Supply and Demand Together

Now you have a good understand of how supply and demand work separately – but the crucial knowledge is understanding how these two economic features work together.

If we refer back to the scarcity concept – the more scarce a good or service is at any particular time, the more you have to be willing-to-pay to acquire it – that is the supply of the good or service is low which drives the demand for the goods or service high. Conversely, if a good or service is very common then you do not have to pay as much for it. This is because the good or service is frequently available meaning the supply of the good is high, which means that demand for the good is low because it is so freely available.

The supply and demand laws are continually moving back and forward freely within society and constantly recorrecting themselves in order to find the best supply and demand equilibrium – the point at which the amount of goods and services supplied is equal to the amount of goods demanded and vice-versa. Demand and supply will always attempt to allocate resources in the most economical way possible so that there is never an excess/shortage of goods and services demanded or an excess/shortage of goods and services supplied. This can be shown graphically by combining the previous two diagrams:

This is the Equilibrium Supply and Demand diagram. It indicates that at point (Pe. Qe) all resources have been allocated efficiency. It means that the quantity of goods demanded, is equal to the quantity of goods supplied for a given price.

It is important to remember that this is a theoretical model that assumes time has stopped. The quantity of goods and services demanded and quantity of goods supplied can only realistically be modeled in this fashion. In real life, measures of demand and supply are constantly changing so the equilibrium point is never truly reached.

When supply or demand change, they disrupt the supply and demand equilibrium which implies that there is an inefficient allocation of resources – this is termed disequilibrium. Since the market always wants to remain efficient, it attempts to recorrect itself whenever disequilibrium occurs by recorrecting itself.

At P1, the price has increased meaning that demand (A) has decreased and supply (B) is still in excess. To recorrect itself the market must either supply less of the G&S or decrease the price of the G&S to increase demand and return to (Pe. Qe) once more.

At P2, the price has decreased meaning that demand (Z) is now in excess of supply (Y). To recorrect itself the market must either supply more of the G&S or increase the price of the G&S to increase demand and reach (Pe. Qe) once more.

Conclusion

You now have a basic understanding of market forces that influence the economic process. In applying this information to the investment process, you want to research companies that are producing goods in excess demand, or in limiting supply so that their stock price is generally increasing. While this is a vast generalization, it shows you that the stem of all economic reasoning lies behind the study of this model, and its application is important when choosing the right investment in your investment strategy.