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What Are Supply And Demand?

The theory of supply and demand is used to determine and predict prices in fluctuating markets. Supply is the number of products or services available for purchase. Demand is the desire and ability of consumers to acquire those products and services.

What are supply and demand in the real world? If you find something you want, and everybody else does too, the price will be determined by how much of it is available.

What are the Principles of Supply and Demand?

The cost of a good is directly related to the balance between how much supply the manufacturer has and the demand from the consumer to buy it. As supply increases, prices go down. As demand increases, prices also increase.

How Supply and Demand Work

For example, if a clothing manufacturer produces more goods than the public is willing or financially able to buy, their inventory (supply) will be greater than they can sell (demand). Therefore, they are likely to drop their prices to reduce their stock on hand.

On the other hand, if a product is in high demand but the availability is limited, then the price will increase, particularly for items that are unique, seasonal, or difficult to produce.

What Determines Demand?

Things that affect demand are an increased quality of a product, the product becoming more fashionable, or similar products becoming more expensive. Like, when a new cell phone comes on the market and everybody wants to buy it.

That increases the demand for the new phone and decreases the demand for the old phone. Demand is determined by the number of people that want something.

Long-term demand can fluctuate as consumers’ choices and tastes change, while the price of other items, like wages, is slow to change over time. This is sometimes referred to as the product’s stickiness because the amount is less likely to fluctuate and stays at or near its current amount.

What Happens to Supply and Demand When Price Increases

When increased demand sets off a purchasing frenzy, prices will often rise until equilibrium (supply equals demand) is achieved. However, a producer can overcome supply shortages by ramping up production to reduce the stress on the demand, resulting in relatively steady prices.

Example of Supply and Demand

There are two main types of supply and demand within the housing market: a seller’s market and a buyer’s market. A seller’s market occurs when house prices in a particular area rise because the supply has decreased.

A buyer’s market happens when the quantity of houses in one specific area is greater than the number of interested purchasers. 

In both cases, the relative cost of the house is not the issue. The bottom line is whether there is a buyer for that house.

For example, there are two houses. The asking price of House 1 is $1,000,000 and for House 2 is $100,000.

Even though the purchase price is higher for House 1 than House 2, if multiple buyers are interested in purchasing House 1, it is likely to sell quickly and possibly over the asking price because demand is greater than the supply.

If House 2, though more modestly priced, is one of many similar homes at a comparable price, the buyer may have to reduce the asking price to successfully sell because supply is now greater than the demand.

So, How are Supply and Demand Related?

Supply and demand work hand in hand and can be driven by the market. Very simply put, if a lot of people want something the price can go up.

If there is not much of it available, the price can go up very quickly. The opposite happens if there is too much of it available, the price goes down.

If you see something on Instagram and realize the price went up soon after, there’s a good chance that the demand went up and so did the price.

To save some money, try not to get caught up in the trends or newest gadgets and you’ll notice the price may drop after the frenzy.

By: Robert Puharich | November 11, 2021 |