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 supply-demand 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 gains significant market power and 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 manufacturing 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 entire 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 market 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 market 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.
Real-world examples of supply and demand in action
You see supply and demand working everywhere around you, from the coffee shop on your corner to major retail chains. These market forces shape how businesses price their products and how much they produce.
When demand increases beyond what's available, prices typically rise, but when supply exceeds what people want, businesses often lower their prices to move inventory. Let's look at some concrete examples of how this plays out in different situations.
Seasonal product demand
Think about how certain products become hot commodities at specific times of the year. Pool supplies fly off the shelves in spring and summer when demand exceeds supply, driving prices up until manufacturers can ramp up production to meet the equilibrium quantity.
Come fall, when fewer people are thinking about swimming, demand decreases significantly, and retailers start marking down pool equipment and chemicals. This seasonal pattern repeats year after year, with smart retailers adjusting their inventory and pricing strategies accordingly.
Product scarcity and price increases
When a product becomes scarce, the market dynamics shift dramatically in favor of sellers. We saw this clearly during the early pandemic when hand sanitizer and face masks were in short supply; demand equaling supply became impossible to maintain, and prices skyrocketed.
Graphics cards are another great example, where cryptocurrency mining and gaming demand often outstrips production capacity, keeping prices elevated. Once production costs are covered and supply catches up to demand, prices fall back to more reasonable levels.
New tech launches and consumer behavior
New technology releases create fascinating supply and demand scenarios that tech companies have learned to master. When Apple launches a new iPhone, or Sony releases a new gaming console, initial production is limited while consumer excitement is at its peak.
This intentional scarcity keeps prices high and creates buzz around the product. As production scales up and the initial rush subsides, the quantity demanded typically stabilizes, and companies can better predict how much to produce.
Eventually, when supply decreases become unnecessary, and the market reaches balance, prices often drop to attract broader consumer segments.
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.
Common supply and demand challenges for businesses
Running a business means constantly juggling the delicate balance between what customers want and what you can deliver. Many companies struggle with predicting customer behavior, especially when markets shift quickly, or seasonal patterns don't play out as expected.
These challenges can lead to missed opportunities, wasted resources, and frustrated customers. Understanding the most common pitfalls helps business owners prepare better strategies and avoid costly mistakes.
Misjudging demand
One of the biggest headaches for business owners is getting demand forecasts wrong. You might stock up for what you think will be a busy season, only to find yourself with warehouses full of products nobody wants.
On the flip side, underestimating demand means missing out on sales when customers can't find what they're looking for. This guessing game becomes even trickier with new products where you don't have historical data to guide your decisions.
Oversupply and waste
When businesses increase supply without properly reading market signals, they often end up with too much inventory taking up valuable space and tying up cash.
Perishable goods create an even bigger problem since they can spoil before being sold, leading to complete losses. Smart businesses learn to read the warning signs early and adjust their production or ordering before waste becomes a major issue.
Slow response to market trends
Markets move fast, and businesses that can't keep up often get left behind. Whether you experience a sudden shift in consumer preferences or a competitor launching a game-changing product, slow reactions cost money and market share.
Companies that take too long to recognize price changes in their industry or fail to adapt their offerings quickly find themselves struggling to stay relevant.
How to use demand insights to shape your marketing
Smart marketing isn't just about getting your message out there; it's about timing that message perfectly with when customers actually want to buy. By understanding when demand peaks and dips, you can make your marketing budget work much harder for you.
The key is using data about customer behavior to guide not just what you say but when and how you say it. This approach helps you connect with existing and potential customers at exactly the right moment when they're most likely to make a purchase.
Create targeted promotions
The best promotions happen when customers are already thinking about buying what you're selling. Use your demand data to identify slow periods when a well-timed discount could boost sales or busy periods when customers might pay full price but appreciate added value.
Understanding your customer's buying patterns helps you craft offers that feel helpful rather than pushy.
Align email campaigns with peak demand
Timing your email campaigns with natural demand cycles can dramatically improve your open rates and sales conversions.
Send pool equipment emails in early spring when people start thinking about summer, not in the middle of winter when it's the last thing on their minds. Your customers will appreciate relevant messages that match their current needs and interests.
Adjust pricing and inventory strategies
Use demand insights to make smarter decisions about when to stock up and when to scale back. If you know certain products sell better at specific times, you can adjust your pricing strategy accordingly.
You might offer discounts during slow periods to move inventory and optimize prices during peak times. This data-driven approach helps you avoid both stockouts and overstock situations.
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.
Key Takeaways
- Supply and demand fundamentals drive pricing decisions, inventory management, and overall business profitability across every industry.
- Seasonal patterns, product scarcity, and tech launches create predictable market behaviors that savvy businesses can anticipate and capitalize on.
- Most companies struggle with demand forecasting, maintaining inventory balance, and responding quickly to changing market conditions.
- Demand data helps businesses time promotions effectively, optimize email campaigns, and make smarter pricing decisions.