Analysis of supply and demand is mostly used by economists to illustrate the functioning of markets. Where supply and demand equal that will be the quantity and price of a good which prevail in the market.
Let’s consider David, who owns a car and has joined a ride-hailing service as a driver. He is usually able to service 15 riders per day at an average of $3 per km but on special occasions like when there is a new movie or concert he serves as many as 20 rides at $3.5 per km. By studying his past experience regarding the number of rides he has been able to accept at different locations and times of a day, he has adjusted his workday to maximize his income. Even though there may be thousands of drivers and hundreds of thousands of consumers in the ride-hailing market, it all depends on supply and demand.
Explaining supply and demand
It illustrate the functioning of a market and the actions or reactions of suppliers and consumers. The price and quantity of commodities and services are determined by supply and demand curves. Any changes in it will affect the equilibrium price and quantity of the good sold or service provided. The incentives of the producers and consumers will also be affected by changes in it.
What is supply in economics? Supply is the amount of the good or commodity which is available in the market for sale by producers. At higher prices, it is more encourageable for producers to increase supply, so supply curve slopes upward.
What is demand in economics? Demand is the quantity of the good that consumers’ wish to purchase and willingness to pay a price for that specific good. At higher prices, less will be demanded. As prices fall, more will be demanded. So demand curve slopes downward.
Determinant of price of a good/service
The most important feature of supply and demand is their part in determining the price of a good/service.
Let’s begin at a price of P2, there will be demand of Q2. As there is a supply of only Q1 there will be a shortage of supply and there will be a line of consumers trying to buy the limited stock available. In this case, there is an incentive for producers to raise the price. As the price is increased, producers will produce more and supply more. The raised price will also affect the demand and demand will decrease. The price will rise until supply equals demand at Price P1 and quantity at Q3.
This operation of the invisible hand explains how market equilibrium will occur i.e. where demand equals supply. Only at this point, there will be no change in price.
An easy example of supply and demand
An easy example to consider is why house prices in a city are over double as compared to house prices in another city. It is because of supply and demand.
In first city where prices are high, supply is limited as compared to demand because of higher standard of living and more word or job opportunities in the city. This situation is also attractive for international investors who buy houses as an investment.
In second city which is somewhat backward as compared to the first city. Here demand is less than supply. This is because of fewer opportunities of work or jobs which directly affect the incomes of the household. Because of weaker economic growth, the area is less attractive to buy to let investors.