The law of demand and supply is one of the basic tenets that underpin economic theory. It is define as the willingness and the ability of a consumer to buy a particular good or a service at the prevailing market price (Kash, 2002). Demand is inversely related to the price of a good or a service such that holding all the other factors that influence demand constant, a rise in the price of a commodity will lead to a fall in the demand of that commodity. Plotting the price of a commodity against quantities of the commodity yields the demand curve.
Besides price, other factors have been known to influence price. These factors include the following income, consumer’s tastes and preferences price of related goods and consumer’s expectation about the future price.
A rise in consumer’s income will lead to a rise in demand, whereas a fall will result in decrease in the demand for the goods or the commodities
Consumer’s tastes and preferences
If the changes in preferences and tastes are in favor of a particular good or a service the demand of such goods increases (Morse, 1958). On the other hand, if the changes in preferences and tastes the demand reduces.
Price of Related Goods
Based on their relationship, goods can be categorized into three groups namely substitutes, complementary goods and finally independent goods. The price of a substitute is positively related to the demand of a good. For instance, the price of coffee is positively related to the demand of tea so that when the price of coffee raises the demand for tea increases. Price of complementary goods, on the other hand, are negatively related to the quantity so that whenever the price of one good increases the demand for the others reduces and vice versa (Barnett, 1981). For example, when the price of vehicles increases the demand for petrol reduces. Finally, the price of one good has no correlation to the demand of an independent good.
Expectations about future prices
If consumers anticipate that there is going to be a rise in the price of a commodity, they may increase their demand in order to protect themselves from the effects of higher prices in the future. If on the other hand they expect future prices to fall, they may reduce their current demand so that they can leverage on this by buying at cheaper prices in the future.
The other side of the market is the supply side. Economists define supply as the quantity sellers are willing and able to take to the market at the prevailing price and time. Economic theory suggests that there is a positive relationship between price of a commodity and its supply ceteris paribus so that whenever the price rises the supply of that commodity rises, as well. The opposite is true in case of a fall in the price. Plotting price against quantity depicts such a positive relationship.
Just like demand, supply is influenced by a number of factors which namely production cost, technology and expectations of future prices to mention but a few.
The goal of private firms is ideally to make profits which are largely influenced in turn by the costs incurred in the production of these goods. It therefore means that, increase in the costs of production will reduce profit margins. The spiral effect of this is that, producers are discouraged from producing and therefore supply reduces (Schultz, 1938). Reduction in the cost of production produces reverse results.
Advance technology aids in reducing costs by enhancing efficiency. It therefore means that supply is encouraged. Obsolete technology on the other hand, discourages supply.
Expectations about future prices
Whenever suppliers expect that prices will rise in the future, they try to hold on to their stocks so that they can take advantage of such future rises in prices. By contrast, if they anticipate that there is going to be a drop in the prices, they willingly dispose off the stocks. If this is not the case, they risk losses in the future.
The interaction of the demand and supply constitute the equilibrium in the market. This is only so if the demand and supply equates. Whenever this happens, economists say that the market has cleared. In case either of the supply or demand exceeds the other, two situations may arise depending on which one exceeds the other. If for instance, demand exceeds supply a shortage results. By contrast, if supply outstrips demand a surplus results. Any situation typified by either a surplus or a shortage is referred to as disequilibrium in the market.
Market equilibrium is said to be a stable one if in presence of any interference to the equilibrium the market forces operate to restore the equilibrium (Prasch, 2008). For example, in case price falls below equilibrium, an upward pressure is exerted on it so that finally it corresponds with the equilibrium price. Excess supply on the other hand exerts a downward pressure on the price to ultimately correspond with the equilibrium price.