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Supply and Demand Economics

Supply and Demand Economics

Author: Jeff Carroll
Description:

Determine the effects of supply and demand on different economies.

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Tutorial

Source: Image of arrow, tablet computer, circle, square, images by Video Scribe, License held by Jeff Carroll; Image of euro, Public Domain, http://bit.ly/1kmVRg9; Image of supply and demand graph, Public Domain, http://bit.ly/1nxaxhr.

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Hi, I'm Jeff. In this lesson, we'll discuss supply and demand economics and how they impact choices in a business organization. Let's begin.

In a market economy, supply and demand define the market price. The market price is the current price of a good or service which a customer is willing to pay. The law of demand is often depicted as a downward sloping curve on a graph where price is along the left axis and quantity available is on the bottom axis.

This demonstrates that consumers will buy more products as price decreases, and inversely they will purchase less as price increases. In statistics this is known as an inverse correlation between price and quantity, assuming that all other variables in the system remain unchanged. The law of supply is a curve that slopes upward along the same price and quantity axis. This demonstrates that producers will want to create and sell more of their goods and services as the price increases. This is a positive correlation between price and quantity with all other variables fixed.

When the demand and the supply curve are combined into one graph, there is a point at which the two lines cross. This is the equilibrium price, which is the price at which quantity demanded and quantity supplied meet. As each business attempts to find the equilibrium price in their market, they will need to make choices about value, opportunity, and production.

Now when a choice is made, there is an opportunity cost associated with the choice not taken, and each business must account for the benefits lost due to opportunity cost. Supply and demand graphs also indicate points at which there may be surpluses and shortages in the market. A surplus is when there is more supply of a product than demand. Those are the points to the right of the equilibrium price on the supply and demand graph.

Shortage is the opposite when there is more demand for a product than supply. These points are to the left of the equilibrium price on the graph. Surpluses and shortages can be difficult for businesses to manage, especially if production is impacted.

Larger organizations often weather these changes better since they have more flexibility to find alternative sources for their production. Since they have greater capital, their orders are often filled before smaller businesses, too. Still since large organizations need more supply for their production, it can still be challenging.

For small businesses, though, the loss of supply can be crippling, sometimes forcing a business to shut down operations temporarily or even permanently. Not all supply and demand changes are driven by the market. Sometimes companies in order to stimulate demand will limit the supply of a product. For example, Apple will sometimes limit supply of its new phones to carriers in order to drive demand higher. But primarily supply and demand is driven by the economics of markets.

In addition to supply and demand, price and quality in a market can be driven by competition. This is when businesses attempt to sell similar products at the same time. They will compete on price and quality, often improving quality while reducing price in the process. Competition comes in multiple variations there are in fact four degrees of competition. There is perfect competition, which is an industry market structure characterized by a very large number of firms selling a homogeneous otherwise identical product. Commodities such as oil or soybeans are examples of such a product.

Monopolistic competition is a market structure characterized by a large number of firms selling similar products. A monopoly is characterized by one firm supplying a unique product to the entire market. Barriers will exist that prevent other firms from providing competition. And in an oligopoly, few firms will sell similar products, again limiting the competition that can help products improve.

Though we've discussed these competition markets individually, it's rare that pure versions of these markets exist. Most markets are a combination of multiple types of competition. And businesses need to be aware of these combinations since it affects the way products are marketed.

With perfect competition, there will be no marketing. An example might be the milk in your grocery store. With monopolistic competition, marketing is key, and businesses will strive to publicize their differences. In a monopoly, there is no need for marketing at all since one business provides all the goods and services. And in an oligopoly, pricing will be key as each organization strives to become larger and monopolize the market.

Nicely done. In this lesson, we learned how supply and demand work to drive price in a market. We discuss surplus and shortage, and we talked about competition in economic markets and how it can change the marketing for a business. Thanks for your time and have a great day.

Terms to Know
Equilibrium Price

The price at which quantity demanded and quantity supplied meet.

Market Price

The current price of a good or service which a customer is willing to pay.

Monopolistic Competition

An industry market structure characterized by a large number of firms selling similar products.

Monopoly

An industry market structure characterized by one firm supplying a unique product to the entire market. Barriers to entry prevent competition.

Oligopoly

An industry market structure characterized by a few firms selling similar products.

Perfect Competition

An industry market structure characterized by a very large number of firms selling a homogeneous (identical) product.

Shortage

When there is more demand for a product than supply.

Surplus

When there is more supply of a product than demand.