What is the Law of Supply and Demand

What is the Law of Supply and Demand

The law of supply and demand is a theory that explains the interaction between the supply of a resource and the demand for that resource. The theory defines the effect that the availability of a particular product and the desire (or demand) for that product has on its price. Generally, low supply and high demandincrease price. In contrast, the greater the supply and the lower the demand, the price tends to fall.

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Law of Supply and Demand

BREAKING DOWN Law of Supply and Demand

The law of supply and demand, one of the most basic economic laws, ties into almost all economic principles in some way. In practice, supply and demand pull against each other until the market finds an equilibrium price. However, multiple factors can affect both supply and demand, causing them to increase or decrease in various ways.

How Do Supply and Demand Create an Equilibrium Price?

Also called a market-clearing price, the equilibrium price is the price at which the producer can sell all the units he wants to produce and the buyer can buy all the units he wants.

For a simple illustration of how supply and demand determine equilibrium price, imagine a business launching a new product. It sets a high price, but only a few consumers buy it. The business anticipated selling more units, but due to lack of interest, it has warehouses full of the product. Due to the high supply, the business lowers the product price. Demand increases, but as the supplydwindles, the business raises the price until it finds the perfect, or equilibrium, price to balance its product supply with consumer demand.