Supply and Demand Definition and Determinants

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What is supply and demand? Information on supply and demand, effects of substitution, determinants.

Supply” and “demand” are headings under which the economist studies the behavior of sellers and buyers and their influence on prices, production, and consumption.

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Most commonly, supply and demand are expressed in “schedules”—also called “functions”- relating quantity to price. A supply schedule relates the quantity that sellers will offer for sale to the price they expect to receive. A demand schedule relates the quantity that buyers will purchase to the price they will have to pay. Normally, the higher the prospective selling price, the larger the quantity that sellers will supply; the lower the price, the larger the quantity that buyers will purchase. Strictly speaking, supply and demand schedules apply only to situations where each seller or buyer handles a small volume and adjusts quantity to price as if price were beyond his control.

Supply and Demand Definition and Determinants

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Effects of Substitution:

Supply and demand schedules reflect opportunities for substitution. Consumers may be able to choose among many similar items to meet their needs. Pork can be substituted for beef, and margarine for butter. However, should beef fall in price while the price of pork remains unchanged, buyers will tend to buy more beef. The quantity purchased responds to changes in price according to the elasticity of demand. Where substitution is easy, demand tends to be highly elastic. Products with no close substitute, such as salt, tend to have low demand elasticity.

Determinants:

The demand schedule for a consumer product depends on the incomes of buyers, their subjective preferences, and the prices of other products. A change in any of these determinants tends to shift the demand schedule.

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Demand for productive inputs by business firms is considered to be a derived demand, arising from the final demand for the output that these resources can produce. Business firms, when buying input services, may substitute one for another when their prices change. The demand schedule for services of any input reflects the revenue productivity of the input: how much it adds to the output and revenue of a firm. The input’s productivity depends on its intrinsic quality, on the technique of production, on the quality and quantity of other inputs, and on the final demand for the product.

In the supply schedule of a product, the quantity supplied tends to be larger at a higher price because of substitutions by producers: a rise in selling price means producers can increase their incomes by producing more of that product and shifting away from other items. The supply schedule depends on the producer’s costs, which in turn depend on the technique of production and the prices of needed inputs. With the introduction of mass production methods in the 1950’s for poultry production, the supply of chickens and eggs increased substantially.

There are supply schedules for the services of labor, land, and capital. Given the limitations of population size, the supply of labor depends on people’s willingness to substitute work for leisure as wage rates change. The supply of land is usually treated as completely inelastic, fixed by nature.

Reaching an Equilibrium:

Prices reach an equilibrium at the level where quantity demanded equals quantity supplied. Only at this level are the desires of buyers and sellers mutually consistent. If the price is above the equilibrium level, buyers will not purchase the quantity sellers want to sell, and the price will tend to fall. If the price is below equilibrium, sellers will not furnish the quantity buyers want, and prices will be bid up.

An increase in the demand for a product tends to raise its price. This may result from a change in consumer preference. An increase in supply tends to lower price. Thus chicken and egg prices dropped in the 1950’s when supply increased.

Most household incomes are earned from the sale of services of labor, land, and capital. The supply-demand interaction that determines prices for these services also determines the pattern of income distribution among households.

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