Economic Equilibrium: Understanding Supply and Demand

by David Dierking

2 min read

Balancing the demand for your business’s products and services with the appropriate supply is one of the most important aspects driving your company’s financial success. Too much demand without supply can drive prices up, but it also leaves customers disappointed if they can’t get their purchase in a timely fashion or at all. Too much supply can result in a costly inventory glut with difficulty moving it out the door.

The Basics of Supply and Demand

The law of demand states the marketplace will demand a certain amount of a good at any given price. If you price your good or service lower than what the market is willing to pay, demand goes up because of the perceived relative value. Price it too high, and demand drops. The law of supply says that the amount of a good that is produced is related to the price that can be charged for it. The more that can be charged for something, the more the company will want to produce to drive revenue. On the other hand, a company won’t be compelled to produce a great quantity of something that it can’t charge much for.

Equilibrium in the Supply/Demand Curve

The point where the supply and demand curves cross is market equilibrium. This is the point where the market is at its most efficient – where the quantity of goods produced equals the demand for them – and it should be the price point your business aims to achieve. The market tends to move towards equilibrium over time, as business owners adjust their prices in response to demand and buyers adjust their demand to prices. Market equilibrium tends to be a fluid target so it’s important to continue analyzing market conditions.

Movements Along the Curve

A movement along the supply and demand curves take place in response to short-term market changes. These are temporary fluctuations that are expected to disappear relatively shortly. For example, consider ice cream sales on a hot day. The demand for ice cream would be expected to increase in warm weather, possibly to the point of a temporary shortage. Once temperatures cool off, ice cream demand would return to normal levels, restoring the supply and demand balance.

Shifts in the Curve

Shifts in the supply and demand curves take place in response to long-term market changes. These are changes to market conditions that are expected to alter the supply and demand landscape permanently. Imagine there is a medical study that determines that doughnuts are actually healthy for you. The long-term demand for doughnuts would be expected to increase and would potentially be followed by a corresponding rise in prices to balance out the increased demand. Managing the supply and demand for your business’s products and services is one of the most important factors to achieving financial success. The supply and demand curve is constantly changing. Your business should be constantly evaluating these elements to ensure that it’s satisfying market demand without being over- or under-supplied.

References & Resources

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