Law Of Supply And Demand Definition, Explaining Supply And Demand
In 1998, HDTV sets were made available for the first time to American consumers. The pictures were stunning, as were the prices—$5,000 to $15,000 on average.
Fast-forward 21 years and the average HDTV costs less than $500. What changed?
An oversimplified answer to that question would be supply and demand.
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21 years ago, nobody was mass-producing HDTVs. The first TVs that were available to the public carried a huge price tag because the components the manufacturers needed were more expensive than anticipated. So it was hard to estimate how much it would cost to make them and how much to charge to sell them.
Panasonic released a limited supply of mass-produced sets to a couple of stores on the west coast. One of those stores, Dow Stereo/Video in San Diego, reported that 15,000 people visited the store on the first weekend. Dow’s inventory of 30 sets quickly sold out.
Most of those 15,000 people were curious to see HDTV and didn’t intend to purchase a set. However, the fact that those first 30 HDTV sets sold out so quickly at a price of $5,500, plus the $1,700 that was charged for the set top box that was required to receive digital signals, indicated that there was some demand.
As your business seeks to determine the right price point for products and the amount needed to satisfy demand, supply and demand graphs can help. Read more about how this economic principle works.
Supply and demand explained
What is supply and demand? Simply defined, supply and demand says that prices are low when there are plenty of products available for purchase. When supplies are scarce, prices are driven up, and demand decreases.
So the law of supply and demand can be summed up as the relationship between demand for a product or service, the supply of that product or service, and the price that consumers are willing to pay.
What is a demand curve?
To understand what a demand curve is, you’ll need to understand the law of demand.
Demand explains how a market is driven by consumers, who base their decisions mainly on how much money they make and whether they can find a similar product at a lower price. At lower prices, consumers purchase more products. When the price increases, the expectation is that consumers will purchase fewer items or will seek out similar, less expensive products as a substitute.
In 1998, the HDTV supply was very limited. The demand was also limited as it was mostly driven by early adopters who had the means to pay thousands of dollars for a home entertainment system. However, because the limited supply sold out quickly, more manufacturers were eager to produce their own versions of HDTVs to try to grab a share of the market. More product eventually led to lower prices and higher consumer demand.
So what does a demand curve illustrate? A demand curve is the visual representation of the law of demand. The following example is an oversimplification of the relationship between the supply, demand, and the price of the first HDTVs in 1998.
Demand curve example: In this example, a store was able to sell 30 HDTVs in a week at a price of $5,500. In an effort to sell more sets the next week, the store offered a $500 discount and was able to sell 60 sets.
What is a supply curve?
If demand is driven by consumers, then the law of supply is driven by manufacturers and sellers and their desire to make money. The supply is the amount of product that manufacturers are willing to make available to sellers, and the amount that sellers are willing to make available to the consumer at a particular price during a specified time frame.
Today, you can buy larger flatscreen TVs with superior picture quality than those from 1998 for approximately $500 or less. This is possible because there are more players in the game, production costs have come down, and manufacturing is more efficient. These circumstances have made it much easier to get more product to the consumer.
Suppliers have to be careful not to supply too much product so the market does not become saturated. As prices go down, that cuts into profits. Also, lower prices can have a negative impact as consumers perceive less expensive items as being cheaply made and of low quality.
The supply curve is the visual representation of the law of supply. The following supply curve graph tracks the relationship between supply, demand, and the price of modern-day HDTVs.
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Supply curve example: In this example, 50-inch HDTVs are being sold for $475. As demand increases for these particular models, the manufacturer supplies more to the seller to meet the demand. The seller increases the price to $500 to make more money while demand remains high. When prices are raised again, the demand will level off and may start to wane, leading to a supply surplus.
Supply and demand equilibrium
When we put the demand and supply graphs together, the curves will intersect. This intersection is used to determine the equilibrium price. The equilibrium price represents the point where the supply of a product is equal to the demand for that product.
The example supply and demand equilibrium graph below identifies the price point where product supply and the price consumers are willing to pay are equal, keeping supply and demand steady.
Supply curve example: In this example, the lines from the supply curve and the demand curve indicate that the equilibrium price for 50-inch HDTVs is $500. Prices too high above $500 can decrease demand and lead to a product surplus. Prices too far below $500 can increase demand and lead to a product shortage.
You want to keep your product supply and price points as close to the equilibrium as possible to avoid a surplus or shortage of goods.
A surplus occurs when the price is set too high. This cuts into profits as demand decreases and consumers stop buying your product. Some people will look for substitutes or cheaper alternatives to your product or just stop buying them completely. Sellers try to eliminate the surplus by reducing prices to entice consumers to start buying again.
A shortage can occur when demand outpaces supply, which occurs when the price is set too low. Manufacturers may have a hard time producing enough product to keep up with demand. However, a shortage will drive up the price as consumers compete to buy the product. Sometimes manufacturers will deliberately hold back the product to create demand so prices can be raised.
Price elasticity
Not all products behave the same way to supply and demand fluctuations. Some products are more sensitive to price changes than others.
For example, everybody needs to eat to live. An early freeze or drought conditions might drive up food prices, but people are still going to buy food. They may not buy as much as they normally would, or they might opt for cheaper, lower quality alternatives, but they are still going to buy groceries.
On the other hand, if the cost of the components needed to make HDTVs rises and causes TV prices to rise beyond what people are willing to pay, chances are they won’t be running out to buy a new TV.
The effect that demand has on the set price is known as the product’s price elasticity. If a product’s change in price causes substantial changes in demand and supply, that product is elastic. If a product’s price changes don’t have that much of an effect on demand, that product is known as inelastic.
In our examples above, essential live-sustaining foods are inelastic because people have to eat if they want to stay alive. They may skip the candy and cookies, but they will always buy the items they need to live.
When the price of luxury or nonessential items such as HDTVs rise too much, it has a big effect on the demand as consumers decide to wait to buy a new set or decide not to buy a new TV at all. Home electronics are nice to have, but they are very elastic products because we don’t need to buy them, and it’s very likely that nobody has died yet from not watching enough TV.
Get started on a supply and demand graph
Product prices are determined by consumer demand and the amount of goods suppliers are willing to make available. Where the two curves meet helps you to determine the equilibrium price that balances the supply and demand. Use phunutiepthi.vn to make supply and demand graphs so you can make better pricing decisions faster.
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When you understand the relationship between the demand, supply, and equilibrium price, you can more effectively analyze the market you work in or want to break into. The analysis helps you to allocate resources and be more cost-effective.