If we look at consumer demand from a business perspective, how would a firm detect if customer demand is increasing or decreasing?
There are two primary laws of markets: law of demand and law of supply. Both laws attempt to illustrate how consumers and producers respond to changes in price for goods and services.
Law of demand states that consumers will demand more of a good when prices fall, all else constant (McConnell et al., 2021). A bottle of pinot noir might sell for $25 and consumer demand might equal 20,000 bottles for a specific market over a period such as one year. If only price decreases, more wine should be sold. For example, price might fall to $20 per bottle and demand increases to 25,000 bottles. Therefore, there is an inverse relationship between price and quantity for consumers. As prices fall, consumers demand more and as prices rise, consumers demand less. A demand curve is always downward sloping and falls from right to left on a graph.
Law of supply states that producers will supply more of a good when prices rise, all else constant (McConnell et al., 2021). If the price of a box of sugar cookies is $4, producers are willing to supply 40,000 boxes. If price increases to $5, producers might offer 50,000 boxes of cookies. Therefore, there is a direct relationship between price and quantity for producers. As prices rise, producers are willing to provide more goods and services. As prices fall, sellers are less willing to supply goods and services to market.
Notice there is an antagonistic relationship between producers and consumers over prices of goods and services. Consumers will want more product at a lower price, but producers are only willing to offer more product at higher prices. Price is the common signal between consumers and producers. When we look at market dynamics, we see how price coordinates supply and demand of a market toward an equilibrium point. Equilibrium occurs when there is no pressure for market price or quantity to change with elimination of surpluses or shortages.
Market demand is just the horizontal summation of all consumers in a market. Each person’s willingness to purchase and ability to buy will be different at each price from other consumers. However, individual demand will be more inelastic than the market. Elasticity of demand refers to how sensitive consumers are to changes in price. The more sensitive to changes in price the more elastic demand will be. We will cover elasticities during week three.
In addition, market supply is the horizontal summation of all the producers in a market. Like consumers, individual producer supply tends to be more inelastic than market supply. Market supply curve will be flatter and less steep than supply curves of individual producers.
An automatic beauty of markets is that supply and demand for a market will be more elastic or responsive to changes in price than any one individual consumer or producer.