Business Glossary

What is Supply and Demand?

Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.

Supply and demand ebbs and flows but it’s one of the major drivers in a free economy. It dictates how much businesses can charge for products (goods or services) and how much they need to produce. If you’re the only person selling something, you can pretty much charge what you like, but if lots of people are in the same market, you need to be competitive to stay afloat.

In practice, it means that whatever your business sells can fluctuate, depending on multiple factors. Thanks to supply chain disruptions and the scarcity of some raw materials caused by Brexit and Covid-19 lockdowns, for example, there have been hefty price rises across many markets.

Effect of supply and demand on business

As a business, if you experience problems with supply but great demand, there are two things you can do – pass on the cost to your customer, in which case you charge more for your product, or absorb the cost so price remains competitive but you suffer lower profit margins.

If the opposite happens – there’s lower need and lots of the product on the market – you can lower your prices to remain competitive, or keep them where they are and risk sales and profits falling.

Definition of a demand curve

A demand curve or a demand graph is a way of demonstrating the relationship between the price of a product and the need for it during a given time period.

On a demand curve, the price is plotted on the vertical y axis while the quantity is plotted on the horizontal x axis. It is an inverse curve – if the price is high, demand will be low; then as the price drops, demand will increase because more people are able to buy.

Definition of a supply curve

A supply curve is the opposite of a demand curve with an upward slope and represents the correlation of price with the supply of products. Again, the price is plotted on the vertical y axis while supply is on the x axis.

As the commodity price increases, supply will also increase. There are factors which cause the supply curve to shift. For example, lower production costs mean businesses can make more at the same price, and the curve moves to the right.

The equilibrium price is where the two curves intersect – the number of products consumers want to buy is equal to the amount producers want to sell.

How price elasticity works

Price elasticity refers to the change in quantity of a particular product in relation to its price. A product is considered elastic if a small change in price triggers a large change in demand; it is inelastic if a large change in price has little effect on it. Understanding elasticity can help you forecast your sales figures more accurately, for example, by discovering that a small price reduction could lead to a 20% increase in sales.

Frequently asked questions

What is the role of supply and demand?

In a free market, it determines the price of goods and services being sold. Supply represents the amount available in the market, and demand represents the amount consumers want to buy.

Does demand affect supply?

The two are inextricably linked. The law of demand states that buyers want less of a product at a higher price. The law of supply says that if prices are higher, there is more supply of a product.

What causes supply and demand?

Market forces and consumer behaviour:

  • Income changes – If people have more income, they can afford to buy more.
  • Trends and tastes – If something is in fashion, for example, the latest smartphone, demand increases. If a newer model is released, demand for it drops.
  • Related goods prices – The fall in the price of one product can increase demand for another product.
  • People’s expectations – These can significantly affect price and demand.

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