The Rule of Supply and Demand

To better understand the impact of global market crisis and how customers will behave.

The law of supply and demand is an economic theory that explains how supply and demand are related to each other and how that relationship affects the price of goods and services.

“It’s a fundamental economic principle that when supply exceeds demand for a good or service, prices fall. When demand exceeds supply, prices tend to rise.”

There is an inverse relationship between the supply and prices of goods and services when demand is unchanged.

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If there is an increase in supply for goods and services while demand remains the same, prices tend to fall to a lower equilibrium price and a higher equilibrium quantity of goods and services.

If there is a decrease in supply of goods and services while demand remains the same, prices tend to rise to a higher equilibrium price and a lower quantity of goods and services.

“Supply and demand rise and fall until an equilibrium price is reached. “

For example, suppose a luxury brand sets the price of its new sneaker model at $700 While the initial demand may be high, due to the company hyping and creating buzz for the shoe, most consumers are not willing to spend $700 for a pair of shoes. As a result, the sales of the new model quickly fall, creating an oversupply and driving down demand. In response, the company reduces the price of the item to $399 to balance the supply and the demand for the shoes to reach an equilibrium price ultimately.

Prices are elastic.

Increased prices typically result in lower demand, and demand increases generally lead to increased supply.

However, the supply of different products responds to demand differently, with some products’ demand being less sensitive to prices than others. Economists describe this sensitivity as price elasticity of demand; products with pricing sensitive to demand are said to be price elastic. Inelastic pricing indicates a weak price influence on demand. The law of demand still applies, but pricing is less forceful and therefore has a weaker impact on supply.

Price inelasticity of a product may be caused by the presence of more affordable alternatives in the market, or it may mean the product is considered nonessential by consumers. Rising prices will reduce demand if consumers are able to find substitutions, but have less of an impact on demand when alternatives are not available.

The exemption to the rule

While the laws of supply and demand act as a general guide to free markets ( The free market is an economic system based on supply and demand with little or no government control. It is a summary description of all voluntary exchanges that take place in a given economic environment)

The perception of the consumer

If consumer information about available supply is distorted , the resulting demand is affected as well. When a huge event that largely affect the public can also have an impact and the consumers immediately became concerned about the future availability of goods.

Some companies take advantage of this and temporarily might raise their prices. Even there is no actual shortage, but the perception of one can artificially increase the demand for certain goods, resulting retailers in raising prices in a massive way.

Likewise, there may be a very high demand for a benefit that a particular product provides, but if the general public does not know about that item, the demand for the benefit does not impact the product’s sales. If a product is struggling, the company that sells it often chooses to lower its price. The laws of supply and demand indicate that sales typically increase as a result of a price reduction – unless consumers are not aware of the reduction.

This common referred as the invisible hand (The invisible hand is a metaphor for the unseen forces that move the free market economy) as a result the supply and demand economics does not function properly when public perception is incorrect.

What happens in restricted market.

Supply and demand also do not affect markets nearly as much when a monopoly exists.

Even though governments have measure in place to avoid monopoly, there are still examples that show how a monopoly can negate supply and demand principles.

Traditional supply and demand theories rely on a competitive business environment, trusting the market to correct itself.

Planned economies, in contrast, use central planning by governments instead of consumer behavior to create demand.

In a sense, then, planned economies represent an exception to the law of demand in that consumer desire for goods and services may be irrelevant to actual production.

Price control can also distort the effect of supply and demand on a market. Governments sometimes set a maximum or a minimum price for a product or service, and this results in either the supply or the demand being artificially inflated or deflated.

Supply and Demand and it’s monetary policy.

While we’ve mainly been discussing consumer goods, the law of supply and demand affects more abstract things. For example, banks interest rates.

When interest rates are lower, more people are borrowing money.

This expands the money supply; there is more money circulating in the economy, which translates to more hiring, increased economic activity, and spending.

Raising interest rates leads people to take their money out of the economy to put in the bank, taking advantage of an increase in the risk-free rate of ROI.

This also often discourages borrowing and activities or purchases that require financing. This tends to decrease economic activity.

In some cases, government and central banks tend to increase the money supply with the aim of stimulating the economy, prevent deflation ( Deflation is a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy).

During deflation, the purchasing power of currency rises over time) increases asset prices, and increase employment.

How recession affect the market and what can be the better approach to restart

During a recession, most investors should avoid investing in companies that are highly leveraged, cyclical, or speculative, as these companies pose the biggest risk for doing poorly during tough economic times.

A better recession strategy is to invest in well-managed companies that have low debt, good cash flow, and strong balance sheets.

Some industries are considered more recession-resistant than others, such as utilities, consumer staples, and discount retailers.

Raffaele Felaco

All rights reserved |2020

Published by Raffaele Felaco

I am an enthusiastic leader with strong background in direct and indirect sales with an exten- sive experience in both retail and wholesale business. I have been fortunate to have worked alongside teams in structured environments both in Italy and abroad over the last 20 years, en- abling me to develop strong leadership skills, a natural approach in effective communication, the ability of positively influencing others and master complex business negotiations.

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