What Is the Law of Supply and Demand?

The law of supply and demand is actually not a law but an economic theory that explains a fundamental concept of economics and provides the basis for the market economy. As a theory, it explains the relationship that the availability of a product and the desire for it have on its price in the marketplace. Simply put, the law says that the price of a product, although it might vary some, will eventually settle to the point where the quantity that consumers demand is the same as the quantity that producers provide. The end result is the establishment of what is known as an equilibrium price.

In reality, the law of supply and demand is made up of two separate laws: the law of supply and the law of demand. Each of these laws operates independently of the other but, in a market economy, they work together to set the price of any given good or product. The law of supply states that producers of goods will offer more products for sale if they can sell them at higher prices rather than lower prices. A direct effect of this is that supply increases as price increases, but supply decreases when price decreases. The law of demand states that the lower the price of a good, the more people will buy of it, as long as nothing else changes.

Through their interaction, these two laws set prices in a market economy. If demand increases but the supply of a good stays the same, its price will go up. On the other hand, if demand decreases but the supply of the good stays the same, its price will go down. If the supply of a good increases but consumer demand stays the same, the price will go down. When the supply of the good decreases but consumer demand stays the same, the price will go up.

The law of supply and demand might seem something of a common-sense principle or observation. In the study of economics, however, it is the foundation on which a basic understanding of economics is built. Over time, significant economic theories have developed around these simple concepts, and highly sophisticated and mathematically-based econometric models have been built to show and explain how the mechanisms of this law interact and work in an economy.