What is the Law of Supply and Demand?

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Definition:

The law of supply and demand explains the relationship between buyers and sellers: In general, when supply is high and demand is low, prices go down; when demand is high and supply is low, prices go up.

🤔 Understanding the law of supply and demand

The level of supply and demand for a good or service impact each other. They also affect the price of the good or service. As consumers demand more of a good, its price increases and more producers work to provide that good. As more producers offer a good, its supply increases, causing its price to fall. In the reverse scenario, prices drop as demand for a product decreases, causing fewer companies to produce that good. As production falls, supply decreases, and price rises back to equilibrium. The law of supply and demand can be broken into separate parts, allowing you to examine the laws of supply and demand separately.

Example

Consider a fictional small town with one café. The café is the only supplier of coffee beverages in the area. That means with sufficient demand the supply of coffee might be low, leading to high prices.

These high prices could make opening a new coffee shop an attractive business opportunity. A second café opens a few blocks away from the first.

The supply of coffee in the town increases. As the suppliers compete, they reduce their prices to attract customers — but not so far that either is losing money or forced to shut down.

Supply has risen to meet the demand for coffee in town, and the price has reached an equilibrium. The market for coffee in this small town has followed the law of supply and demand.

Takeaway

The law of supply and demand is like a seesaw…

As production goes up and demand stays the same, prices for a good should fall. Similarly, if the number of orders goes up and supply remains the same, the cost of a good should rise. The law of supply and demand means that the seesaw will find a balance over time. As changes in supply or demand change prices, the changes in price affect supply and demand, creating an equilibrium (at least temporarily) over time.

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What is the Law of Supply and Demand?

The law of supply and demand explains the relationship between the availability and desire for a good or service. It also describes the price of that good or service. It also describes how supply, demand, and price react to a change in any of the other factors.

The levels of supply and demand affect the price of a good or service. Usually, when production is high and demand is low, prices will drop as producers try to increase sales. When supply is small, and the number of orders is high, prices tend to rise as producers seek to maximize their profits.

Prices, supply, and demand all affect each other.

When demand falls, producers will reduce their production because lower demand leads to lower potential profit. As demand rises, producers increase production to try to make additional sales. This causes supply levels to adjust to meet demand.

In this way, the law of supply and demand creates an equilibrium.

What are some real-world examples of the law of supply and demand?

One real-world example of the laws of supply and demand is the fidget-spinner fad. Fidget-spinners were relatively unknown toys, carried only by a few retailers. Demand for fidget-spinners spiked after a series of online videos sparked interest in the toys. As factories noticed the demand increases, they began making more fidget spinners, allowing more retailers to sell them to consumers. As the fad began dying, demand fell. Factories produced fewer fidget-spinners, and businesses started marking down their inventory to sell through their remaining fidget spinners.

Another example of the laws of supply and demand is a seasonal fruit. Most fruits only grow during specific parts of the year. For example, watermelons are a summer fruit, so the majority of melons are harvested during the summer months. During the summer, supply is high, so it is easy to purchase watermelons at a reasonable price. If you want to buy watermelons out of season, your options are more scarce, and you’re likely to pay more because of the reduced supply.

What is the law of demand?

The law of demand states that the price of a good plays a significant role in determining consumer demand for that good. All else being equal, the more something costs, the fewer consumers will buy that good. The lower a goods’ price, the higher the purchases for that good will be.

As prices rise, consumers need to forgo other purchases to buy the desired good. If the price of a product rises to the point where consumers need to stop buying too many other things, they will stop purchasing that product. If prices drop to the point where consumers must forgo fewer purchases, more people will be able to make the purchase.

You can think about the law of demand as a downward-sloping curve. Price is on the Y-axis, and demand is on the X-axis.

What is the law of supply?

The law of supply says that a good’s price determines the supply of a good. As the price that consumers are willing to pay increases, the number of units that businesses produce rises.

Think about an area that experiences heavy snow for a few months each year. During the summer, people don’t need shovels, so retailers sell shovels at low prices. Producers won’t make many shovels because there is little profit for them to make.

As winter nears, the prices of shovels increases in anticipation of increased snow. Because shovels are worth more, businesses will make more shovels to try to capture the available profits.

You can think about the law of supply as an upward sloping curve with the price on the Y-axis and supply on the X-axis.

Is the Law of Supply and Demand true?

The Law of Supply and Demand is an economic theory. In many scenarios, the argument is correct, but there are some situations where it does not hold.

Luxury goods can defy the law of supply and demand. As prices rise, luxury goods become more premium, increasing their desirability to consumers, which can boost demand instead of curtailing it.

For some goods, price decreases can decrease demand by making consumers believe that a product is low in quality. Consumers may avoid a low-quality good for a higher-priced one.

What are supply and demand curves?

When looking at supply and demand on a graph, you can think about the law of supply as an upward sloping curve and the law of demand as a downward sloping curve. Price is the Y-axis, and the quantity supplied/demanded is the X-axis.

In theory, by plotting these curves on the same chart, you can use it to find the supply, demand, or price of a good or service. For example, if you know the price of a good or service, you can determine how that will affect demand and supply.

Typically, on a supply and demand curve, different quantity levels are labeled as q0, q1, q2, and so on, and price levels are p0, p1, p2, and so on.

The supply and demand curves let you visualize how changes in any factor affect the other elements. If the quantity supplied decreases from q1 to q0, then you can look at the demand curve to see that demand must decrease for the price to remain the same.

The point where supply and demand meet on supply and demand curves is the equilibrium price for a good or service — There is no surplus supply or desire for a good or service. Producers meet all demand, and no one produces extra units of the good or service.

What are shifts in supply and demand?

A shift in supply or demand occurs when supply or demand change for a non-price reason. These types of shifts typically occur when outside factors change the level of demand for a good. For example, if a grocery store stops carrying beef products, the need for other meats would likely increase as consumers shift their meat consumption to other meats. Suppliers would increase the supply of other meat to compensate for the higher levels of demand.

A shift in supply could occur if something like a natural disaster destroyed part of the stockpile of a good. For example, if drought kills a significant portion of the corn crop in a state, the supply of corn would decrease. Consumers would have to purchase other food.

When supply or demand shifts, the other factors, including price, will have to follow suit. If supply drops, demand must decrease, or prices will rise. If demand drops, supply must decline, or prices will fall. Similarly, if supply increases, prices will decrease unless demand also rises, and increases in demand must be met by increases in supply to avoid price rises.

What are moves in supply and demand?

Moves in supply or demand refer to price-based changes in the supply or demand of a good or service.

As price increases, demand and supply move along their curves. Price increases cause supply increases, and demand decreases. While price decreases lead to supply decreases and demand increases.

If supply and demand are at equilibrium, then a move in supply or demand means that supply and demand will be out of balance. This means there will either be surplus production or surplus demand. Either the businesses produce too many units of a good or service, or not every consumer who wants to buy a good or service can buy it.

For supply and demand to return to equilibrium, a move in one must be met by a shift in the other.

What factors affect supply and demand?

Supply is affected by factors like weather, employee wages, and the cost of raw materials.

For goods, such as crops, where weather plays a significant role in production, good weather can lead to high levels of supply, while poor weather can reduce the supply below normal levels.

For example, a drought affecting areas that farm corn would lead to a lower supply of corn until the next growing season.

Weather can also impact supply by making it difficult to ship a good to market. If bad weather, such as heavy snow, makes it so that shipments don’t arrive on time, the supply in the local market will be low until the weather lets up.

If the input costs for an item( including employee wages or raw material prices) increase, supply tends to drop. Fewer manufacturers will make the good because the higher input costs produce lower profits.

Things like consumer income, prices of other, similar goods, or changes in consumer preference can affect the demand for a good or service.

Typically, when the economy is good, and consumer income rises, demand for goods and services also increases. Consumers have more money available to spend — so, on average, they spend it, leading to an increase in the amount of every item and service they purchase.

The price of similar goods impacts consumer demand by shifting their purchases between products and services. Consumers have limited amounts of money to spend. If a grocery shopper notices that the price of beef has risen, they may shift some of their grocery spending to other meat, such as pork or chicken. If the price of beef falls, consumers may buy more of it and less other meat.

Consumers also change their preferences over time, which can cause changes in demand for a good. For example, pet ownership has increased among Americans, showing an increased preference for owning pets. As more Americans prefer to own pets, the demand for pet-related goods, such as food and toys, must increase.

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