Law of Supply and Demand in Economics: How it Works (2023)

What is the law of supply and demand?

The law of supply and demand combines two basic economic principles that describe how changes in the price of a resource, commodity, or product affect supply and demand.

When the price increases, the supply increases while the demand decreases. On the other hand, when the price falls, the supply decreases while the demand increases.

The supply and demand levels for different prices can be plotted as curves on a graph. The intersection of these curves marks thebalance, omarket equilibrium pricewhere demand is equal to supply and represents the processprice discoverynot market.

The central theses

  • The law of demand states that the demand for a product or resource decreases when the price increases and increases when the price decreases.
  • On the other hand, the law of supply states that higher prices tend to increase the supply of an asset, while lower prices tend to decrease it.
  • A market settlement price balances supply and demand and can be graphically represented as the intersection of the supply and demand curves.
  • The extent to which changes in price are reflected in changes in supply and demand is called the price elasticity of the product. Demand for staple items is relatively inelastic, meaning it is less responsive to price changes.

law of supply and demand

(Video) 🤝 Supply and demand | How does The Law of Supply and Demand work?

Understand the law of supply and demand.

It may seem obvious that this is the case with all salestransactionThe price satisfies both the buyer and the seller and matches supply and demand. The interactions between supply, demand and price in a (more or less) free market have been observed for thousands of years.

Many medieval thinkers, as well as modern critics of market prices for selected goods, made a distinction between a "fair" price based on reasonable costs and returns, and a price at which the sale actually took place.Our understanding of price as a signaling mechanism linking supply and demand isrooted in the work of Enlightenment economistswho examined and summarized the relationship.

It is important to note that supply and demand do not necessarily respond proportionally to price movements. The extent to which price changes affect the supply or demand for a product is called price elasticity. products with highthe price elasticity of demandDepending on the price, there will be greater fluctuations in demand. Conversely, basic necessities will be relatively inelastic in price because people cannot easily do without them, which means demand will change less relative to price changes.

Price discovery based on supply and demand curves assumes a market where buyers and sellers may or may not trade freely, depending on price. Factors such as government taxes and regulations, the market power of suppliers, the availability of substitutes, and business cycles can change or alter the shape of supply or demand curves. But as long as buyers and sellers have leeway, merchandise affected by these external factors will remain subject to the fundamental forces of supply and demand. Now let's take a look at how demand and supply react to price changes.

(Video) Law of supply | Supply, demand, and market equilibrium | Microeconomics | Khan Academy

The Law of Demand

Olaw of demandIt states that the demand for a product changes inversely with its price, other things being equal. In other words, the higher the price, the lower the demand.

Since buyers have limited resources, their spending on a particular product or item is also limited, so higher prices reduce the quantity demanded. On the other hand, when the product becomes more accessible, the demand increases.

As a result, the demand curves slope from left to right, as shown in the graph below. Changes in the level of demand as a function of the price of a product relative to the income or resources of buyers are calledperformance effect.

Of course there are exceptions. one andGiffen merchandise, usually budget staples, akainferior goods. Inferior goods are those for which demand falls as income rises because consumers switch to higher value products. But when the price of an inferior good goes up and demand goes up because consumers are using more instead of more expensive alternatives, thereplacement effectconverts the product into a Giffen good.

At the other end of the income and wealth spectrumVeblen-Warethey are luxuries that increase in value as their price increases and, consequently, generate greater demand because the price of these luxuries signals (and possibly even increases) the status of the owner. Veblen products are named after economists and sociologists.Thorstein Veblen, who developed the concept and coined the term “conspicuous consumption”.

The law of supply

Olaw of supplyrelates the price variations of a product to the quantity shipped. Unlike the law of demand, the law of supply is simple, not the other way around. The higher the price, the higher thedelivered quantity. Lower prices mean less supply, all else being equal.

Higher prices give suppliers an incentive to offer more of the product or merchandise, as long as their costs do not increase too much. Lower prices lead to acost pressurethat limits supply. As a result, the supply slopes increase from left to right.

(Video) Supply and Demand: Crash Course Economics #4

As with demand, supply constraints can limit thisprice elasticity of supplyfor a product whilesupply shocksmay result in a disproportionate change in the price of an essential good.

equilibrium price

The equilibrium price, also known as the clearing market price, is the price at which demand equals supply and an acceptable market equilibrium is established for buyers and sellers.

At the point where an ascending supply curve and a descending demand curve intersect, supply and demand balance in terms of quantity of goods, leaving no excess supply or unsatisfied demand. The market equilibrium price level depends on the shape and position of the respective supply and demand curves, which are influenced by numerous factors.

Factors influencing supply

In industries where suppliers are not willing to lose money, the prices of the products below will tend to be close to zero supply.production costs.

Price elasticity also depends on the number of sellers, their total production capacity, the ease with which it can be reduced or increased, and the industry.competitive dynamics. Taxes and regulations can also play a role.

Factors Affecting Demand

Consumer income, preferences, and willingness to substitute one product for another are among the most important determinants of demand.

Consumer preferences will depend in part on product preferences.Marktdurchdringung, from themarginal utilityof goodsdecreaseswhen the possessed mob increases. The first car is more life-changing than the fifth addition to the fleet; the television in the room more useful than the room for the garage.

(Video) Law of Supply and Demand in Economics How It Works

What is a simple explanation of the law of supply and demand?

If you've ever wondered how supply of a product matches demand or how market prices are set, the law of supply and demand has the answers. Higher prices cause supply to increase while demand decreases. Lower prices drive demand while limiting supply. The market equilibrium price is a price at which supply and demand balance.

Why is the law of supply and demand important?

The law of supply and demand is fundamental as it helps investors, businessmen, and economists to understand and predict market conditions. For example, a company considering raising the price of a product will typically assume that demand for the product will fall and try to estimate price elasticity and the substitution effect to decide whether to proceed anyway.

What is an example of the law of supply and demand?

When gasoline consumption plummeted with the outbreak of the COVID-19 pandemic in 2020, prices quickly followed suit as the industry ran out of storage space. The price decline, in turn, was a strong signal for suppliers to rein in gasoline production. On the other hand, crude oil prices in 2022 provided an additional incentive for producers to increase production.


How does supply and demand work in economics? ›

Supply is generally considered to slope upward: as the price rises, suppliers are willing to produce more. Demand is generally considered to slope downward: at higher prices, consumers buy less.

How does supply and demand work example? ›

These are examples of how the law of supply and demand works in the real world. A company sets the price of its product at $10.00. No one wants the product, so the price is lowered to $9.00. Demand for the product increases at the new lower price point and the company begins to make money and a profit.

How does supply and demand work easy definition? ›

In economic theory, supply and demand is the main model of price determination. In other words, the price of a good or service is set by the dynamic between supply and demand. As a general rule, prices will fall when supply is greater than demand, whereas prices will rise when demand is greater than supply.

How does the law of supply and demand work quizlet? ›

-the law of demand says that at higher prices, buyers will demand less of an economic good. -the law of supply says that at higher prices, sellers will supply more of an economic good.

How does supply and demand work in everyday life? ›

Demand leads to the total quantity on goods or services that are needed to buy various commodities and supply is the quantity of goods and services business will make available to make profits. Thus in our daily life everything is based on the demand and supply from a small commodity to a large corporations.

What is an example of law of supply? ›

The law of supply operates throughout the market: 1. Price rises, supply rises. Due to a new study on the health benefits of apples, the price of apples rises, so apple harvesters begin to work overtime to harvest more apples to offer to the public.

What is law of demand explain it with real life example? ›

For example, if a consumer is hungry and buys a slice of pizza, the first slice will have the greatest benefit or utility. With each additional slice, the consumer becomes more satisfied, and utility declines. In theory, the first slice might fetch a higher price from the consumer.

Why is the law of supply and demand important? ›

Supply and demand have an important relationship because together they determine the prices and quantities of most goods and services available in a given market. According to the principles of a market economy, the relationship between supply and demand balances out at a point in the future.

What is law of demand in real life example? ›

Shoppers buy more strawberries when they are in season and the price is low. This is evidence for the law of demand: only at the lower, in-season price are consumers willing to buy the higher amount available.

Which statement best explains the law of supply and demand? ›

Answer: ✔ The quantity demanded by consumers decreases as prices rise, then increases as prices fall.

What best explains the law of demand? ›

The Law of Demand states that there is an indirect relationship between the price of a good or service and the quantity of that good or service that consumers are willing and able to buy. In other words, as the price of an item increases, buyers are less willing and able to buy it and vice versa.

How do you explain a supply and demand diagram? ›

If the available quantity of the good increases, the supply curve shifts right. If quantity decreases, the supply curve moves left. The demand curve is plotted as a line with a negative slope, pointing down and to the right. If the quantity demanded increases, the downward-sloping demand curve moves right.

What is law of supply in simple words? ›

(##include msid=4006719,type=11 ##) Definition: Law of supply states that other factors remaining constant, price and quantity supplied of a good are directly related to each other. In other words, when the price paid by buyers for a good rises, then suppliers increase the supply of that good in the market.

What are the 4 basic laws of supply and demand? ›

1) If the supply increases and demand stays the same, the price will go down. 2) If the supply decreases and demand stays the same, the price will go up. 3) If the supply stays the same and demand increases, the price will go up. 4) If the supply stays the same and demand decreases, the price will go down.

How does supply work in economics? ›

What Is Supply? Supply in economics is defined as the total amount of a given product or service a supplier offers to consumers at a given period and a given price level. It is usually determined by market movement. For instance, a higher demand may push a supplier to increase supply.

What is the law of supply and demand for dummies? ›

The law of supply states that the quantity of a good supplied (i.e., the amount owners or producers offer for sale) rises as the market price rises, and falls as the price falls. Conversely, the law of demand (see demand) says that the quantity of a good demanded falls as the price rises, and vice versa.

What is an example of law of demand in real life? ›

For example, if a consumer is hungry and buys a slice of pizza, the first slice will have the greatest benefit or utility. With each additional slice, the consumer becomes more satisfied, and utility declines. In theory, the first slice might fetch a higher price from the consumer.

What is law of demand in simple words? ›

Definition: The law of demand states that other factors being constant (cetris peribus), price and quantity demand of any good and service are inversely related to each other. When the price of a product increases, the demand for the same product will fall.


1. Supply and Demand
(Professor Dave Explains)
2. Demand and Supply Explained- Macro Topic 1.4 (Micro Topic 2.1)
(Jacob Clifford)
3. Supply and demand in 8 minutes
(Jacob Clifford)
4. Introduction to Supply and Demand
(Virtual High School)
5. Law of Supply & Types of Supply
(Mr. Sinn)
6. Economics basics: The Law of Supply and Demand
(The Metro-classic Japanese)


Top Articles
Latest Posts
Article information

Author: Geoffrey Lueilwitz

Last Updated: 10/31/2023

Views: 6096

Rating: 5 / 5 (80 voted)

Reviews: 87% of readers found this page helpful

Author information

Name: Geoffrey Lueilwitz

Birthday: 1997-03-23

Address: 74183 Thomas Course, Port Micheal, OK 55446-1529

Phone: +13408645881558

Job: Global Representative

Hobby: Sailing, Vehicle restoration, Rowing, Ghost hunting, Scrapbooking, Rugby, Board sports

Introduction: My name is Geoffrey Lueilwitz, I am a zealous, encouraging, sparkling, enchanting, graceful, faithful, nice person who loves writing and wants to share my knowledge and understanding with you.