation to a change in price.
- Demand elasticity: When the demand for a product changes dramatically with a small change in price, we say that demand is elastic. For example, luxury goods often have elastic demand. If the price of a luxury watch decreases, demand may increase significantly. Conversely, if demand does not change much despite an increase or decrease in price, demand is said to be inelastic. A typical example is staple foods such as bread or milk.
- Offer Elasticity: Supply is elastic when producers can easily increase or decrease the quantity offered in response to a change in price. For example, crop production is often inelastic as it takes time to increase production even if the price increases.
Real Life Example: The Fuel Market
The fuel market is a classic example of the interaction between supply and demand. When oil prices rise, producers can increase production, but only to a limited extent, as extracting and processing oil takes time and resources. On the demand side, consumers may only reduce their fuel use if prices increase drastically. This situation often creates elastic divergences, with supply and demand influenced by exogenous factors such as political decisions or geopolitical developments.
Conclusion
Supply and demand are fundamental concepts that determine how markets work. By understanding these principles, consumers can make more informed decisions, while entrepreneurs can design strategies that maximise their profits.
Elina Karamanou
CEO / Business Consultant
