What Is Supply and Demand?
What does equilibrium mean?
Hi, I'm Jim Flink from About.com and today I'll be explaining the concept of supply and demand.The forces of supply and demand determine the prices of goods and services in any market. Supply refers to the amount of a specific good a firm will offer and demand refers to the amount of a specific good consumers will expect.The concept of supply and demand holds true that the amount of a good demanded by consumers will fall into a natural line with the amount of that product supplied.Supply and demand literally affects every item an individual purchases, from the price of gasoline to bananas, from a new home purchase to dog food and even a haircut. When a specific good is priced correctly in the market, it is said to be at equilibrium price.The law of supply states that the price of a good and the quantity producers are willing to supply is positively correlated, when everything else is held constant. This means that as the price of a good goes up, firms will increase production and supply more units. The higher the price rises, the higher the quantity supplied will rise. The same is true of the opposite. The more the price declines, the less units firms will produce.The law of demand states that the price of a good and the quantity consumers will demand are negatively correlated, when everything else is held constant. This means that as the price of a good goes up, consumers will demand less of it. The higher the price goes, the less units are demanded. The same is true for the opposite. As the price declines, the more units consumers will demand.There are four basic points to consider in relation to supply and demand.When demand goes up but supply stays the same, equilibrium price rises. For example: If there are five watermelons at a farmer's market that are priced at $1 each with 5 buyers, then they will each sell for $1. If there are suddenly 20 buyers, those same 5 watermelons will sell for a higher equilibrium price because the demand rose significantly.If demand goes down but the supply stays the same, equilibrium price drops. Think of the same watermelon example. If the 5 watermelons are priced at $1 each, but there is only 1 buyer all day, the farmer will likely mark them down to 50 cents due to little demand.If the demand stays the same but the supply increases, the equilibrium price will fall. The effect will be the same as in example two. Instead of five watermelons at $1 each with five buyers, now the farmer has 25 watermelons but still only five buyers, the farmer may reduce the price or offer to give one free with each purchase.If demand stays the same but the supply falls, then equilibrium price will rise. Again, if there are five watermelons and five buyers but the farmer drops and ruins three watermelons, his supply falls to two. It is likely that the equilibrium price will now rise.That's a quick look at supply and demand. For more info, be sure to check out About.com. Thanks for watching.