Supply and demand

Although technically two separate terms in the world of economics—“supply” refers to the amount of materials or service available for a consumer in a competitive market, and “demand” refers to the actual want (not need) consumers have for a particular good or service—the two terms are inevitably bound together in shaping a model for economic activity. The law of supply and demand is a fundamental principle of a free-market capitalist economy as it relates goods and services to consumers, and in turn serves to help predict economic activity by measuring the relationship between market and goods that determines price. Given the fluid nature of free-market capitalism and how a variety of events can affect the availability of goods and even the market need, the law of supply and demand is used by businesses (and governments) as a predictor of short- and long-term economic activity and growth.

Background

According to economic historians, the concept of relating supply and demand to market price dates back to the late thirteenth century when shipping lanes and trading markets were first established and coordinated all along the Mediterranean coast. Applied to marketable goods from fruits and vegetables to livestock and artisan wares, the logic was simple. If the desire for a good or service increases while at the same time its availability, for whatever reason, is curtailed, the price for the items still available will rise—sellers can ask for and receive whatever price the market will sustain. If, however, the market is oversaturated with the product—that is, there are more units available than people who want them—the seller must drop the price in order to sell the product.

Although first codified in the groundbreaking economic theoretical works of English philosopher John Locke (1632–1704) in the late seventeenth century, the term is most often associated with the economic writings of Scottish economist and philosopher Adam Smith (1723–1790), whose landmark Wealth of Nations (1776) influenced the development of the free-market economic superstructure of the fledgling American nation. The free-market economy essentially allowed the marketplace and the judgments and decisions of the buyers to determine the price for goods, a kind of democratic economic structuring in which demand, supply, and price are directly related.

The law of demand says that, in the absence of some unexpected influence (say, a natural disaster), as the price of a good or service increases, the number of buyers willing to pay that price decreases. If the only way to acquire that good or service is for the person to revisit their personal budget and eliminate other items in order to allow the purchase, consumers will not pursue the purchase. If a high-end motorcycle costs $42,000, the person interested in the motorcycle will not pursue that purchase unless they are willing to reallocate their own private funds to allow for that. One of the exceptions to the law of demand is the concept of the attractiveness of high-end purchases—that is, the willingness of some buyers, usually under pressure by marketing campaigns, to buy exactly because the price of the good or service is high. If an off-brand motorcycle is marketed at under $10,000, and all other things are equal, people would logically demand that bike.

The law of supply is similar. As the price buyers are willing to pay for a good or service increases, the more willing producers are to increase the quantity they offer for sale. If there is a measurable market for $42,000 motorcycles, the company will produce them and sell them at that price, thus generating increased revenue. Of course, there is implicit in the law of supply a question of expediency—how quickly can the producer make available the goods or service. Thus, if the expensive motorcycle proves a fad and the company expends resources to produce high-end motorcycles that, by the time they arrive at sales locations, have dropped out of interest, the company will suffer the economic consequences. Thus, companies employ entire legions of market analysts whose job is to measure and forecast trends and to ensure that the company anticipates market needs and thus maintains the desired equilibrium between market, price, and consumer. Indeed, a fundamental expression of economic theory is charting the movements or shifts in market needs and demands and charting both supply and demand curves to use as predictors of market activity. Should the government, for instance, legislate that, because of environmental concerns, cars were no longer permitted and that only motorcycles could be driven, then the high-end motorcycle company would push adaptations into long-term production to meet the market demand and would market a far cheaper model of the motorcycle in order to adequately secure the desired market share.

In any case, the goal is equilibrium—that is, the supply of a good or product is equal to its demand. At that point the economic model is said to operate at peak efficiency and productivity, maintaining a fair market price for a good that in turn provides the producer with compensatory revenue. If either the supply is in excess of demand or the demand is in excess of the supply, the resulting disequilibrium compels the market to adjust itself.

Supply and Demand Today

The law of supply and demand does not take into consideration the inevitable reality of external forces reshaping the market, such as pressures from artificial government controls, war, weather catastrophes, the greed of producers, or the often curious logic of consumers. In addition, two very pressing commodities appear to violate the theoretical model. The cost of fuel oil, for instance, does not appear to abide by the theory, as consumers appear to accept as inevitable paying more for the same good even when there is no great threat to its availability and no satisfactory economic explanation for the fluctuations. And virtually each generation of computer technology, whether video-game consoles, phones, or laptops, must actually create demand as no one actually “needs” a new (and expensive) gadget that itself will most likely be obsolete within months.

Bibliography

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Cachon, Gérard, and Christian Terwiesch. Matching Supply with Demand: An Introduction to Operations Management. 3rd ed. New York: McGraw, 2011. Print.

Cashin, Paul, Kamiar Mohaddes, Maziar Raissi, and Mehdi Raissi. The Differential Effects of Oil Demand and Supply Shocks on the Global Economy. International Monetary Fund, Oct. 2012. Digital file.

Friedman, Milton S. Capitalism and Freedom. 40th anniv. ed. Chicago: U of Chicago P, 2002. Print.

Hines, Tony. Supply Chain Strategies: Demand Driven and Customer Focused. 2nd ed. New York: Routledge, 2013. Print.

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