Supply and demand is perhaps one of the most fundamental concepts of economics

and it is the backbone of a market economy.

Demand refers to how much (quantity) of a product or service is desired by buyers. The
quantity demanded is the amount of a product people are willing to buy at a certain
price; the relationship between price and quantity demanded is known as the demand
relationship.

Supply represents how much the market can offer. The quantity supplied refers to the
amount of a certain good producers are willing to supply when receiving a certain price.
The correlation between price and how much of a good or service is supplied to the
market is known as the supply relationship. Price, therefore, is a reflection of supply and
demand.

The relationship between demand and supply underlie the forces behind the allocation
of resources. In market economy theories, demand and supply theory will allocate
resources in the most efficient way possible.

How? Let us take a closer look at the law of demand and the law of supply.

What is 'Demand?'

Demand is an economic principle that describes a consumer's desire and willingness to

pay a price for a specific good or service. Holding all other factors constant, an increase
in the price of a good or service will decrease demand, and vice versa.

Think of demand as your willingness to go out and buy a certain product. For example,
market demand is the total of what everybody in the market wants.

BREAKING DOWN 'Demand'

Businesses often spend a considerable amount of money to determine the amount of

demand the public has for their products and services. Incorrect estimations either
result in money left on the table if demand is underestimated or losses if demand is
overestimated.
Demand is closely related to supply. While consumers try to pay the lowest prices they
can for goods and services, suppliers try to maximize profits. If suppliers charge too
much, demand drops and suppliers do not sell enough product to earn sufficient profits.
If suppliers charge too little, demand increases but lower prices may not cover suppliers’
costs or allow for profits. Some factors affecting demand include the appeal of a good or
service, the availability of competing goods, the availability of financing and the
perceived availability of a good or service.

Aggregate Demand vs. Individual Demand

Every consumer faces a different set of circumstances. The factors she faces vary in
type and degree. The extent to which these factors affect market demand overall is
different from the way they affect the demand of a particular individual. Aggregate
demand refers to the overall or average demand of many market participants. Individual
demand refers to the demand of a particular consumer. For example, a particular
consumer’s demand for a product is strongly influenced by her personal income.
However, her personal income does not significantly affect aggregate demand in a large
economy.

Supply and Demand Curves

Supply and demand factors are unique for a given product or service. These factors are
often summed up in demand and supply profiles plotted as slopes on a graph. On such
a graph, the vertical axis denotes the price, while the horizontal axis denotes the
quantity demanded or supplied. A demand profile slopes downward, from left to right.
As prices increase, consumers demand less of a good or service. A supply curve slopes
upward. As prices increase, suppliers provide less of a good or service.
What is 'Supply'

Supply is a fundamental economic concept that describes the total amount of a specific
good or service that is available to consumers. Supply can relate to the amount
available at a specific price or the amount available across a range of prices if displayed
on a graph. This relates closely to the demand for a good or service at a specific price;
all else being equal, the supply provided by producers will rise if the price rises because
all firms look to maximize profits.

BREAKING DOWN 'Supply'

Supply and demand trends form the basis of the modern economy. Each specific good
or service will have its own supply and demand patterns based on price, utility and
personal preference. If people demand a good and are willing to pay more for it,
producers will add to the supply. As the supply increases, the price will fall given the
same level of demand. Ideally, markets will reach a point of equilibrium where the
supply equals the demand (no excess supply and no shortages) for a given price point;
at this point, consumer utility and producer profits are maximized.

‘Supply’ Basics

The concept of supply in economics is complex with many mathematical formulas,

practical applications and contributing factors. While supply can refer to anything in
demand that is sold in a competitive marketplace, supply is most used to refer to goods,
services or labor. One of the most important factors that affects supply is the good’s
price. Generally, if a good’s price increases so will the supply. The price of related
goods and the price of inputs (energy, raw materials, labor) also affect supply as they
contribute to increasing the overall price of the good sold.

The conditions of the production of the item in supply is also significant; for example,
when a technological advancement increases the quality of a good being supplied, or if
there is a disruptive innovation, such as when a technological advancement renders a
good obsolete or less in demand. Government regulations can also affect supply, such
as environmental laws, as well as the number of suppliers (which increases
competition) and market expectations. An example of this is when environmental laws
regarding the extraction of oil affect the supply of such oil.
Supply is represented in microeconomics by a number of mathematical formulas. The
supply function and equation expresses the relationship between supply and the
affecting factors, such as those mentioned above or even inflation rates and other
market influences. A supply curve always describes the relationship between the price
of the good and the quantity supplied. A wealth of information can be gleaned from a
supply curve, such as movements (caused by a change in price), shifts (caused by a
change that is not related to the price of the good) and price elasticity.

History of ‘Supply’

Supply in economics and finance is often, if not always, associated with demand. The
Law of Supply and Demand is a fundamental and foundational principle of economics.
The law of supply and demand is a theory that describes how supply of a good and the
demand for it interact. Generally, if supply is high and demand low, the corresponding
price will also be low. If supply is low and demand is high, the price will also be high.
This theory assumes market competition in a capitalist system. Supply and demand in
modern economics has been historically attributed to John Locke in an early iteration,
as well as definitively used by Adam Smith’s well-known “An Enquiry into the Nature
and Causes of the Wealth of Nations,” published in Britain in 1776.

The graphical representation of supply curve data was first used in the 1870s by English
economic texts, and then popularized in the seminal textbook “Principles of Economics”
by Alfred Marshall in 1890. It has long been debated why Britain was the first country to
embrace, utilize and publish on theories of supply and demand, and economics in
general. The advent of the industrial revolution and the ensuing British economic
powerhouse, which included heavy production, technological innovation and an
enormous amount of labor, has been a well-discussed cause.

Related Terms & Concepts

Related terms and concepts to supply in today’s context include supply chain finance
and money supply. Money supply refers specifically to the entire stock of currency and
liquid assets in a country. Economists will analyze and monitor this supply, formulating
policies and regulations based on its fluctuation through controlling interest rates and
other such measures. Official data on a country’s money supply must be accurately
recorded and made public periodically. The recent and ongoing European sovereign
debt crisis, which began in 2007, is a good example of the role of a country’s money
supply and the global economic impact.

Global supply chain finance is another important concept related to supply in today’s
globalized world. Supply chain finance aims to effectively link all tenets of a transaction,
including the buyer, seller, financing institution—and by proxy the supplier—to lower
overall financing costs and speed up the process of business. Supply chain finance is
often made possible through a technology-based platform, and is affecting industries
such as the automobile and retail sectors.

Law Of Supply And Demand

The law of supply and demand is the theory explaining the interaction between the
supply of a resource and the demand for that resource. The law of supply and demand
defines the effect the availability of a particular product and the desire (or demand) for
that product has on price. Generally, a low supply and a high demand increases price,
and in contrast, the greater the supply and the lower the demand, the lower the price
tends to fall.

BREAKING DOWN 'Law Of Supply And Demand'

One of the most basic economic laws, the law of supply and demand ties into almost all
economic principles in one way or another. In practice, supply and demand pull against
each other until the market finds an equilibrium price. However, multiple factors affect
both supply and demand, causing them to increase or decrease in various ways.
How Do Supply and Demand Create an Equilibrium Price?

Also called a market-clearing price, the equilibrium price is the price at which the
producer can sell all the units he wants to produce, and the buyer can buy all the units
he wants.

For a simple illustration of how supply and demand determine equilibrium price, imagine
a business brings out a new product. It sets a high price, but only a few consumers buy
it. The business anticipated selling more units, but due to lack of interest, it has
warehouses full of the product.

Due to its high supply, the business lowers the price. Demand increases, but as the
business's supply dwindles, it raises the price until it finds the perfect price to balance its
supply with consumer demand.

What Factors Affect Supply?

In the above example, supply only takes into account the supply created by a single
business. In real economies, supply is predicated on many other factors. Production
capacity, production costs such as labor and materials, and the number of competitors
directly affect how a much supply businesses can create. Ancillary factors such as
material availability, weather and the reliability of supply chains can also affect supply.

What Factors Affect Demand?

Demand is affected by the quality and cost of a product. The number of available
substitutes, advertising and shifts in the price of complementary products also affect its
demand. For example, if the price of video game console drops, demand for games for
that console may increase as more people buy the console and want games for it.

Does Supply and Demand Only Affect Prices?

The law of supply and demand does not just apply to prices. It may also describe other
economic activity. For example, if unemployment is high, there is a large supply of
workers. As a result, businesses tend to lower wages. Conversely, when unemployment
is low, the supply of workers is also low, and as a result, to entice workers, employers
tend to offer higher salaries. Similarly, in the world of stock investing, the law of supply
and demand can help to explain a stock's price at any given time.
1. Go over past sales records. One of the most commonly used indicators of current
demand is past demand. Add up the total units sold over the past year and pay attention
to any seasonal trends that may be displayed by spikes or dips in the amount of product
sold. The pitfalls with this method are that it doesn't account for changes in the
marketplace, competitors' products or a change in your marketing strategy.

2. Use marketing projections to help determine demand. If you increased your

marketing efforts and planned to add "X" amount of customers per month, your
inventory will need to increase with this amount. Typically you can estimate "X" amount
of customers equal to "X" amount of products sold, plus or minus a few percent in either
direction. This method also contains pitfalls, since there is no way to accurately forecast
whether or not you will actually get as many new customers as you expect.

3. Use a competitor's sales data. This is useful for small businesses that plan to roll out
a competitive pricing strategy for a similar product or for those releasing a new product
that they have not yet experienced selling.

4. Pay attention to the local and global economy. If your local economy is depressed,
your local sales will logically decline. The same is true with the global economy. Periods
of economic depression are marked by poor retail sales and this will affect the amount
of inventory you want to have available.

5. Estimate sales on recent performance. This is helpful for new products that do not yet
have a history. When a product first comes out, chances are if the marketing efforts are
working, it will sell well. This will gradually begin to taper off as the newness of the
product wears off. Pay attention to declining sales numbers and adjust your inventory
expectations accordingly.