- Demand-Supply Analysis Explained
- Example
- Applications
- Frequently Asked Questions (FAQs)
- Recommended Articles
- Demand and supply analysis is the study of price changes with respect to the number of buyers and sellers for a particular product.
- In a state of market equilibrium, the demand curve and the supply curve intersect. At this point, the demand and supply for a commodity are equal.
- The fair price of farm yield is also based on demand-supply. In a perfectly competitive market, farmers are price takers and demand-supply is the price maker. Therefore, governments set a minimum price to protect farmers.
Demand-Supply Analysis Explained
The demand for goods and services signifies the consumers' need, willingness, and ability to buy a particular product. Supply, on the other hand, refers to the production capacity of manufacturers and distributors. A demand and supply analysis is essential to understand the impact of those forces on buyers, sellers, buyer-seller interactions, and prices.
The demand-supply study is based on the laws of demand and supply. The law of demand depicts an inverse relationship between goods price and goods demand. The law of demand renders a downward sloping curve—demand goes up when goods price falls.
If other factors remain constant, the law of supply suggests that an increase in goods price should result in an increase in the supply of goods and vice-versa. It establishes a direct relationship between the price and supply of a commodity—forming an upward curve.
Demand and supply together help determine market conditions and consumer behavior. Thus, understanding economic equilibrium is crucial in economics.
Economic equilibrium or market equilibrium is a point where the demand curve cuts across the supply curve. It is a scenario where the demand for a commodity is equal to its supply. On a graph, it is represented as follows:
However, if demand exceeds supply, then there is a shortage of that product. Also, if supply is higher than demand, there is a surplus.
The demand for a product or service is dictated by various factors—goods price, consumer income, consumer taste, consumer preference, price of related goods, competition, consumer expectations, and income distribution.
Similarly, supply fluctuates due to price changes, fiscal policy, monetary policy, natural disasters, price of production factors, monopoly, climate conditions, infrastructure, and technological advancement.
Example
The most common example of demand and supply is the price fluctuation of securities. Stock market analysts study both the demand and supply of stocks to predict future price trends.
Let us assume that the demand for a particular security is high. In that case, there will be many buyers in the market, and the security will be low in supply (a smaller number of people would be willing to sell the security). Due to the high demand-low supply predicament, the security's price is expected to shoot up.
In contrast, if a stock's demand shows a downfall, a smaller number of people are interested in buying it. Let us assume that its supply is high—many stockholders are willing to sell the shares. In this scenario, the stock price will fall—due to surplus supply.
Applications
In economics, the demand-supply study elucidates the dynamics between buyers and sellers (in a free market). Other applications are as follows:
Price Control: When at war, governments use demand-supply analysis to set a price ceiling for each product. The price ceiling is the maximum price of essential goods or services. In order to ensure public wellbeing during pressure situations, this price is kept lower than the equilibrium price.
Housing Rent Control: Here, the government ascertains a maximum rental price that can be charged to tenants for occupying houses for rent. Again, the set limit is below the equilibrium for housing rent price. This is done to safeguard lower or middle-income tenants from exploitation.
Taxation: The analysis considers the impact of direct and indirect taxes on consumers. When indirect taxes are raised, consumers are burdened. It results in a shift in demand and supply curves.
Subsidy: To encourage a particular commodity, the government offers subsidies to manufacturers. Such grants decrease the price of that particular good or service. As a result, there is an increase in both demand and supply.
Farm Product Pricing: The fair price of farm yield is also based on demand-supply. In a perfectly competitive market, farmers are price takers, and market forces (demand and supply) are the price makers. However, the government sets a minimum price to protect farmers from losses.
Black Market Identification: Black marketers flourish when demand for a commodity is high but the supply is low. They sell products at a price higher than the ceiling price. The demand and supply study reveals such practices.
Minimum Wage Legislation: State governments undertake such analyses of labor markets to determine minimum wages. A minimum wage cap protects employees and laborers from exploitation.
Consumer Surplus and Producer Surplus: A demand-supply study explains the consumer surplus—the gap between the amount consumers are willing to pay and the actual amount paid for a particular commodity. The study also sheds light on the producer surplus—the amount at which producers were ready to sell and the actual selling price.
Frequently Asked Questions (FAQs)
What is the relationship between supply and demand?If the demand for a commodity exceeds the quantity supplied, then there is a shortage of that commodity in the market. This shortage results in a price rise. In contrast, if supply surpasses demand, there is a surplus of that product—resulting in a price fall.
What affects supply and demand?The price of a product or service is the major factor causing demand and supply changes. Other factors include consumer income, customer preference, price of related goods, competition, consumer expectations, fiscal policy, monetary policy, price of production factors, monopoly, climate conditions, infrastructure, and technology.
How Does the Law of Supply and Demand Affect Prices?The law of demand states that when commodity prices increase, their demand decreases. In contrast, the law of supply states when commodity prices increase, its supply also increases.
Recommended Articles
This has been a guide to what is Demand and Supply Analysis & definition. We discuss Demand and Supply Analysis meaning, graph, application, & examples. You can learn more about it from the following articles -
- Derived Demand
- Determinants of Demand
- Joint Supply
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