Understanding the law of supply and demand in business

The law of supply and demand is a balancing act that your business needs to master to have any chance of turning a profit. It doesn’t matter if you’re running a one-man startup or a multinational corporation — understanding it can make all the difference between your ultimate success or failure. 

Read on to get to grips with the law of supply and demand with some real-life examples.  

What is the law of supply and demand?

Imagine you’re at a food stand, and there’s only one slice of pizza left for sale. Everyone’s pushing to the front, desperate to get their hands on it. The more slices people want (demand), the more the food stand can decide to charge for them. 

At the same time, if the stand has one hundred slices of pizza and only ten customers, they might slash their prices to shift as much as they can. 

This basic example is the true essence of the law of supply and demand. 

It’s all about how the availability of the product (supply) and the desire for the product (demand) interact with each other to determine the price set for the product. 

When demand increases, and supply remains unchanged, a shortage happens. This will eventually push prices up. On the flip side, when supply increases and demand remains unchanged, a surplus occurs, which will cause prices to drop. 

The law of supply 

The law of supply states that, all else being equal, an increase in the price of goods leads to an increase in the quantity supplied, while a decrease in price results in a decrease in the quantity supplied.

This usually happens because the manufacturers are more willing to create and supply a product when they can sell for more cash as they can enjoy a bigger profit. They’ll also supply far less when the price drops because the incentive to keep producing is no longer there. 

Let’s go back to the food stand theory again. If the market price of a slice of pizza goes up, the stand will want to bake more of them to maximize their profits. If the price plummets, the stand will cut back on baking since the cost of the ingredients isn’t worth it. 

The law of demand

The law of demand states that, all else being equal, an increase in the price of goods leads to a decreased demand, while a decrease in price results in increased demand.

Basically, consumers want to get the best value for their money, so they’re far more likely to buy more of a product when it’s cheaper. 

In the food stand example, this would mean that if the price of a slice of pizza doubles overnight, fewer people will go there for lunch — they might look for a cheaper option nearby. But if the price drops by half, customers might buy two slices. 

The law of supply and demand 

Now that we’ve covered the basics of supply and demand, we can bring them together. 

The law of supply and demand states that if the supply and demand of a product are equal, the balance is reached. This point is known as the equilibrium price. Basically, the market is in balance, and there’s no pressure for the price to go up or down. 

If you decide to plot supply and demand on a graph, the point where the two lines intersect is the equilibrium price. When the market price is above this equilibrium point, it represents a surplus, and prices will start to fall. 

At the same time, if the market price sits below the equilibrium line, then there’s a shortage, and prices will start to creep up. 

Why is the law of supply and demand important for your business?

Without the law of supply and demand guiding your decision-making, you’d be making decisions regarding your pricing and production in the dark. 

By knowing how changes in supply and demand will affect pricing, your business can make better predictions when it comes to market trends so that you can adjust your strategy. 

Let’s say your business anticipates a spike in demand for one of your products using the law of supply and demand. You can increase your production to meet that demand and enjoy higher profits. 

At the same time, if you predict a drop in demand, you can slow down production to avoid excess inventory and potential losses. 

The basic laws of supply and demand

If you’re still unsure of how the law of supply and demand might look in practice, read the basic laws with examples below. 

The law of supply — As prices rise, the supplied quantity rises. As prices fall, the supplied quantity also falls.

Example: A coffee shop owner increases prices when there’s a coffee shortage. Farmers grow more coffee beans because they can sell them at higher prices. 

The law of demand — As prices rise, the demand falls. When prices fall, the demand rises.

Example: A tech company slashes its smartphone prices. Sales boom as customers rush to buy discounted phones. 

Equilibrium — The point where supply successfully meets demand. 

Example: A food stand sells 100 slices of pizza every day. If they make exactly 10 pizzas with 10 slices each, they’re at equilibrium. Any more, then there are leftovers. Any less, and they run out, and their profits decline. 

Balance supply and demand with Katana

In business, you have to strike the balance between supply and demand — but it can be as challenging as finding a needle in a haystack. That’s where Katana comes in. Our inventory management software helps you keep your finger on the pulse of your supply chain so you never miss a beat. 

With Katana, you have the ability to track your inventory levels and forecast demand, allowing you to adjust your production levels in real time. Sign up for a demo today and find the equilibrium point with ease. 

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