Question

Define the so-called “Fundamental Law of Demand and Supply”.  With is definition, use the law of demand, the law of supply, and the laws of market adjustment to demonstrate its logic. Provide a carefully labeled supply and demand diagram and an example of the operation of this law drawn from a life experience of yours. Describe how your example connects with the Law of Demand and Supply.

Answer 1

The Laws of Demand and supply, help in establishing equilibrium in any market, the law of demand states, that as prices of goods and services goes down, the demand goes up. This is because the relative income of people changes. For example, if we earn 10$ and the price of a good we want to purchase is 5$, we can purchase only 2 units of the good. Now if the price falls to 2$, we can then purchase addition 3 units making our total demand as 5 units as the income which we hold increases in terms of the quantity we may be able to buy.

On the other hand, the law of supply states that as the prices move in the upward direction, the supply sees an increase. This is because producers increase their production levels to be able to maximize their profits. For example, if as a producer I am able to receive 10$ for a product instead of 8$ at which it was earlier selling, then I would extend my production to increase my profit levels.

A market now, is said to be in equilibrium when the interests of both the producers and the consumers is maximized, this happens at an agreeable quantity of demand and supply and price so that each party can maximize their satisfaction or profits.

Graphically the above discussion can be explained with the help of the following diagram: -

Here, we can see that an optimum result is arrived only at the intersection of point P and Q points P1 Q1 and P2 Q2 give negative returns to either the producer or the consumer as the prices are either high or low and the quantity is either high or low.

Similarly, two lines indicate the demand and supply curves which have been explained in the sections above. The inequilibrium at Points P1 Q1 indicate a greater demand than supply and the exact opposite is for P2 Q2.

Please feel free to ask your doubts in the comments section.