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Supply and Demand

The Supply and Demand model is based on the notion that both Demand by consumers and Supply by providers will provide a price equalisation based on the strength of each.

This concept is the opposite of Price Regulation.

What is Supply and Demand?

Supply indicates the total number of items of a product available for sale in a market, as well as the number of items that can be brought to market within a useable timeframe.

 

Demand indicates the number of items of that product which people or organisations in that same market that want.

 

Pricing in a free market based on supply and demand is complex but can be simply stated that when the demand exceeds the supply the price goes up, and vice versa.

Supply and Demand

Why is Supply and Demand Important?

Recently the price of steel went up dramatically around the world because everyone wanted it and companies could not make it quickly enough. Prices are set this way based on the maximum price customers (or companies) will pay. Price it too high and the supplier cannot move stock, price it too low and supplier misses out on profit to grow the business. Companies may set their own prices, or use a central exchange so that the market may set the price.

 

Supply and demand is beneficial for keeping prices low through competition, and provide investment Capital to increase supply when the prices are high. Many like soft drink or juice, but if it cost $200 a litre most would stick to water. Lots of competition between manufacturers and their high supply keep prices low. In times of war supply of certain goods may be restricted thus driving up prices, at the same time there would a huge demand for weapons and the basic materials and labour that goes into making them, with limited supply the purchasing costs for armies go up. Supply and demand can restrict the length of wars in developed countries due to the fact that running costs keep going up.

Supply and Demand is a Balancing Act

Rising prices always stabilise as they strike a new balance with increased supply as companies rush in to sell goods (they see the potential for profit). Increased production brings down costs due to economies of scale and competition driven by consumers searching for a bargain and a sustainable equilibrium is reached. For example, a new computer technology comes onto the market, it is expensive to make and can only be created if the company believes there is an adequate Return on Investment. Initially prices are high as the market desires the advantages of a bigger screen, faster memory or processor the demand and find value in the product for the price being asked. This generates competition as other suppliers race to gain a share of this market. As more and more companies make competing products the prices are driven down over time to a very low point as more and more are made and manufacturing costs come down. The competition becomes so tight that only a few companies are efficient enough to stay in the market as the profit per item becomes so small that they only keep making the item if they can make lots of them. There is a maximum number of items the market wants and thus competitors have to create new technologies to stay alive, and then the whole process starts again. If a competitor ignores these laws of trading they usually fail.

Supply and Demand is a Natural System

Supply and demand mimics the natural order closely, like the water cycle, the carbon cycle and even the food chain.  Left on their own these natural systems regulate themselves, but introduce something like price regulation (or a human presence in a natural system) then things can become unbalanced and destructive. Human activity must be balanced with nature, e.g. limiting carbon emissions and maintaining forests. Human markets must also have boundaries to prevent systems collapsing, if our money markets collapsed there would be massive knock-on effects. Regulation usually puts a range on activities rather than directly setting inflexible prices.