Supply and Demand

Supply and Demand, in economics, basic factors determining prices. According to the theory, or law, of supply and demand, the market prices of commodities and services are determined by the relationship of supply to demand. Theoretically, when supply exceeds demand, sellers must lower prices to stimulate sales; conversely, when demand exceeds supply, buyers bid prices up as they compete to buy goods. The terms supply and demand do not mean the amount of goods and services actually sold and bought; in any sale the amount sold is equal to the amount bought, and such supply and demand, therefore, always equalizes. In economic theory, supply is the amount available for sale or the amount that sellers are willing to sell at a specified price, and demand, sometimes called effective demand, is the amount purchasers are willing to buy at a specified price.

The theory of supply and demand takes into consideration the influence on prices of such factors as an increase or decrease in the cost of production, but regards that influence as an indirect one, because it affects prices only by causing a change in supply, demand, or both. Other factors indirectly affecting prices include changes in consumption habits (for example, a shift from natural silk to artificial silk fabrics) and the restrictive practices of monopolies, trusts, and cartels. In the view of many economists, the multiplicity of such indirect factors is so great that the terms supply and demand are inclusive categories of economic forces affecting prices, rather than precise, primary causal factors.

The price-determining mechanism of supply and demand is operative only in economic systems in which competition is largely unfettered. Recourse, in recent times, to governmental regulation of the economy has tended to restrict the scope of the operation of the supply-and-demand mechanism. It was greatly restricted in many countries by the temporary governmental price regulations and rationing during World War II. Under Communist systems the planned economy is controlled by the state, the supply-and-demand mechanism being overridden. However, in recent years there has been a remarkable trend towards the reintroduction of market forces in many former planned economies.