Supply and Demand

Based on demand and available supply, prices are formulated and reach equilibrium once these two elements intersect. 

Adin Lykken

Reviewed by

Adin Lykken

Expertise: Consulting | Private Equity


October 25, 2023

What are the Laws of Supply and Demand?

Economies worldwide are built through a direct relationship between sellers and buyers. The sellers are considered the suppliers of products and services, and the buyers are the demand for these products and services. Both are the basics of an economy

In economics, these law determines the prices of products and services. Based on demand and available supply, prices will be formulated and reach equilibrium once these two elements intersect. 

The law of both governs the economic interaction between the sellers and the buyers of various goods. 

According to the supply and demand theory, a product's price is influenced by its availability and consumer desire. Therefore, when a product is expensive, its suppliers will put more of it on the market.

However, maintaining a high price may harm consumers' perceptions of the goods. Customers can start purchasing a less expensive alternative if they don't believe the product is worth the high cost. 

A higher price may cause less demand, which may cause a decrease in supply.

Before understanding their nature, we should understand the demand and supply curves. These two elements are usually represented through a graph that enables experts and professionals to determine prices' status and relevance. 

Demand curve: Demand for a particular commodity is influenced by its price and various other variables, including consumer income, consumer tastes, and seasonal impacts. 

Fundamental economic analysis entails studying the relationship between several price levels, and the maximum quantity consumers might purchase at each price while frequently holding all other variables constant.

The price-quantity combinations can be shown on a curve, where the horizontal axis represents the quantity and the vertical axis represents the price. A demand curve almost usually slopes downward, demonstrating consumers' willingness to buy more of the goods at lower prices. 

Supply curve: The quantity of a good sold in the market is determined by several variables, including the price of the good, the price of replacement goods, the technology used in manufacturing, the cost and availability of labor, and other production factors. 

Fundamental economic analysis entails holding all other potential price determinants constant while examining the link between different prices and the quantity that producers might offer at each price. 

These price-quantity combinations are plotted on the curve, where the price is represented on the vertical axis and quantity on the horizontal axis. 

The readiness of producers to sell more of the commodity they produce in a higher-priced market is typically reflected by an upward-sloping curve. 

While changes in the price of the commodity can be tracked along a stable supply curve, changes in non-price elements would result in a shift in the curve.

What is demand & how is it impacted?

Demand is the number of items that customers desire to purchase and can afford to do so at a variety of price points. 

The demand for commodities will remain steady up to a particular price point. But after that, consumers will deem the products too pricey, and demand for them will decline. Here are the factors that impact it: 

  • Product price
  • Buyer income
  • Buyer preference
  • Buyer expectation
  • Available substitutes
  • Complementary products
  • Market size

Product price: The demand from consumers for a commodity declines as its price rises. Less of the more expensive goods are purchased, and consumers search for less costly alternatives.

Buyer income: The purchasing power and demand for a product depend on the buyer's payment. Demand and purchasing power rises in response to greater income levels, whereas these two factors fall in response to lower income levels. 

Additionally, there is a connection between revenue and the caliber of commodities.

With an increase in income, demand for quality goods will rise, while it will fall for less desirable goods. However, if income declines, there will be less need for expensive things and more of a request for cheap ones.

Buyer preference: Customers' preferences for a product are influenced by trends and societal changes in habits and conventions. Demand for popular products will increase, but this can happen quickly when trends shift.

Buyer expectation: If consumers believe a product will soon be scarce, unobtainable, or more expensive, demand may increase. There is a clear link between the current market and future pricing since, based on their predictions, they will purchase and stock more of it now.

Available substitutes: The demand for alternatives will rise if a particular commodity's price rises. For instance, if you consistently buy a cereal brand and its cost increases to the point that it is unaffordable, you can start purchasing a comparatively less expensive cereal brand. 

As a result, there will be a greater need for readily available and less expensive cereal.

Complementary products: When two products are complementary, a rise in price for one can result in a decline in demand for the other. This is because using both products together will be challenging due to the price increase.

For instance, the cost of using a printer would increase if printing ink cartridge prices increased exponentially, reducing the demand for printers.

Market size: The number of consumers who buy the offered products depends on the market size. There will be fewer customers and less commodity demand if the market is tiny. Conversely, more people will purchase the products as the market grows, increasing demand.

The demand for the goods that this age group typically needs will increase if there is an increase in the market of purchasers of that age. For instance, if birth rates rise in a particular region, there will be a rise in demand for infant food and related goods.

What is supply & how is it impacted?

The relationship between the cost of goods and services and their accessibility to consumers is known as supply. This is because the sellers will supply the goods in large quantities if prices rise to earn high profits.

Demand-driven supply responds promptly to price fluctuations and changes in demand. The supplier must modify their collection in response to seasonal, transient, or permanent variations in order and price. Here are the factors that impact it: 

  • Production capacity
  • Production costs
  • Competitors
  • Availability of materials
  • Supply chains

Production capacity: The ratio of product output to resource input is known as production capacity. The firm will expand the work to supply additional supplies if there is an increase in market demand.

Production costs: Manufacturing costs include supplies, labor expenditures, and utilities like power and water. The product's market price will rise if the production costs are high. The collection will increase if the market can support high pricing. There will be a drop-in store if it can't.

Competitors: Any business that offers the same good or service at a comparable cost is considered a competitor. If customers opt for alternatives, competitors could make it difficult for a business to maintain a supply of goods at an affordable price. 

To get a stronger position in the market, they could cut output or switch to other products.

Availability of materials: The availability of low-cost raw materials can boost production and product supply. The show will decline, and lower collections will hit the market if the natural resources are hard to come by or are too expensive.

Supply chain: At every point of the manufacturing process, from obtaining raw materials to developing the product to moving them in the market-bound phase, the producer should have a well-managed, reasonably priced, and dependable supply chain. 

As a result, the market supply will effectively meet customer demand.

Market equilibrium 

The price dynamics in a free market equalize supply and demand. Buyers will bid a higher price if they want to buy more of a good than is offered at the going rate. Suppliers will lower their pricing if they want to accept less than what is provided at the going rate. 

Thus, the price mechanism determines how many units of a good will be produced.

The price system determines the distribution of goods, i.e., how they are produced, dispersed and who will receive them. Consumer goods, services, labor, and other salable commodities may be included in the goods created and supplied.

In each situation, a rise in demand will result in a bid up in price, which will encourage producers to supply more; a fall in order will result in a request down in price, which will enable producers to give less. 

Thus, the price system offers a straightforward scale by which every consumer or producer may weigh conflicting demands.

The market mechanism is the propensity to move toward equilibrium prices, and the resulting equilibrium between supply and demand is referred to as the market equilibrium.

A good's price increase typically results in an increase in the quantity supplied and a decrease in consumer willingness to purchase the good; however, these changes are not always proportional. 

The price elasticity of supply or demand, computed as the ratio of the percentage change in quantity provided or demanded to the percentage change in price, is a measure of how responsive supply and demand are to changes in price. 

The price elasticity of demand for a commodity is therefore considered to be two if its price drops by 10% and sales rise by 20%.

Over time, several additional forms of elasticities regularly employed to characterize well-known economic variables have become known by their unique names.

These include, but are not limited to, the demand elasticity of income, the cross-price elasticity (the elasticity of one good's price to another good's worth), and the elasticity of substitution between various factors of production (for instance, between capital and labor). 

It also includes the elasticity of intertemporal substitution (for example, the elasticity of consumption in the future relative to consumption in the present).

It is expected that the demand for products with easy substitutes would be elastic, which implies that it will be more responsive to changes in the product's price. This is so that if the cost of the goods increases, users can switch to another product. 

If there are no close replacements and a small portion of a consumer's income is spent on the goods, the demand for that product may be inelastic. Those with relatively inelastic demand for their products can raise prices to boost total revenue; companies with elastic demand cannot.

Markets for finished goods and services and those for labor, capital, and other production elements can benefit from applying supply-and-demand research. It can be used at the level of the business, the sector, or the overall level of the economy.


Both are directly related and fully correlate with each other. Markets depend on both elements to operate and continue their existence. Therefore, prices are dependent on the level of supply and level of demand as well. 

These two elements must balance to be healthy and relevant to the public. Excessive supply or demand is not a good sign as it will lead to implications translated through the prices, which can then translate to a more profound impact on markets in general. 

An excessive supply will lead to a drop in prices, negatively impacting suppliers; an unreasonable demand will increase costs and negatively impact buyers. 

Hence an equilibrium must be reached organically. Fluctuation in prices because of both is a typical trend, increasing severity until balance exists. 

These two elements can be observed even in our everyday lives, in local stores, and even in our homes. Knowing such details in our economy will require a reliable source of information. 

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Researched and authored by Ahmed Fagiry | LinkedIn

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