The Law of Supply and Demand is the basic principle on which a market economy is based. This principle reflects the relationship between the demand for a product and the quantity offered of that product taking into account the price at which the product is sold.
Thus, according to the price that exists in the market of a good, the bidders are willing to manufacture a certain number of that good. Just as plaintiffs are willing to buy a certain number of that good, depending on the price. The point where there is a balance because the plaintiffs are willing to buy the same units that the bidders want to manufacture, for the same price, is called market equilibrium or break-even point.
Law of Demand and Supply
According to this theory, the law of the demand establishes that, keeping everything else constant, the quantity demanded of a good diminishes when the price of that good increases. On the other hand, the law of supply indicates that, while everything else remains constant, the quantity offered of good increases when it does its price.
Thus, the supply curve and the demand curve show how the quantity offered or demanded varies, respectively, as the price of that good varies.
To understand how you can reach the point of balance you have to talk about two situations: scarcity and excess:
- When there is excess supply, the price at which products are being offered is higher than the equilibrium price. Therefore, the amount offered is greater than the quantity demanded. As a result, bidders will lower prices to increase sales.
- On the other hand, when there is as hortage of products, it means that the price of the offered good is less than the equilibrium price. The amount demanded is greater than the quantity offered. So the bidders will increase the price, since there are many buyers for few units of the good so that the number of plaintiffs decreases, and the break-even point is established.
Graphical representation of the Law of Supply and Demand
By transferring to a graph the supply and demand behaviors we have just explained, it is understood that the supply curve (0, blue line) is increasing and the demand curve (D, red line) is decreasing. The point where they cross is known as market equilibrium.
If we start from the initial point in which the quantity Q1 of a good is demanded at the price P1, and due to some external cause there is an increase in demand up to the quantity Q2, the price of the good will increase to P2.
If, on the contrary, it happens that the sellers for some reason decrease their production (for example, floods cause wheat production to decrease), in the graph we observe a movement of the supply curve (O) to the left and, therefore, increases The price of the good in question and thus the demand will be reduced.
How does competition affect the Law of Supply and Demand?
As we have seen in the examples above, depending on the movement of supply and demand, prices may be affected. In some cases, if the supply or demand for a good is very strong, they can affect the price of that good.
Types of Competition
Perfect competition: It is an almost ideal economic situation and unlikely in reality. It is a market in which the market price arises from the interaction between companies or people who demand a product and others who produce and offer it. None of the agents can influence the price of the good or service , that is, they are price-acceptors.
Imperfect competition: Individual sellers have the ability to significantly affect the market price of their products or services. We can distinguish according to the degree of imperfect competition:
Monopolistic competition: There are a high number of sellers in the market, although they have a certain power to influence the price of their product.
Oligopoly: The given market is controlled by a small group of companies.
Monopoly : A single company dominates the entire market for a type of product or service, which is often translated into high prices and a low quality monopolized product or service.
Oligopsonio: It is a type of market in which there are few plaintiffs, although there can be a lot of bidders. Therefore, the control and the power over prices and the conditions of purchase in the market, resides in the plaintiffs or buyers.
Monophonic: It is a market structure where there is a single plaintiff or buyer. While there may be one or more bidders.
Let’s look at graphically when the competition is not perfect and the sellers can affect the price of the good. For example, if the supply (O) necessarily reduces its production, it will cause an increase in the price of the good in question, and the demand for that good will is reduced.
Producer Surplus and Consumer Surplus
Through the law of supply and demand producers and consumers can know at what price they are willing to buy a good or service. The difference between the market price and what they are willing to pay or charge is known as consumer surplus and producer surplus , respectively.
For example, if a seller has a hard time producing a good cost of 150 Euros and sells it for 200 Euros; he will have a producer surplus of 50 Euros. If the market price were 130 Euros, the product would not participate in it, as it would not gain surplus, and therefore, it is not profitable to enter that market. The surplus graph is as follows: