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Understanding Supply and Demand in Business

The Law of Supply and Demand is one of the most important economic theories. Learn what it is and how it can help business owners make informed decisions.

Supply and demand is an economic model that provides the basis for the consumer economy. The given supply and cost of a good is driven by demand and how much consumers will pay for the good.

When demand for a good is high, the price increases, and when the demand is low, the price drops in response. Both consumers and producers engage in a push-and-pull dynamic as both respond to these two market forces.

Just about every good or product that reaches the market is affected by the law of supply and demand. It affects products that are new to the market and ones that have been available for some time.

The law of supply and demand on an established good was obvious during the early days of COVID-19 when people were buying toilet paper in large quantities. The price of toilet paper increased in response to the demand because manufacturers had a hard time keeping up with the supply.

Businesses, small and large, benefit from understanding the law of supply and demand as it helps them find an equilibrium price for their products, how to maintain a steady supply of goods and services, and drive profitability.

Read on to learn more about this important law of economics and how to use it to your advantage.

What is the law of supply and demand?

The law of supply and demand enables a manufacturer or provider to anticipate demand for a product or service and drive more sales while engaging in effective customer care.

It's something that can be visualized on a graph to help track pricing data, inventory, sales and find the sweet spot for steady sales and profits.

The law of supply

The law of supply refers to the product being created and sold by a manufacturer to consumers. A supplier introduces a product to the market or maintains a regular supply of a product for ongoing demand.

When a new product comes onto the market and sells extremely well, the supplier has the job of keeping up with demand. The supplier may also decide to increase the price.

A manufacturer can use this to increase or decrease the price depending on demand. If the manufacturer has an exclusive for the item, it can control inventory levels and price the product at a point where the product sells without a loss in demand.

In the event the product is not exclusive and easily copied, the strong demand can draw other manufacturers into the market to sell their version of a popular product. This runs the risk of oversaturating the market and reducing demand.

What affects supply?

Price is the main factor that affects the supply of goods or services, but the manufacture and delivery also affect the supply curve.

Some of the pressures that affect supply include the demand for goods from the consumer, the availability of raw materials to make the goods, and the ability to get the goods to the consumer.

The law of demand

The law of demand is determined by the ability of a consumer to make a purchase of necessary or discretionary items.

It's a given that consumers buy more when prices are lower and buy less when a price rises. Consumers are also more likely to look for a less-expensive version of an item with the knowledge that they're buying a lower-quality item.

What affects demand?

The amount of discretionary income a consumer has is the largest driver of demand, but other factors also affect the demand curve. They include effective marketing efforts, changes in trend and taste, consumer confidence, perception of quality, and price.

All of this influences how well a product will sell from the time it's introduced to the market and throughout its lifespan.

The supply and demand curve

The supply curve and demand curve are two separate graphs that are used to track the price, inventory, and consumer demand for an item.

Generating a supply and demand curve graph results in a visual representation of how well a product is selling at what price and how consumers are responding to pricing.

Supply curve

The supply curve graph shows the price of the goods along one side of a right-angle graph and the inventory amount on the other side. A line is drawn from the corner of the graph on the diagonal to show the point where quantity supplied and price intersect to determine how much inventory is needed to meet the demand curve for the goods.

Demand curve

The demand curve begins with the same graph as a supply curve, but instead of drawing a line out at a 45-degree angle from the corner, the line is drawn from end to end.

A pricing line is drawn to the angle, then down to the inventory levels. This graph shows how much a particular good has sold at different market price points, enabling the seller to change the price accordingly if necessary.

Combining supply and demand curves together results in something known as market equilibrium or the equilibrium price.

Market equilibrium price

Putting both graphs of the supply and demand curves together along the same axis shows the effectiveness of pricing if more or less inventory is needed and the optimal or market equilibrium price that encourages consumers to buy without rapidly drawing down inventory. The graph also shows if the market price rises or is too low.

How can supply and demand guide business owners?

Business owners can use supply and demand to help them with product development, launch a business, and engage in customer care to make a customer feel heard and satisfied.

It can also be used to set a price for a product after the basic costs are factored in. Here's a look at some of the ways you can make this law serve your business needs and purpose.

Maintain a steady inventory

You have a product to sell, and you have customers who want to buy that product. The consumer demand curve can help you determine how much inventory you're going to need during peak seasons and throughout the rest of the year.

Customers figure out that you're a reliable seller and return to you for sales because they know you're going to have a product in stock.

Keep up with the competition

Customers are fickle at the best of times. They want their goods, and they're not going to wait if there's a competitor that has the goods in stock.

Forecasting the demand for your product helps you maintain an adequate inventory while minimizing lost sales.

Avoid having too much or not enough inventory

One of the risks of selling physical goods is not having enough or too much inventory. Too much inventory results in lower prices and reduced sales, while not enough inventory on hand leads to higher prices and lower sales.

Using a supply and demand curve chart along with determining the price elasticity of a good helps you keep the right amount of stock available for sale.

Helps you set your pricing

Setting your ideal price for your product is a balancing act, especially if you have a seasonal good or something that experiences steady demand throughout the year.

For example, you sell a component for a certain type of craft on a crafting site. Your customers buy steadily from you throughout the year, but there's always a spike in sales for the holiday season.

The law of supply and demand gives you the opportunity to set the price a little higher during spikes to increase profits, keep the sales at a steady pace so you can reduce the strain on your inventory levels, or keep the same price and order more inventory to meet the demand. The same goes for services, but instead of inventory, it helps you figure out if you need to hire more employees to provide the service.

Find out how well a product is going to sell

Part of product development is putting it through a market assessment to determine its sales potential.

You can sample the market by releasing a few of the products to the market, using advertising or marketing to attract attention, and sending out a survey questionnaire to get customer feedback.

The information that is collected from these efforts can be extrapolated to the market at large to determine customer satisfaction with pricing, the product, and how desirable it is to consumers.

Knowing when to put a product or service on sale or discontinue it

Sometimes a product hits big because everyone wants it, but the market eventually becomes saturated and sales decline. When the demand for a particular item falls off, it can be put on sale to spur people to buy more of it.

A decision can be made to discount the item further and eventually stop restocking inventory as it's more costly to carry the item than it is to sell it.

Drive sales with Mailchimp

Understanding and applying the law of supply and demand helps you launch a business or make your existing business more successful.

It shows you how data tracking enables you to set the best price for your product or service, maintain your inventory levels to meet demand, and anticipate your customer's needs. You'll find that your business runs better and customer care improves because you have the information you need to run your business in an optimal fashion.

At Mailchimp, we provide you with business tools that help you determine your next business move and which of your online business ideas are most likely to succeed.

Mailchimp offers an ecommerce platform that enables you to build the e-commerce business of your dreams and easily track your metrics. We can help you collect customer feedback, create marketing campaigns, find new customers, and help you find out how popular your business is through the use of social listening tools.

In the meantime, you can build your brand and business from anywhere you have an internet connection, improve your sales, and enjoy the freedom that comes with being an entrepreneur.

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