Demand and supply - how do they affect the market?
Everyone is a market participant, acting both on the demand side and on the supply side. The market is where the buying and selling of goods takes place. According to economists, it is a mechanism in which, under competitive conditions, there is a confrontation between supply and demand. How to set the price when sellers want it to be as high as possible, while buyers expect it to be as low as possible? Are there any situations when a higher price means more interest in a product? Find out what supply and demand are, how they affect the market, and when there are exceptions to the law of supply and demand.
Demand and supply - definition
It is worth getting acquainted with the definition of demand and supply to better understand how they affect the market, and thus how they affect the reality around us.
Demand is the amount of a good that buyers want and can buy at a given price within a certain period of time. The law of demand says that under the same conditions (ceteris paribus), as the price increases, the demand for a given good decreases, while its reduction causes an increase in demand.
Factors affecting the volume of demand:
- buyers' income,
- substitute prices,
- prices of complementary goods,
- predictions about future price developments,
- consumer preferences,
- social, demographic and geographic factors,
- economic and political situation.
We define supply as the amount of good that suppliers want and can deliver to the market in a given period of time. According to the law of supply, a higher price of a good corresponds to an increase in supply, while a lower price limits the quantity of supply, assuming a ceteris paribus.
The supply is primarily influenced by price. However, there are other determinants, such as:
- production factor prices,
- expectations regarding price changes on the market,
- export and import
- state intervention policy (subsidies, subsidies, legal conditions).
The presented definitions show that if we buy something, we are on the demand side, and if we sell - then we are on the supply side.
Equilibrium price - how to reach a compromise?
If it is known that the seller wants to sell as expensive as possible and the buyer wants to buy as cheaply as possible, how can a compromise, i.e. the equilibrium price, be reached? The competition comes to the rescue. Whenever we find a product to be too expensive, we can look for another retailer who offers it at a lower price. By selling at excessively high prices, the seller is exposed to the risk of losing the customer, therefore he has to adapt his pricing policy to the prices prevailing on the market. Market equilibrium occurs when the quantity buyers want to buy at a given price is equal to the quantity sellers want to sell.
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Supply and demand and paradoxes - does the exception prove the rule?
Usually, the volume of supply and demand follows the principles of the law of supply and demand. However, there are times when price reacts in the opposite way to supply and demand. We observe such phenomena when it comes to speculative Giffen, Veblen or sheep rush effects. Let's take a look at what these paradoxes characterize.
The Giffen Paradox - Affects low-income consumers and lower-order goods, which are called Giffen goods. This paradox says that despite the increase in the price of a given product, e.g. bread, the demand for a given good is also growing, while the number of purchases of other food goods, such as meat, for example, decreases.
The Veblen paradox - we see it in the case of high-income consumers interested in luxury goods. As in the case of the Giffen paradox, demand increases as the price of a product rises, but mainly for snobbish reasons.
Speculative effect - in this case, the demand for a good increases with the higher price, because the consumer believes that the price will continue to rise in the future.
We observed such a situation in 2011 on the Polish market, when the price of sugar began to increase rapidly. Many families decided to stock up on sugar for the following months, fearing that its price would be higher and higher.
Sheep Rush Effect - is based on an increase in demand for a given good due to the emerging fashion. Consumers buy products chosen by others because they want to imitate them or identify with them.
Steve Jobs took great advantage of this effect, using it for business needs. Appropriate marketing techniques sparked the fashion for having an iPhone and the demand for this product increased due to the sheep's rush effect.
The market works according to certain rules and it is rare for something to happen by chance. Supply and demand are constantly struggling with each other, but they cannot exist without each other, and in order to buy and sell, they must find a balance.