Category: Basic

While the law is fundamental, it assumes:

• Perfect competition.
• Rational consumers and producers.
• No government interference.

In reality, markets face monopolies, advertising influence, emotional buying, and government interventions. These factors can distort the law of supply and demand.

• Helps predict how markets respond to changes.
• Guides businesses in pricing strategies.
• Assists governments in policymaking.
• Explains consumer behavior and producer decisions.
• Ensures efficient allocation of resources in a free market.

Sometimes governments step in to regulate markets.

• Price Ceiling: Maximum price limit (e.g., rent control). Prevents prices from going too high but may cause shortages.
• Price Floor: Minimum price limit (e.g., minimum wage, agricultural price support). Prevents prices from going too low but may cause surplus.

Example:
If the government sets a price ceiling on wheat to make food affordable, it may discourage farmers from producing more, causing shortages.

The law of supply and demand is not just theory—it shapes everyday life.

Housing Market:
When more people move into a city, demand for housing increases. If supply cannot keep up, rents and property prices rise.

Labor Market:
When a skill (like AI programming) is in high demand but supply of skilled workers is low, salaries for that job rise significantly.

Oil Prices:
Global oil prices fluctuate depending on demand (economic growth) and supply (OPEC production limits, wars, sanctions).

✅ Seasonal Products:
During mango season, supply increases, and prices drop. But out of season, demand remains while supply decreases, raising prices.

Demand and supply do not remain static. They shift due to external factors:

Factors that shift demand:

• Income changes (higher income → more demand).
• Consumer preferences (healthy lifestyle increases demand for organic food).
• Price of related goods (if the price of tea rises, demand for coffee may increase).
• Population growth (more consumers → higher demand).

Factors that shift supply:

• Technology (better machinery → more supply).
• Cost of production (higher wages or raw material costs reduce supply).
• Government policies (taxes or subsidies).
• Natural conditions (drought reduces agricultural supply).

At equilibrium price:

• Buyers are satisfied (they can purchase the quantity they want).
• Sellers are satisfied (they sell the quantity they want at a profitable price).
• No surplus or shortage exists.

Example:
If the demand for face masks rises during a pandemic, equilibrium price increases because more consumers are willing to pay higher prices, and suppliers adjust to produce more.

• Demand curve slopes downward (negative relationship with price).
• Supply curve slopes upward (positive relationship with price).
• The point where they intersect is called the Equilibrium Point – the market price where quantity demanded equals quantity supplied.

Illustration (conceptual):

• If demand > supply → shortage → prices rise.
• If supply > demand → surplus → prices fall.

The law of supply states that, all else being equal, when the price of a product rises, the quantity supplied also rises; when the price falls, the quantity supplied decreases.

Formulaically:
Supply is directly related to price.

Why does this happen?

• Profit Motive – Higher prices encourage producers to increase output.
• New Entrants – Rising prices attract new businesses into the market.
• Production Costs – Higher price justifies covering higher production costs.

Example:
If the price of wheat increases, farmers will be motivated to grow more wheat next season.

The law of demand states that, all else being equal, when the price of a product falls, the quantity demanded rises; when the price rises, the quantity demanded falls.

Formulaically:
Demand is inversely related to price.

Why does this happen?

• Income Effect – When prices fall, consumers can buy more with the same income.
• Substitution Effect – When a product becomes cheaper, people switch from alternatives to this product.
• Diminishing Marginal Utility – Each additional unit of a good provides less satisfaction, so consumers will only buy more if the price drops.

Example:
If the price of apples drops from $3 to $2 per kg, more people will buy apples instead of bananas or oranges.

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1. Human Behavior – Economics assumes rationality, but emotions like fear or greed often drive decisions.
2. Changing Conditions – Economic predictions may fail during unexpected events (wars, pandemics, natural disasters).
3. Inequality – Economic growth does not always mean fairness. Some groups benefit more than others.
4. Environmental Impact – Traditional economics often ignored the cost of pollution, which modern economics now addresses.