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Supply and Demand: Prices
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The laws of supply and demand state that the equilibrium market price and quantity of a commodity is at the intersection of consumer demand and producer supply. Here, quantity supplied equals quantity demanded (as in the enlargeable Figure), that is, equilibrium. Equilibrium implies that price and quantity will remain there if it begins there. If the price for a good is below equilibrium, consumers demand more of the good than producers are prepared to supply. This defines a shortage of the good. A shortage results in the price being bid up.
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The theory of supply and demand is a central part of economics about price in competitive markets. Demand is a force which tends to increase the price of an item, and supply a force which tends to lower price. When the two forces balance one another, price will neither rise nor fall, and will stablilise. This stability leads to "equilibrium" of price. "Price equilibrium" exists when price is balanced at the point where the quantity supplied equals the quantity demanded. At equilibrium, there is no competition to buy or sell, because everyone can buy or sell ... much they wish, at the going price.
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Demand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in "structural estimation." Typically, data on exogenous variables (that is, variables other than price and quantity, both of which are endogenous variables) are needed to perform such an estimation. An alternative to "structural estimation" is reduced-form estimation, which regresses each of the endogenous variables on the respective exogenous variables.
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Supply and demand is a fundamental factor in shaping the character of the marketplace, for it is understood as the principal determinant in establishing the cost of goods and services. The availability, or "supply," of goods or services is a key consideration in determining the price at which those goods or services can be obtained. For example, a landscaping company with little competition that operates in an area of high demand for such services will in all likelihood be able to command a higher price than will a business operating in a highly competitive environment. But availability is only one-half of the equation that determines pricing structures in the marketplace. The other half is "demand." A company may be able to produce huge quantities of a product at low cost, but if there is little or no demand for that product in the marketplace, the company will be forced to sell units at a very low price.
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Supply and demand match when the quantity traded is two sacks and the price is between $15 and $20. Whether Dan sells to Cathy, and Emily to Bob, or the other way round, and what precisely is the price agreed cannot be determined. This is the only limitation of this simple model. When considering the full assumptions of perfect competition the price would be fully determined, since there would be enough participants to determine the price. For example, if the "last trade" was between someone willing to sell at $15.50 and someone willing to pay $15.51, then the price could be determined to the penny. As more participants enter, the more likely there will be a close bracketing of the equilibrium price.
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The laws of supply and demand become a little more high-tech in DemandTec's hands. The company makes software that helps manufacturers and suppliers predict consumer demand and then use their predictions to develop strategies for pricing and promotions. Designed to help clients improve their planning and profitability, the company's consumer demand management software is available in versions tailored to the needs of retailers (with tools for pricing, promotions, and markdowns) and consumer products manufacturers. Customers have included Best Buy, General Mills, and Office Depot.
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