you probably have at least some familiarity with the terms. Perhaps you’ve heard them

used in conversation, a segment on the evening news, or maybe you’ve taken a class in microeconomics.

If you live in the United States or any other country whose economic system resembles a

market economy, then you’ve experienced first-hand supply and demand at work.

Recall that in a market economy a nation’s government generally doesn’t get involved

in setting prices for markets. Instead, markets rely on supply and demand to determine how

to allocate resources and make decisions regarding price. Now that you know some of the theory

behind supply and demand lets define them.

Supply represents how much of a good or service a seller is both willing and able to provide

at various price levels. Now there are two important components to this definition. The

first is willingness, which refers to a desire. So in order for a firm to be considered one

who factors into supply they must have the desire to provide a good or service to consumers.

The second component is ability, which refers an actual ability to provide a good or service.

If a firm has a desire to provide a good or service, but lacks the financial means necessary

to do so, then it would not be considered according to this definition. Now being that

firm’s are run by people like you and I, and we all respond to incentives, sellers`

respond to markets in somewhat predictable ways. As the price that the seller can charge

for a good or service increases, they are willing to provide more of that good or service.

But as this price decreases, than sellers are less willing to expend the resources to

offer the good or service. This is because a firm’s profit margin decreases if they’re

forced to reduce prices. At a certain point, firm’s find it unwise to provide goods or

services and it’s likely that better opportunities exist for the firm. However if the price a

seller can charge increases, then firm’s will likely enter the market since they have

a greater chance at earning profit. This movement of the quantity that a seller will provide

at various price levels is called a supply curve, and is represented by an diagonally

upward sloping line. But without its counterpart supply would be virtually meaningless. So

lets talk about demand.

Demand represents how much of a good or service a buyer is both willing and able to purchase

at various price levels. Again, the presence of both willingness and ability is necessary

for there to be true demand. For example, lets say I wanted to purchase a brand new

car but my credit is poor and I lack the cash needed to complete the transaction. You would

say that although I have the willingness or desire to purchase a new vehicle, I lack the

ability to do so. Now as consumers we obviously respond to incentives as well. Naturally,

our incentive is acquire as many goods and services as we can without giving up our scarce

resources. So we will purchase more of something as its price decreases, while we will purchase

less of something as its price increases. This is exactly why retailers run sales promotions,

because they realize that doing so will increase demand for goods and services. Now the idea

that buyers will demand more goods as the purchase price decreases is characterized

by the demand curve. A downward sloping line that looks a bit like this.

It’s this tug of way balancing act that takes place between supply and demand that

explains how prices are set. Although each group, sellers and buyers, would rather acquire

as much money or spend as little as possible this wouldn’t work. Because the other party

is necessary to complete the transaction. Although buyers would likely purchase a large

amount of goods at low prices, sellers wouldn’t provide them. And likewise, although sellers

would be clamoring at the chance to sell goods and services at premium prices, buyers may

not be willing to purchase them. The point at which both parties compromise and the supply

and demand curves intersect is called the market price. At this price, both parties

are willing and able to sell and purchase goods at similar prices. We experience this

on a small scale when we go to the store and make a decision to purchase a tablet computer

or a new car. On a larger scale, if a sellers products go unpurchased, this could be a reflection

that buyers don’t have adequate demand at the offered price.

Again, it’s this interaction between buyers and sellers that helps us make decisions on

resource allocation as well as pricing. One thing I’ll add is supply and demand is a

helpful in interpreting, understanding, and articulating how markets operate, but they

don’t provide tactical application for a firm trying to set prices. With that said,

an understanding of supply and demand is important to grasping some of the more advanced concepts

in economics and understanding how we allocate resources.