Supply and demand is an economic concept relating to the relationship between the supply of goods, the quantities available, and the demand for them. In the context of the real world, the price of every item or service is determined by supply and demand.
The idea of supply and demand is applicable to commodities, products, services, goods, labor, assets, securities, and currencies. That said, this economic concept can be helpful to economists and investors alike because it can be a predictor of market conditions.
Demand
The demand curve often looks like the price of a commodity or good increasing, the demand decreasing, and having surplus as a result. When you think about it in practical terms, the price of a product increasing can lead to consumers looking for cheaper alternatives and the demand dropping. This can especially be true when there are multiple alternatives for said products However, when the price of a product goes back down, demand is likely to increase again.
There are some circumstances when the price of a commodity goes up and demand does too, such as with veblen goods-a type of luxury good that signifies social status. Modern day examples could include Birkin bags, Cartier jewelry or ferraris.
Factors that can affect demand include the price of the product, a buyer’s income, available alternatives, and buyer preferences influenced by changes in trends.
Supply
Supply is about how much goods or services are available within the economy and is typically viewed from a producer’s lens. When prices for a product go up, producers may make and supply more products to realize greater profit. In sum, supply usually hinges on demand and price changes and adjusts accordingly to ensure the producer makes a profit.
Factors that can affect supply include competitors (especially when they produce the same product for less), supply chains, availability of materials, production costs and production capacity.
Equilibrium Price
In an ideal market, buyers and sellers would both be happy and all products would be sold. There would be an efficient number of sellers, products, and people to buy the products, prices would be unaffected, and there would be perfect competition. That type of market equilibrium is known as ‘market clearing price’ or ‘equilibrium price’.
While there are times when equilibrium price occurs, supply and demand don’t always balance each other out and prices aren’t always stable.
Elasticity vs inelasticity
Elasticity is when changes in demand occur as a result of changes in other factors like price or consumer income. Examples of elasticity of demand include a dishwasher or television Essentially, anything that isn’t essential and can wait.
On the other hand, inelasticity is when a product or service’s demand is mostly unaffected by price increases. Necessities tend to be inelastic because they’re essential to daily living. This means even when the price goes up, people are still likely to buy them. Examples of inelasticity of demand include utilities or prescription drugs.
Real Life Examples of Supply And Demand
During the pandemic, we saw the price of many things go up including cars due to chip shortages. There was a strong demand for chips, and not enough supply because of labor shortages, resulting in the price of cars shooting up. Despite prices going up, the demand for cars still remained relatively high.
Similarly, the price of homes have gone up over the past few years due to a shortage of available houses and a high demand. While this is a simplistic way of looking at the car and housing markets, keep in mind that other factors can affect supply and demand too.
Supply And Demand In Investing
As mentioned earlier, supply and demand can also affect stock and securities. How much you pay for a stock per share is often determined by demand. When demand is high and supply is low, the stock price typically goes up. However, when demand for a stock is low, that’s when investors can buy stocks ‘on sale’ or at a discounted price. Buying stock when demand is low can result in you making notable profit when demand and price goes back up.
Some factors that affect the demand for stock include interest rates and how well a company is performing. Supply of stock can be affected by economic conditions and changes to central bank policies.
If you’re looking to start investing in the stock market, consider speaking with one of our portfolio managers.
