How Supply and Demand Affect the Prices

There are a lot of different factors that affect prices on the markets. One of these being supply and demand, which we are going to dive deeper into in this post.

How supply and demand work

Simply put, supply and demand mean how much certain goods or services are available in the market, and how much there is demand for that good or service. If supply is in balance with demand, prices stay steady. Meaning there is a buyer for every product that is produced.

If there is more supply than demand, prices will often lower over time, since producers will lower prices when competing for customers.

If there is more demand than supply, prices will rise. This is because there is not enough supply of a certain product or service for the audience. When there is not enough for everybody, prices will be lifted since customers will be willing to pay more in order to get the product.

In the free market, new producers will pop up until a point, where production is no longer so profitable. If everybody could start growing flowers for 5 dollars and selling them for 10, everybody would soon be growing and selling flowers.

Example of too much supply and too little demand.

There are 10 flower sellers in the market. Each of them sells 1 flower each day. There are only 5 customers who each want to buy 1 flower each day. The sellers will be competing over customers and will lower prices when doing so.

They will lower the prices daily until selling flowers will not be profitable enough for half of the sellers. When there are only 5 sellers left with 5 buyers, the price should remain steady.

Example of too little supply and too much demand.

Let’s continue with the flower example. When there is 5 sellers and 5 buyers, there is a good balance in the markets. But when 5 more buyers enter the markets, they will be competing to get those flowers.

Flower prices will increase until half of the buyers think the flowers are too expensive, and the remaining 5 buyers will pay the price that is considered fair. If sellers keep rising, prices, there won’t be enough customers to buy them, and then the sellers will be left to compete for the smaller audience again.

Price cartels

Price cartels mean, that if there are 5 sellers and 5 buyers, the sellers will do an agreement, that they will all keep the flower prices above 10 dollars per flower. Even if the fair price would be 7 dollars or so. Since there will be nobody selling the flower for the fair price, customers are forced to pay 10 dollars if they wish to have the flower.

Price cartels can also be on the buying side. Flower buyers might have an agreement, that they would not pay more than 5 dollars for a flower. This way, producers are forced to sell for 5 dollars if they wish to continue their business.

Often, price cartels are illegal. Still, every now and then new price cartels come up. Price cartels will affect negatively free markets and will force customers to pay more for their goods.

Other things that affect supply and demand pricing

Regulations, taxes and support packages can affect the free market as well. Even if producing flowers would be unprofitable, governments could give support packages to flower producers in order to keep them alive.

This way there will be supply for the flowers even at lower prices, because the profit comes from the support package. This is sometimes the case in the food industry.

Taxes can raise the prices of certain goods as well. For example, cigarette supply and demand could meet even at very low prices, but the majority of the price comes from taxing.

This is because governments are trying to keep cigarette prices high to keep people away from them. At the same time, governments will pocket the highest profits from selling those highly taxes goods. Of course, this will vary in different countries.

Hopefully these examples will help you to understand how supply and demand work. Also, what things affect prices and how supply and demand might be manipulated. Have a nice day.

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