Demand and Supply are the numbers of goods that are available for sale for a given price and the level of customer demand for that product at the appropriate price.
Demand and Supply determine the market according to a simple principle: services and goods constitute the offer. The demand is the willingness of customers to buy these products and services.
Whenever supply and demand are in harmony, jargon refers to the “equilibrium price”. This means that deviations of one side can lead to an imbalance. Closely interwoven with supply and demand are also the price of the product or service and the quantity. The following mechanisms can be observed:
- As the price of the offer increases, products and services become more expensive. This, in turn, causes a falling demand in most sectors. There is more of the product offered or the service offered, as companies can place their services on the market in a cost-covering way or even with a profit margin. Consumers, on the other hand, take a step backward. Too expensive for them is the price.
- If demand declines, a product or service is much less in demand, the price drops. Companies underbid each other. The so-called market price is falling. This, in turn, spurs consumers on to buy the product or service at a cheaper price. Demand is rising, supply is falling.
This procedure is repeated automatically on the market until the aforementioned price equilibrium is restored.
This means that the mechanism only stops when supply and demand are back on one common denominator. Therefore, the balance of supply and demand is shaken by price, quantity or customer demand.
Related Article: Determinants of demand
Households aim to maximize their use of the resources at their disposal.
Depending on the value of the goods they purchase, they are willing to pay a certain price. However, if the price of the good increases, so will the demand.
Households will now switch to other goods that have the same or similar benefits, but where the price is lower. This is called substitution goods.
(Example: if the prices of one type of bread increase, more will be bought from a cheaper type of bread)
Depending on the following factors, the dependence of demand on the price varies:
- Average income
- Number of customers
- Usage Estimation of Demand for a Specific Good
- Price of comparable goods
The ratio of change of demand to change of price means price elasticity of demand:
As a rule, the calculated elasticity is negative because a positive change in the price causes a negative change in demand – and vice versa.
Elasticity <-1 is called elastic demand and> -1 is inelastic demand.
Easily dispensable or exchangeable goods are more elastic.
If the elasticity comes to a positive value, then these are luxury goods, with which one wants to express a social status (the more expensive, the better).
The cross-price elasticity indicates the ratio of the percentage change of the demand (good A) to the percentage change of the price (good B).
Substitute goods: Cross price elasticity is positive
Complementary goods: Cross price elasticity is negative
Substitute goods: goods with similar fulfillment burr (butter/margarine)
Complementary goods: complementary goods (car / tires)
Rising or falling demand is represented by a shift in the demand line to the right or left
The providers are anxious to achieve the highest possible profit. Thus, the supply increases, the higher the profit to be made.
The offer elasticity indicates the following relationship.
Dependence of supply elasticity:
- High production costs (cheaper raw materials allow more companies to produce the goods)
- State of the art (Increased technical level reduces costs)
- Number of providers (competitors)
- Capacity limits
- Price of Other Goods (Causes companies to switch to more lucrative business)
Increasing the supply causes a shift of the offered line to the right and the decrease causes a shift to the left.
Match of Demand and Supply
If supply and demand match, a market equilibrium arises. The corresponding price is the market price (or equilibrium price) and the amount of equilibrium.
If the price of a good exceeds the market price, then it is an excess of supply. Not all goods can be sold completely.
Now prices must be reduced, which now causes an increase in demand. Because of the increase in demand, it can now happen that the supply is again reduced, as some providers can no longer offer the reduced prices.
With demand overhang, providers are encouraged to raise prices as buyers are willing to pay for the good. Now supply will also increase and demand will decline.
These approximations to the market price and to the equilibrium quantity are called “price mechanism”. This self-regulation is the basis for the functioning of the market economy.
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