Essay on Application of the Laws of Supply and Demand

EssayEconomics
Jan 1, 2007

Understanding the laws of supply and demand is integral to comprehending how the economy works. Recent world events, such as the COVID-19 pandemic and Russia-Ukraine Crisis , have shown the volatility of economies. They showcased how prices move with societal issues, consumer behavior, and other factors. While there are many causes for economic shifts and movements, the laws of supply and demand will always be contributing factors. This essay will discuss the laws of supply and demand, as well as provide fictitious examples of their application.

Law of Supply

The law of supply, along with the law of demand, is a fundamental principle in economics. This law states that there is a direct relationship between supply and market prices. When a product’s market price increases, the number of goods or the supply will also increase (Ehrbar, n.d.). This relationship occurs from the incentives that high prices give to suppliers (Fernando, 2021). A product with a high price means that there are more earnings per unit sold. Alternatively, the law also dictates that when market prices are low, supply will decrease. Since there will be lower earnings from the low prices, suppliers may slow down or halt production. It is also important to note that the law of supply is mostly from a manufacturer’s perspective and consumer behavior has limited effects on it.

To better understand the law of supply, we can examine a fictitious company that sells computer parts. Company Z, a tech store, may learn from their market research that the product “processor A” has a high market price compared to other similar products. From this finding, the company assessed that selling processor A earns them 15% more profit compared to selling other products. Since the company’s goal is to earn revenue, it will increase its supply of processor A. Alternatively, the market price of “processor B” may have declined to a level that makes it nonprofitable. The company may then stop acquiring more supply of processor B until its market price returns to normal.

Law of Demand

The law of demand has an inverse relationship with the market price. Fundamentally, a product with a high price is less desirable because of consumers’ finite resources while affordable products have increased demands (Fernando, 2021). Unlike the law of supply, the law of demand depends heavily on consumer behavior. The law is a prediction of how consumers will react to the increase or decrease in market price. However, different types of goods can change consumer behavior, rendering the fundamentals of the law inapplicable. Some examples are Veblen goods and Giffen goods which tend to defy the laws of supply and demand (Bloomenthal, 2022). Still, the law of demand applies to most economic activities, and economists have explained the exceptions which do not invalidate the basic rules.

We can further examine the law of demand by utilizing the previous fictitious example. As mentioned earlier, Company Z is selling different types of computer processors. Processor A is their best-selling product. However as production cost increases due to various factors, the price of processor A starts to increase. When processor A’s price reached a 20% increase, consumers started to look for alternatives. This then results in low demand for high-priced products. For an inverse example; processor C, a product that has a similar quality to processor A, is cheaper. This causes the demand for processor C to increase.

What is the law of supply and demand?

Equilibrium Prices

The market price is an integral aspect of the law of supply and demand. Price movement is the factor that affects whether supply and demand increase or decrease. In theory, both suppliers and consumers can affect market price. Suppliers can dictate the offering price and supply of their products while consumers can directly affect demand. Suppliers will want to charge higher prices to earn more and consumers prefer to purchase quality products for cheap prices.  Therefore, there must be an agreement between the wants of suppliers and consumers to establish the market price for a product and promote economic activities. This agreement comes in the form of the “equilibrium prices” which is the price range where suppliers are willing to sell and consumers are willing to buy (Ehrbar, n.d.). Equilibrium prices stabilize the market and promote a good economic climate as they prevent extreme price movements or power imbalances between suppliers and consumers (Kiseleva et al., 2021). As long as a product’s price is within the equilibrium prices, there will be stable economic activities. However, moving too far from the equilibrium price range can trigger the effects of the laws of supply and demand.

Price Elasticity

As mentioned earlier, there are exceptions to the laws of supply and demand. Some factors can cause prices to increase despite low supply while others have high demand regardless of the high prices. Most of these exceptions are due to a product’s “price elasticity”. Price elasticity is a numerical measurement that economists use to identify the changes in demand or supply based on a product’s price movement (Fernando, 2021). High elasticity means that a product’s price substantially affects supply or demand while low elasticity means that there is less response to supply or demand regardless of price movement. Products with high elasticity tend to behave according to the laws of supply and demand while inelastic products can defy the fundamental rules.

The best examples of inelastic products are necessities, such as food, water, and basic clothing. Since individuals rely on these products to survive, there is always demand regardless of price movement (Fernando, 2021). Alternatively, luxury goods tend to be highly elastic products due to other factors affecting demand. For instance, a limited edition smartphone that is worth double the standard version will have high demand regardless of its extremely high price. This is because purchasing the item potentially improves an individual’s status (Fernando, 2021). Products can also be elastic or inelastic regarding supply. For instance, there is a finite supply of bitcoins. Even if a bitcoin’s price significantly increases or decreases, the supply remains the same. Elastic supply refers to products that are easy to manufacture or acquire (Ross, 2022). The ease of acquisition allows suppliers to retain their inventory regardless of an increase in production cost. These include man-powered services, such as taxi services and delivery services. Easy-to-make toys are also highly supply-elastic since manufacturing them is already cheap.

Conclusion

The laws of supply and demand predict a market’s reaction to price changes. The law of supply utilizes the perspective of manufacturers to assess the shifts in inventory quantity as prices increase and decrease. The law of demand investigates consumer behavior to evaluate their willingness to purchase goods depending on price movement. However, the different zones of price elasticity introduce exceptions to these laws which defy their fundamental rules. Still, since price elasticity is a measurable and observable factor, economists can quantify their effects and provide explanations for their causes. The laws of supply and demand are basic principles necessary in understanding real-life economic phenomena.

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References

Bloomenthal, A. (2022). Giffen Good Definition. Investopedia. Available at https://www.investopedia.com/terms/g/giffen-good.asp. Accessed: August 25, 2022.

Ehrbar, A. (n.d.). Supply. Econlib. Available at https://www.econlib.org/library/Enc/Supply.html#:~:text=The%20law%20of%20supply%20states,price%20rises%2C%20and%20vice%20versa.. Accessed: August 25, 2022.

Fernando, J. (2021). Law of Supply and Demand in Economics: How It Works. Investopedia. Available at https://www.investopedia.com/terms/l/law-of-supply-demand.asp. Accessed: August 25, 2022.

Kiseleva, I., Kuznetsov, V., Sadovnikova, N. & Androshina, I. (2021). Simulations of Supply and Demand Forecasting in a Market Economy. Geintec, vol. 11(4). Available at https://revistageintec.net/wp-content/uploads/2022/03/2218.pdf. August 25, 2022.

Rice University. (2016). Demand, Supply, and Equilibrium in Markets For Goods And Services. In Principles Of Economics. OpenStax. Available at https://opentextbc.ca/principlesofeconomics/chapter/3-1-demand-supply-and-equilibrium-in-markets-for-goods-and-services/

Ross, S. (2022). How Does Price Elasticity Affect Supply? Investopedia. Available at https://www.investopedia.com/ask/answers/040615/how-does-price-elasticity-affect-supply.asp. Accessed: August 25, 2022.

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