Supply and demand
The law of supply and demand explains the interaction between sellers of goods and services and their buyers, describing their behaviour. This paradigm lays the necessary foundation for understanding the dynamics of any market and is essential to ensure its health and proper functioning. In economics, a market is a physical or virtual place where supply and demand meet to allow the exchange of goods and services.
Demand represents the variability in the quantity of goods demanded by consumers: the market is a dynamic place, where several factors affect supply and demand. The determining variable that most influences good purchases is the price. The value attributed to a product or service is also variable, because it is subject to the rate of inflation and the ‘cost of money’ (interest rates). The law of demand, in this respect, defines the relationship between the quantity demanded and price: the demand for a specific product decreases as the relative price increases; the variables of quantity demanded and price are, therefore, inversely proportional.
The law of demand can be represented graphically by means of a mathematical function: the graph is called the demand curve. Since lowering the price generates an increase in demand, the demand curve will have a negative slope.
Individual demand refers to the quantity of a specific good or service that an individual buyer buys at a given price, based on his or her means or preferences. Beyond that, it also considers the price of complementary and substitute goods. If, on the other hand, you want to refer to the overall demand of all buyers with respect to a certain product, you can refer to market demand, obtained through the sum of the individual demands. By considering all market demands together, usually within state borders, for each good and service, it is possible to obtain the aggregate demand. This figure is used in macroeconomics to estimate the national income of a given country, as prices vary.
Supply, the other market force, indicates the quantity of a given product or service that is offered for sale at a certain price and within a specific time frame. As with demand, price is one of the main variables influencing the development of supply.
The law of supply explains the relationship between the quantity offered and the price by analysing the influences generated by a reciprocal increase or decrease. According to this model, as the quantity offered of a given good or service increases, the price of the same product increases. The supply and price variables are thus directly proportional: in order to maximise profit, sellers increase the supply of products as the price increases.
The supply curve is the graphical representation of the relationship between supply and price: since they increase reciprocally, the curve will have a positive slope.
The individual offer takes into account a single seller who makes a certain economic good available in a certain quantity and at a certain price. Adding up all individual offers of that good results in the market (or overall) demand.
Aggregate supply, on the other hand, is obtained by simultaneously considering all market demand, related to each good and service and present in a given territory. In macroeconomics, aggregate supply is an estimate of GDP (Gross Domestic Product), i.e. the index of a state’s productive activity.
The market is a dynamic and complex environment, but it is possible to understand its basic functioning by comparing the forces of supply and demand. By nature, the market tends towards stability, seeking a balance between supply and demand: if demand for a product is high, but supply is unable to meet consumer needs, its price will rise. This will push companies to increase production and thus the supply of that product, for the greater possibility of profit, until supply and demand are in equilibrium again. The price will then adjust accordingly, this time decreasing.
Conversely, in a situation where there is too much supply, sellers have an incentive to lower the price to meet demand.
Market equilibrium refers to the level at which supply and demand are equivalent and can be identified by the point of intersection of the two curves in the supply and demand graph.
By superimposing the supply and demand curves, it is therefore possible to define the equilibrium price: the value that equals the quantity offered of a given good and the quantity demanded by buyers in a given market, referred to as the equilibrium quantity. This value is able to bring both sellers and buyers into agreement, as it satisfies both and thus allows the market to find stability.