The Market of Demand and Supply
What is a Market?
This is a place where makers, distributors, or retailers sell and consumers buy. In other words, this is a regular gathering of people for the purchase and sale of goods and services.
What is Demand?
It refers to the measure of desire to own and purchase a product or service. It is the quantity of a product consumers are willing and able to buy at different prices over a given time period, assuming all other things to remain constant.
The Law of Demand
As prices increases, demand falls and when price falls, demand rises. Such an inverse relationship will create a demand curve sloping downward from left to right. This can be explained through the law of demand that ceteris paribus, more of a good will be demanded at a lower price rather than at a higher price because when price is low real income is high.
Factors affecting demand
(a) Factors causing a movement along the demand curve
- The price of the good itself – When the price of a good falls, assuming all other factors remain constant (ceteris paribus), consumers experience an increase in their real income—that is, the purchasing power of their money increases. Real income reflects how much goods and services a consumer can buy after accounting for price changes. With greater purchasing power, consumers are more likely to buy larger quantities of the good. This results in an extension in demand, shown as a downward movement along the existing demand curve, rather than a shift.
(b) Factors causing a shift in demand
- Changes in disposable income -An increase in disposable income enhances consumers’ purchasing power, thereby stimulating demand for most goods and services. Goods that experience higher demand as income rises are termed normal goods, reflecting a positive relationship between income and quantity demanded. However, inferior goods exhibit an inverse relationship: as income increases, demand for these goods tends to decline as consumers shift toward higher-quality alternatives or more desirable substitutes.
- Changes in population size – An expanding population typically leads to a rightward shift in the market demand curve, as a larger number of consumers contributes to greater aggregate demand for a wide range of goods and services. The nature of this shift can also depend on the demographic composition. For example, an ageing population may increase demand for healthcare services and assistive devices, whereas a youthful population is more likely to drive demand for education, entertainment, and digital technologies.
- Changes in Consumer Preferences and Tastes – Evolving consumer preferences, driven by factors such as culture, trends, advertising, or awareness (e.g., environmental or health consciousness), can significantly influence demand. When a product aligns with current consumer tastes, its demand increases, shifting the demand curve to the right. Conversely, if a product falls out of favour, demand may decline despite no change in price, shifting the curve to the left.
- Prices of Related Goods – The demand for a good is affected by the prices of complementary and substitute goods. A fall in the price of a complementary good (e.g., printers and ink cartridges) tends to increase demand, shifting the curve rightward. Conversely, an increase in the price of a substitute (e.g., if tea becomes expensive, more consumers may switch to coffee) can also increase the demand for the original good. These interdependencies play a vital role in consumer decision-making.
- Seasonality – Seasonal changes significantly influence consumer demand for many goods and services. During specific times of the year, certain products experience heightened demand due to cultural practices, weather patterns, or festivities. For instance, in Mauritius, demand for fans and air conditioners increases during the summer months, while raincoats and umbrellas see higher sales during the rainy season. Similarly, festive periods such as Eid, Diwali, or Christmas typically drive up demand for clothing, food, and gift items. These seasonal variations cause temporary rightward shifts in the demand curve, which return to normal levels post-season.
Graphs showing:
(A) Movement along the demand curve
(B) Shifts in the demand curve
What is supply?
It refers to the amount of a product that a producer is willing and able to produce at different prices over a given time period, assuming all other things remain constant.
The Law of Supply
It states that ceteris paribus more of a good will be demanded at a higher price than at a lower price. This is because an increase in price will encourage a producer to produce more as profits will increase.
Supply ≠ Quantity produced
In economics, supply refers to the amount of a good or service that producers are willing and able to sell at a given price over a specific period of time. It is not simply the amount produced.
On the other hand, quantity produced refers to the total output of a good, regardless of whether it is intended for sale or whether it matches current market demand.
The key difference lies in market intention and pricing:
- A firm may produce goods but not offer them for sale if the market price is too low to cover costs. In this case, quantity produced exists, but supply (willingness to sell) may be zero.
- Conversely, if prices are high and profitable, firms may be willing to increase supply, even if production has to be scaled up or inventories reduced.
Factors affecting supply
(a) Factors causing a movement along the supply curve
- Price of the good itself – The price of the good itself is the only factor that causes a movement along the supply curve, rather than a shift of the curve. When the price of a good rises, it becomes more profitable for producers to supply more, leading to an extension in supply. Conversely, when the price falls, profitability declines, and producers are likely to reduce the quantity they are willing to supply, resulting in a contraction in supply. These movements occur along the same supply curve and assume that all other factors remain constant (ceteris paribus). The positive relationship between price and quantity supplied reflects the fundamental law of supply in economics.
(b) Factors causing a shift along the supply curve
- The price of other goods – In competitive supply, multiple goods compete for the same limited factors of production, such as land, labour, or capital. Producers must decide how to allocate these scarce resources based on potential profitability. If the market price of one good increases, it becomes more attractive to produce that good rather than its alternative. As a result, resources are reallocated toward the more profitable good, leading to a reduction in the supply of the competing product. Therefore, changes in the prices of alternative goods in competitive supply can cause a shift in the supply curve, not due to a change in production costs or technology, but because of the reallocation of production decisions by firms seeking to maximise returns.
Joint supply arises when the production of one good inherently leads to the production of another as a by-product or co-product. In such cases, the supply of the secondary good is directly linked to the production volume of the main good. An increase in the supply of the primary product will necessarily result in a higher supply of the associated good, even if the market conditions for the secondary product remain unchanged. This interconnectedness means that the supply of a jointly produced good is not entirely determined by its own price, but is instead influenced by changes in the market for the other good produced simultaneously. As a result, joint supply introduces a dependent relationship in the supply decisions of producers.
2. The state of technology – Technological progress plays a critical role in determining the level of supply by enhancing production efficiency. Improvements in technology allow firms to produce more output using the same or fewer inputs, which effectively reduces the marginal cost of production. As production becomes more efficient, firms are able to supply a greater quantity at each price level, causing the supply curve to shift to the right. Conversely, if technology becomes outdated or breaks down, efficiency may fall, leading to a reduction in supply. Thus, the state of technology is a key determinant of how much producers can supply to the market.
3. Cost of production – The cost of production is a major factor influencing a firm’s willingness to supply goods or services. It includes the expenses associated with inputs such as raw materials, labour, energy, and capital. If input costs rise, profit margins shrink, discouraging firms from producing the same quantity at existing prices, thereby shifting the supply curve to the left. Additionally, productivity—defined as output per unit of input—affects cost efficiency. Higher productivity reduces average costs, enabling firms to increase supply without increasing production costs. Therefore, changes in both production costs and productivity directly impact the overall market supply.
4. Taxes – Taxes imposed on goods or services, particularly indirect taxes such as excise duties or value-added tax (VAT), increase the cost of production for firms. This reduces the incentive to produce and supply the taxed good, as profit margins are squeezed. As a result, producers may reduce the quantity they are willing to offer at any given price, leading to a leftward shift in the supply curve. In some cases, firms may pass part of the tax burden to consumers through higher prices, but the overall effect is a decrease in supply from the producer’s side due to increased operational costs.
5. Subsidies – Subsidies are financial supports provided by the government to reduce the cost of production for firms. By lowering production costs, subsidies make it more attractive and feasible for firms to increase output. This leads to a greater quantity being supplied at every price level, shifting the supply curve to the right. Subsidies can encourage firms to enter the market, expand capacity, or invest in new technology. In doing so, they act as a direct incentive to increase supply, especially in sectors that are considered strategically important or underdeveloped.