What Is the Law of Supply and Demand?

The law of supply and demand is a foundational idea in economic theory that explains how the market price of a good or service is determined in a competitive market. When the price of a good or service increases, supply goes up, but demand goes down. So, the equilibrium market price will be the price where supply and demand meet.

Key Takeaways

• The law of supply and demand is an important concept in economics that explains how the market price of a good or service is reached.
• The law of supply states that as the supply of a good or service goes up, the price consumers are willing to pay goes down.
• The law of demand states that as the price of a good or service increases, the quantity demanded decreases.
• The equilibrium price, or market price, is reached at the point where supply and demand meet.

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Understanding the Law of Supply and Demand

To understand this foundational concept of economics, it helps to first understand the law of supply and the law of demand separately.

The Law of Supply

According to the law of supply, as the price for a product or service increases, sellers will offer a higher quantity of that product or service to improve their cash flow and increase their profits. As the price falls, however, sellers will reduce the quantity they offer.

The Law of Demand

According to the law of demand, as the price of a product decreases, consumers demand a higher quantity of that product and buy more. The reverse is also true. So, at a higher price, consumers demand a lower quantity than they would at a lower price.

The Law of Supply and Demand: Putting It Together

Economists often graph the laws of supply and demand using a line graph. This is a good way to illustrate how the two laws interact with each other to determine equilibrium quantity of goods and market price.

Supply and demand are often shown on a graph where quantity is on the horizontal axis (x-axis) and price is on the vertical axis (y-axis).

Supply is an upward sloping curve on the graph. At a price of zero, the quantity supplied is zero. As the price rises, the quantity supplied also goes up along the curve.

The downward sloping demand curve shows that as price decreases, the quantity purchased increases.

The upward sloping supply curve and the downward sloping demand curve will meet at some point on the graph. This point is the equilibrium, or market price and quantity, at that time.

Factors That Lead to Change

However, the market price and quantity of any product can change over time due to certain factors. If consumer needs or trends change, a demand curve may shift, and the price level will change. Likewise, if production costs increase or materials become scarce, a supply curve may move. These shifts will also cause an adjustment in pricing.

Market Pricing

The law of supply and demand determines the market price of anything that people pay money for in a free market. This includes goods, services, and human resources or employees. In a free market economy, people are free to choose whether to buy something. So, when the price increases, consumers buy a lower quantity of that good. When the price decreases, consumer demand reacts, and people buy a higher quantity.

When the price sellers can get for a good or service increases, they will choose to supply a higher quantity and vice versa. In this way, the interaction of supply and demand determines the market equilibrium for both price and quantity.

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