Supply and Demand

Supply and Demand

To understand what causes changes in supply and demand the first step is to understand what is supply and demand. Mankiw (2007) stated "Supply and demand are the forces that make market economies work. They determine the quantity of each good produced and the price at which it is sold." (p. 63).

The change of supply depends on income changes and demands of consumers for a certain product. For the supply curve to rise and exist, there must be a numerous sellers on the market with excess inventory on hand, and for the demand curve to exist and rise there must be an increase in demand on the consumer side, which may occur as a result of economic condition, e.g. - increase in medium income levels. When one factor changes, it isolates itself, and therefore does not affect the other factors. When consumer income decreases, prices tend to decrease. With a decrease in income the motivation to purchase is also decreased and the industry lowers prices to increase purchasing. However, prices may also increase and thus impact the supply side, as motivation to purchase is lowered resulting in excess inventory. (Schenek, n.d.).

A change in supply can be brought on by new technologies. By implementing technical improvements in production, a company can make production easier and less expensive in a market. If a company is producing 100 units a day and increases to 1000 units a day as a result of technology, this will result in an increase in supply, thereby impacting the supply curve. The increase in supply can cause an imbalance in the market. This imbalance can be corrected by adjusting prices and decreasing supply from alternative sources. If a change in the supply curve increases the curve goes to the right. If it decreases, the curve goes to the left. If prices are steady, the curve will remain steady and even. (Investopedia a Forbes Digital Company, 2010).

A change in demand means there has been a change or shift in the market. Demand is the willingness to buy a certain item or product at any cost. The consumer is willing to pay more for an item because there may be a lack of supply or there is new technology. Introduction of a new technology is a tremendous factor, for example, the introduction of a new video game system. Everyone wants the newest platform because it improves upon a proven and well distributed platform. When Sony puts out their new Playstation 3D next year, they will charge top dollar for it and consumers will pay the price. In two years when the demand decreases because everyone who wants it already has it, Sony will drop the price to dilute inventory and increase their working capital.

Market Equilibrium

Market equilibrium is defined when the quantity supplied equals the quantity demanded of a product at the current price. The equilibrium will change if there is a change in demand of a product, change in supply of a product, or both. When there is a change in demand of a product, and the demand is greater than the supply, the product will increase in price, the demand curve will shift to the right, and a new equilibrium point will be established. Conversely when the demand of a product is less than the supply, the product will decrease in price, the demand curve will shift to the left and a new equilibrium point will be established.

When the quantity supplied exceeds the quantity demanded, the price of the product will decrease, the supply curve will shift to the right, and a new equilibrium point will be established. Conversely, if the quantity supplied is less than the quantity demanded, the price of the product will increase, the supply curve will shift to the left, and a new equilibrium point will be determined. Price can affect demand but not necessarily supply of a product. If a shirt is $200 and there are 10 shirts, but only five shirts sell at the $200 price, the demand is falling and the price will decrease so shirts will sell. If the shirt is $100 and there are 10 shirts and 10 sell, there is a demand and the price can increase.

Price Elasticity

Price elasticity of demand is an important aspect of a product's demand curve. When the demand changes the price also changes. Depending on how essential a product or service is to the consumer, elasticity varies. (Investopedia a Forbes Digital Company, 2010). Essential products are not affected by price change because consumers will continue to purchase them even if the price increases; however, sales of non-essential products or services will decrease if the price increases.