What is Supply and Demand?

What is Supply and Demand?

An overview of supply and demand and how it affects price.

By Marcia Smith

Supply and demand are two of the most important economic concepts and together they form the basis of a market economy.

Demand, as the name suggests, refers to the quantity of an item or service wanted by consumers. This quantity is the amount of the product consumers are willing to purchase at a particular price point. The price and the quantity demanded are linked by a relationship known as the demand relationship.

Conversely, supply is how much of an item the market can offer. The quantity supplied is the amount of an item or service the supplier will provide in exchange for a certain price. In a similar fashion to demand, there is a relationship which links the price and the quantity supplied to the market. This is the supply relationship.

The price of an item is a reflection of supply and demand. The relationship between these two concepts is crucial in determining the distribution of resources – in a market economy these resources should be distributed as efficiently as possible. This is determined by the law of supply and the law of demand.

In its most simple form, the law of demand states that, barring other changes, the lower the cost of an item, the more people will demand it (in most cases). On the other hand, the law of supply states that, again barring other changes, the higher the price of an item, the higher the quantity that’s supplied, as sellers will rundown their inventory and new suppliers will enter the market to take advantage of the price changes.

If you imagine this graphically, with quantity on the vertical axis and price on the horizontal axis, demand is shown as a downwards sloping line from left to right, and the supply as an upwards sloping line from left to right. Where the two lines meet shows the price and quantity of production at which the market sits in equilibrium their intersection point is the point at which the market is said to be at equilibrium.

In practice, this is rare and markets fluctuate as drivers for supply and demand change.