Offer and demand
In economics, supply and demand are respectively the quantity of goods or services that market players are willing to sell or buy based on prices.
Supply and demand is one of the most fundamental economic concepts, and the backbone of a market economy. Demand refers to the quantity of a good or service that is desired by consumers. The quantity demanded is the number of units of a good that consumers are willing to buy at a certain price; The relationship between the price and the quantity demanded is known as the demand ratio.
The offer represents the market’s ability to offer a good. The quantity offered refers to the number of units of a good that producers are willing to produce at a certain price. The correlation between the price of a good and the quantity offered of that good offered in the market is known as the supply relationship. The price, then, is an interaction of supply and demand.
The market economy system depends on the free play of supply and demand to develop its functions. In a perfect market, there is a very large number of buyers and sellers, so the transactions of each of them are small in relation to the total volume of transactions.
To carry out these transactions, it is necessary to allocate resources for the production of the goods and the purchase of these. Supply and demand theories indicate that resources will be allocated in the most efficient manner. How? Let’s look closely at the laws of supply and demand.
Law of the Demand
The law of demand says that, if all other factors remain the same (ceteris paribus), at a higher price of a good, fewer people will demand that good. In other words, at a higher price, lower demand. Consumers buy fewer units when the price is higher because as the price of a good increases, the opportunity cost of buying that good also increases. As a result, people by nature will avoid buying a product that prevents them from consuming something else they value more.
Of course, the price is not the only factor that determines the quantity demanded of a given product. Other factors that intervene are the preferences, the income, the prices of other products. However, it is usually the price of the product itself that most influences demand.
By keeping all other values equal (condition ceteris paribus), we can create a demand table for a product X that relates the quantity demanded and the price of that product.
The demand table
The demand table gives us information about the number of units that the market will buy depending on different prices. As indicated by the law of demand, we can observe that as the price increases, the number of units demanded by consumers decreases. Conversely, as the price decreases, the demand for the product increases.
Table 1: Demand table
Quantity demanded of good X at various prices.
PRICE X DEMAND X
$ 2 8
$ 4 4
$ 6 6
$ 8 2
Continuing with the ceteris paribusy condition for a given price of product X, the sum of the individual respondents will give us the global or market demand for that product.
Why does the demand for a product decrease when the price increases?
There are two main reasons: first, when the price of a product increases, some consumers who previously purchased it will stop doing so and will look for other products that replace them. Second, other consumers will continue to consume the product, but the price increase will make them buy fewer units of it, since it has become more expensive with respect to other goods whose price has not changed.
An increase in the price of a product implies that the consumer’s income loses purchasing power, so he must choose between continuing to buy the same amount of the product that increased in price and stop buying other products, or stop buying that product -or decrease the amount you buy from it- to be able to buy the other products you need.
The curve and the demand function
The declining demand curve relates the quantity demanded with the price. When the price is reduced, the quantity demanded increases. At each price PX corresponds a quantity QX that the plaintiffs will be willing to acquire. The graph collects each pair of numbers (PX, QX) from the demand table DX (Table 1). The graph below shows that the demand curve has a descending slope.
In the graph, A, B and C are points in the demand curve. Each point on the curve represents a direct correlation between the quantity demanded (Q) and the price (P). Then, at point A, the quantity demanded will be Q1 when the price is P1. The demand curve shows the negative relationship between the price and the quantity demanded. The higher the price of a good, the lower the quantity demanded (A). Conversely, the cheaper the good, the greater the demand (C).
The demand curve of a good, as a graphic expression of the demand, shows the quantities of the good in question that will be demanded during a certain period of time and by a specific population at each of the possible prices. In any case, when for example we say that the quantity of demand of a good (QX) is influenced by the price of that good (PX), the rent (Y), the tastes of the consumers (G), and the prices relative to the other goods (PB), we are referring to the demand function, which we can express in the following way:
QX = D (PX, Y, PB, G)
To represent the curve of the figure in Table 1, what we have done is to suppose that in the previous expression (the demand function), the values of all the variables, except the demanded quantity of good X and its price, remain constants That is, we have applied the condition ceteris paribus (everything else remains the same).
The function of demand – price or strict function of demand includes the relationship between the quantity demanded of a good and its price. When plotting the demand curve, we assume that the other factors (ceteris paribus) that may affect the quantity of demand, such as rent or the prices of other goods, remain constant.
From the analysis we have made of the demand we can specify some questions. It is common to hear about the quantity demanded as a fixed amount. Thus, a businessman who is going to launch a new product to the market can ask himself: How many units can I sell? What is the potential of the market with respect to the product in question? To these questions the economist must answer saying that there is no “only” answer, since no number describes the required information, since the quantity demanded depends on several factors and not only on the price per unit.
Law of the Offer
Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain price. But unlike the demand law, the supply ratio shows an upward curve. This means that the higher the price, the greater the offer. Producers are willing to offer more product at a higher price because that way they can increase their profits. As in the case of demand, not only prices determine the supply of a product. Other important factors that influence are, for example, technology and the prices of productive factors (land, labor, capital).
The offer table
Under the ceteris paribus condition, we call the offer table the relationship that exists between the price of a good and the amounts that an entrepreneur would like to offer of that good per unit of time. We can obtain the global and market offer by adding for each price the quantities that all the producers of that market wish to offer.
While the demand table shows the behavior of the consumers, the supply table indicates the behavior of the producers. The offer table represents, for certain prices, the quantities that the producers would be willing to offer. At very low prices, production costs are not covered and producers will have no incentive to produce. But as prices increase, producers will be motivated by potential profits and begin to raise production to launch more units to the market.
TABLE 2: Offer table
Amounts offered of good X at different prices.
X OFFER PRICE X
$ 2 0
$ 4 2
$ 6 4
$ 8 6
The reverse argument can also be used. The growth of the supply curve can be established by saying that if, for example, greater production of a product is desired, it will be necessary to add more quantities of labor or other productive factors. Appealing to the law of diminishing returns, it turns out that the marginal cost necessary to raise production in a unit will be increasing.
The curve and the offer function
The offer can not be considered as a fixed amount, but as a ratio between the quantity offered and the price at which said quantity is offered in the market. In this sense, the curve of the company or industry is the graphic representation of the respective supply table, and shows the quantities of the good that will be offered for sale during a specific period of time at various market prices.
As we can see in the following graph, the supply curve has a positive slope.
In the graph, A, B and C are points in the supply curve. Each point on the curve represents a direct correlation between the quantity offered (Q) and the price (P). At point B, the quantity bid will be Q2 when the price is P2. The higher the price, the greater the offer.
The supply curve, then, graphically shows the relationship between the price and the quantity offered of a product, that is, the supply function. At each price PX corresponds an amount offered QX, and joining the different points (PX, QX) we obtain the supply curve.
The supply function establishes that the quantity offered of a good in a specific period of time (QX) depends on the price of that good (PX), of the prices of other goods (PB), of the prices of the productive factors (r) ), technology (z) and the tastes or preferences of producers (H). In this way we can write the following offer function:
QX = O (PX, PB, r, z, H)
The function offer – price or strict offer function collects ceteris paribusla relation between the quantity offered of a good and its price. When plotting the supply curve, we assume that all other factors that may affect the quantity offered, such as the prices of the factors of production, remain constant.
The time and the offer
Unlike the demand relationship, the supply relationship is a factor of time. Time is important for supply because producers must react quickly to changes in demand or price. It is important to try to determine if a change in the price is caused by a level of demand that will be temporary or permanent.
Suppose there is a sudden increase in the price of umbrellas for an unexpected rainy season. Umbrella manufacturers will have to accommodate the demand by using their production equipment more intensively for a short period of time. But, if the rain persists due to climate change and the population will require umbrellas throughout the year, the change in demand and price will be permanent, forcing manufacturers to improve their equipment and production process to meet the new levels of long-term demand.
Supply and Demand Relationship
Now that we know the laws of supply and demand, let’s see an example of how supply and demand affect prices.
Imagine that a special edition CD of your favorite artist goes on sale for $ 20. As the label knows, thanks to their previous analysis, that consumers will not buy a CD at a price higher than $ 20, they only produce 100 discs because the opportunity cost is too high to produce more.
But, if the 100 CDs are demanded by 200 people, the price will rise subsequently, because according to the relation of the demand, as the demand increases, the price also increases. Consequently, the increase in price should motivate the record company to produce more CDs because, according to the offer’s relationship, at a higher price, greater supply.
But if 300 CDs are produced and demand remains at 200, the price will no longer be pushed up, because the supply more than meets the demand. In fact, once the 200 consumers are satisfied with their CDs, the price of the remaining CDs will tend to go down, because the label will try to sell the remaining CDs.
The reduction in price will make the CD available to people who had previously estimated that the opportunity cost of buying the CD at $ 20 was too high.
An arbitrary price almost never makes the demand and supply plans coincide. Only at the crossing point of the supply and demand curves will this coincidence occur and only a price can produce them. When supply and demand are equal (when the supply function and the demand function intersect), it is said that the economy is in equilibrium. At that point we find the equilibrium price and the equilibrium quantity.
At the equilibrium point, the allocation of resources is at its most efficient level, because the quantity of goods produced is exactly the same as the quantity of goods demanded. Therefore, everyone (individuals, companies, countries) is satisfied with that economic condition. At the equilibrium price, manufacturers are selling all the products they have produced, and consumers are buying all the products they are demanding.
As can be seen in the graph, equilibrium occurs at the intersection of demand and supply curves, where there is no inefficiency in the allocation of resources. At that point, the price of the goods will be P * and the quantity demanded will be Q *. These figures are known as Equilibrium Price and Balance Amount.
In the real market, equilibrium can only be reached in theory, since the prices of goods and services vary constantly in relation to fluctuations in demand and supply.
To analyze the determination of the equilibrium price of a market, the supply and demand curves are drawn in the same graph.
TABLE 3: Table of supply and demand of good X
PRICE X DEMAND X OFFER X
$ 2 8 0
$ 4 6 2
$ 6 4 4
$ 8 2 6
$ 10 1 8
As we can see in the previous example, supply and demand curves intersect in 4.6. This means that at a price of $ 6, producers will be willing to produce 4 units, and consumers will buy them all at that price. If the price were $ 4, consumers would be willing to buy 6 units, but the producers would not have enough incentive and would only be willing to produce 2 units. Conversely, if the price were $ 8, the producers would have enough incentive to produce 6 units, but consumers would only buy 2 units at that price.
The imbalance occurs when the price or quantity is not equal to P * or Q *.
1. Excess Supply: if the price is too high, an excess supply will be created in the economy and there will be an inefficient allocation of productive resources.
At a price P1, the number of units that the producers wish to offer is indicated by Q2. However, at that price the amount that consumers are willing to buy is at Q1, a much smaller amount than Q2. Since Q2 is greater than Q1, too many units are being produced and very few are being consumed. The manufacturers try to produce more units and sell them at a high price hoping to increase their profits, but buyers do not find the products attractive at that price, which makes sales are low.
2. Excess Demand: excess demand occurs when the price is established below the break-even point. As the price is very low, too many consumers want to buy the product, while the producers can not obtain higher profits.
In this situation, at a price P1, the number of units demanded by consumers is Q2. But the number of units that manufacturers are willing to produce at that price is only Q1. Therefore, too few units of the product are being produced to satisfy consumer demand. However, as consumers must compete with each other to buy the product at that price, demand will push the price up, making manufacturers feel motivated to produce more, bringing the price closer to equilibrium.
Movements and Movements of Supply and Demand
We have already analyzed how the demand and supply of a product varies when its price changes, but what will happen when, even if the price of the product remains unchanged, any of the other factors that we considered constant change?
Apart from prices, some of the other factors that also have a significant impact on the demand curve are the number of consumers, future price forecasts and expected future income.
Logically, if the average income of consumers who currently demand a good in question is constant, but the number of consumers increases, the quantity demanded of the good at the different prices will increase. Thus, an increase in the number of consumers will shift the curve to the right and a decrease to the left.
On the other hand, it is evident that the quantity demanded of a good in a given period depends not only on the prices of that period, but also on the prices that are expected in future periods. For example, the amount of gasoline demanded on a given day will be greater if it is expected that the government will imminently decree an increase in the price of fuel.
The incidence of the future also becomes clear when the variable considered is the income of consumers. For example, workers can expect to see a measurable pay rise in the future due to an agreement reached between unions and the government. If consumers believe that their income will increase in the near future, they will want to buy more goods in that period, whatever the price, so the demand curve shifts to the right.
An alteration of any factor different from the price of the product will move the whole curve to the right or to the left, depending on the direction of the change of said factor. This type of displacement is called displacement, while the result in changes in prices is called movement. This distinction is very important and it must be clearly understood what factors produce both types of changes.
In economics, this distinction is very important and the factors that produce movements and displacements in relation to supply and demand curves must be clearly understood.
A movement refers to a change along the curve. In the demand curve, a movement denotes a change in both the price and the quantity demanded from one point to another of the curve. The movement implies that the demand relationship remains the same. Therefore, a movement along the demand curve will occur when the price of the product changes and the quantity demanded changes according to the original demand relationship. In other words, a movement occurs when a change in the quantity demanded is caused only by a change in the price, and vice versa.
Like a movement along the demand curve, a movement along the supply curve means that the supply ratio remains consistent. Therefore, a movement along the supply curve will occur when the price of the product changes and the quantity offered changes according to the original supply ratio. In other words, a movement occurs when a change in the quantity offered is caused solely by a change in the price, and vice versa.
A shift in a demand or supply curve occurs when the quantity demanded or offered of a product changes despite the fact that the price remains constant. For example, if a can of beer costs $ 1 and the amount of beer demanded increases from Q1 to Q2, then we would have a shift in demand for beer. The shifts in the demand curve imply that the original demand ratio has changed, which means that the quantity demanded is being affected by a factor that is not the price. A shift in the demand relationship would occur, for example, if beer suddenly became the only type of alcoholic beverage available to consumers.
On the contrary, if the price of the beer can was $ 1 and the quantity offered decreased from Q1 to Q2, then there would be a shift in the beer supply. A shift in the supply curve implies that the original supply ratio has changed, which means that the quantity offered by the producers is being affected by a factor that is not the price. A displacement could occur, for example, if a natural disaster caused a shortage of hops, one of the ingredients in beer, forcing producers to offer less beer for the same price.