Supply Chain Management in a Nutshell

Supply and Demand Management

In the field of micro-economics, the idea of supply and demand is used as a sort of building block for a multitude of economic theories. Fundamentally, it serves as a description for a market interaction between the producer and consumer of an object in relation to how much the goods cost.

Antoine Augustin Cournot first articulated the idea of supply and demand, but it was Alfred Marshall who would make the idea popular. The fundamental prediction of the supply and demand model is that in a competitive free market economy, the price functions as an equalizer of the quantity demanded by consumers as well as the quantity supplied by the producers, which results in an equilibrium.

The History of Supply and Demand

James Denham Steuart was the first person to use the term “supply and demand.” The phrase appeared in his book Inquiry into the Principles of Political Economy, which was published in the late 1700s. Adam Smith also used the phrase in his study The Wealth of Nations, while David Ricardo elaborated on the idea in his early 19th century treatise Principles of Political Economy and Taxation.

Smith’s book took the stance that the supply price would be fixed, but that the demand would increase or decrease according to the way the price fluctuated. Antoine Augustin Cournot laid down a more mathematical theory in his 1838 work Researches on the Mathematical Principles of the Theory of Wealth. In the latter half of he 19th century, a new school of thought called marginalism emerged. The principle founders of marginalism were Leon Walras, Stanley Jevons, and Carl Menger. The main idea behind their movement was that the price would be set by the most expensive price – in other words, the price on the margin. This marked a major change from Adam Smith’s theories.

In the year 1890, Alfred Marshall developed this idea even further in his work Principle of Economics. Alongside Walras, Marshall was interested in the equilibrium point at which the two curves would cross. Marshall and Walras were also interested in how markets impacted each other. Since this era, the supply and demand concept has not changed much. The vast majority of work in this area that has been done since has been concerned with examining exceptions to the supply and demand model, such as oligarchy, non rationality, and transaction costs.

Supply and Demand Theory

The theory behind the supply and demand model is contingent on the idea that in a free market economy, the amount of an item that the producer supplies and the amount that the customer demands both depend on the item’s market price.  According to the law of supply, supply and price are proportional – the higher an item’s price, the more will be supplied by the producer. According to the law of demand, demand is inversely proportional to price – so the higher an item’s price, the less demand there will be among customers. Hence, both supply and demand vary according to the price.

The market price of a good, according to supply and demand, should be at the intersection of customer demand and producer supply. So if an item’s price is at a low level, then there will be more demand for the item than the producers are able to supply; thus, this will result in a shortage, so customers will be willing to pay more for the item. This enables the producers of the item to raise the price until it gets to the point where the customers are no longer willing to pay that much for it.

On the other hand, if a price is high and the suppliers want to produce more than the customers are willing to purchase, then the producers will have to be willing to lower the price. Then the price falls until it gets to the point where the customers are willing to buy it. So what supply and demand is aiming for is to get prices to the point of economic equilibrium, at which point the amount supplied is the same as the amount demanded. Producers can then sell exactly the number of goods that the customers want to purchase.