Theory of Demand and Supply

The theory of demand and supply both form the most fundamental concepts of economics; the relationship between the number of items that a producer wants to sell at various prices and the goods that customers desire to buy in economics. In a nutshell, we may state people’s willingness to acquire or sell commodities. People are eager to want more when the prices are lower and demand less as the prices rise.

Law of Demand:

According to the theory of demand and supply, the law of demand refers to the quantity’s demand decreasing when the price of a product increases and vice versa. It shows that quantity’s demand is inversely proportional to the price of the product.

Exceptions in the Law of Demand:

There are some cases in which when the price increases, the quantity demand also increases. Thus these are some exceptional cases on which the law of demand does not apply:

• When it has a high-status value, when the price increases, quantity demand must increase for prestige value
• When it’s a Giffen good Eg: wheat, bread, rice, etc
• When the good is a necessity even if the price increases, consumption must rise as the good is a necessity

Demand Curve

In a typical illustration, the demand curve depicts the relationship between the price of a good or service and the quantity demanded over time, with the price on the left vertical axis and the quantity demanded on the horizontal axis.

Law of Supply:

According to the theory of demand and supply the law of supply refers to the quantity demand rising when the price of the product rises in order to earn profit and vice versa.

Exceptions in the law of supply:

• Agricultural products
• Artistic and Auction goods
• Perishable goods

Supply Curve

In a common depiction, the supply curve depicts the relationship between the cost of an item or service and the quantity supplied over time, with the price on the left vertical axis and the quantity supplied on the horizontal axis.

Relationship between Demand-Supply theory:

To fully know the market mechanism, it is important to have a complete understanding of supply and demand, as these two forces control the entire market. A desire for something accompanied by the ability and willingness to pay for it is characterised as demand. Supply, on the other hand, refers to the total amount of a commodity that is available for sale. When demand rises, supply falls, and when supply is ample, demand falls, establishing an inverse relationship between the two elements.

Elasticity

The relative elasticity of demand and supply determines price variations. As a result, a tax can only be adjusted by shifting demand-supply curves. Demand and supply elasticities determine how incidents are shared between sellers and buyers. The higher the demand elasticity, the higher the incidence of sellers; the higher the supply elasticity, the higher the incidence of buyers.

Elasticity of Demand:

The elasticity of demand describes how sensitive a good’s demand is to changes in other economic variables like prices and consumer benefits. Customers that have a higher demand elasticity for an economic variable are more aware of changes in that variable. Elasticity of demand= (percentage change in quantity demanded)/(percentage change in price) If the value of elasticity of demand is equal to “zero” then it is classified as perfectly inelastic demand, which means quantity demanded is completely insensitive to price. If the value of elasticity of demand is between 0 and -1 then it is classified as inelastic demand, which means quantity demanded is relatively insensitive to price. If the value of elasticity of demand is -1 then it is a unitary elastic demand, which means the percentage increase in quantity demanded is equal to percentage decrease in price. If the value of elasticity of demand is between -1 and “–infinity” then it is classified as elastic demand, which means quantity demanded is relatively sensitive to price.

Elasticity of Supply:

The supply elasticity of a commodity provides a quantifiable relationship between its supply and price. As a result, we may use the idea of elasticity to define the numerical change in supply with the change in the price of a commodity. Elasticity of supply=(percentage change in quantity supplied)/(percentage change in price) If the value of elasticity of supply equals to zero then it’s a perfectively inelastic supply. If the value of elasticity of supply is between zero and “+1” then it’s an inelastic supply. If the value of elasticity of supply is between “+1” then it’s a unitary elastic supply. If the value of elasticity of supply is between “+1” and “+infinity” then it’s an elastic supply.

Conclusion

The theory of demand and supply is a vital tool that business owners and economic managers can utilize to calculate their profits. As the demand for a product increases, the business owner must raise his price to earn more profit. If a rise in supply occurs at the same time, the business owner can lower his price to attract more buyers. The above-mentioned was only an outline of how the theory of demand and supply can assist you in understanding its basics. In order for you to be able to answer questions on this topic easily, it is important that you practice from different sources such as CA revision books, exam papers and video tutorials.