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The concept of supply and demand is often called the heart and soul of economics.
Understanding how supply and demand affect the economy helps us recognize economics everywhere in our daily lives and helps us build a New stock strategy.
First, let’s talk about Supply and Demand, as on the IMF website.
Supply and Demand: Why Markets Tick
For many economists, those three magic words are “supply, demand, price.”
In any market transaction between a seller and a buyer, the price of the good or service is determined by supply and demand in the market. Supply and demand are, in turn, determined by technology and the conditions under which people operate.
At one extreme, the market could be populated by a large number of virtually identical sellers and buyers (for example, the market for ballpoint pens). At the other extreme, there might be only one seller and one buyer (as would be the case if I wanted to barter my table for your quilt).
Perfect competition
Economists have formulated models to explain various types of markets. The most fundamental is perfect competition, in which there are large numbers of identical suppliers and demanders of the same product; buyers and sellers can find one another at no cost, and no barriers prevent new suppliers from entering the market.
In perfect competition, no one can affect prices. Both sides take the market price as a given, and the market-clearing price is the one at which there is neither excess supply nor excess demand. Suppliers will keep producing as long as they can sell the good for a price that exceeds their cost of making one more (the marginal cost of production).
Buyers will continue to purchase as long as the satisfaction
They derive from consuming is greater than the price they pay (the marginal utility of consumption). If prices rise, additional suppliers will be enticed to enter the market. Supply will increase until a market-clearing price is reached again. If prices fall, suppliers who are unable to cover their costs will drop out.
Economists generally lump together the quantities suppliers are willing to produce at each price into an equation called the supply curve. The higher the price, the more suppliers are likely to produce. Conversely, buyers tend to purchase more of a product a lower its price. The equation that spells out the quantities consumers are willing to buy at each price is called the demand curve.
Supply and Demand: Why Markets Tick
Demand and supply curves can be charted on a graph (see chart), with prices on the vertical axis and quantities on the horizontal axis. Supply is generally considered to slope upward: as the price rises, suppliers are willing to produce more. Demand is generally considered to slope downward: at higher prices, consumers buy less. The point at which the two curves intersect represents the market-clearing price—the price at which demand and supply are the same.
Prices can change for many reasons.
(technology, consumer preference, weather conditions). The relationship between the supply and demand for a good (or service) and price changes is called elasticity. Inelastic goods are relatively insensitive to changes in price, whereas elastic goods are very responsive to price. A classic example of an inelastic good (at least in the short term) is energy. Consumers require energy to get to and from work and to heat their houses. It may be difficult or impossible in the short term for them to buy cars or houses that are more energy efficient. On the other hand, demand for many goods is very sensitive to price. Think steak. If the price of steak rises, consumers may quickly buy a cheaper cut of beef or switch to another meat. Steak is an elastic good.
Of course, most markets are imperfect; they are not composed of unlimited buyers and sellers of virtually identical items who have perfect knowledge. At the other end of the spectrum from perfect competition is monopoly. In a monopoly, there is one supplier of a good for which there is no simple substitute. The supplier does not take the market price as a given. Instead, the monopolist can set it. (Monopoly’s twin is monopsony, in which there is only one buyer, usually a government, although there may be many suppliers.)
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