The theory of demand and supply tends to explain the behavior of sellers as well as buyers as far as price and quantity of goods supplied and purchased is concerned. This model encompasses two scenarios i.e. the quantity supplied and the quantity demanded. It is in fact two theories in one i.e. the law of supply and the law of demand.
According to the inventor of this theory, Adam Smith, the quantity supplied by the suppliers would be high if the price is high.
The converse is true; there is a direct proportional relationship between price and quantity supplied.
However, there is an inverse relationship between the price and quantity demanded i.e. the higher the price the lower the quantity demanded ceteris paribus.The relationship between the price and quantity can be represented by the following diagrams.
Adam Smith was born in 1723 and died in 1790. He was the main contributor of the theory of Free Markets, a principle that is presumed to be existent in order for the theory of demand and supply can apply.
Smith was a philosopher and economist based in Scotland. Awarded with many honors for his work, Smith invented more other theories apart from the one of demand and supply. A devoted Christian, Smith never married.
Back to his theory of law and demand. He established a point known in economics as the Equilibrium point. This is the point at which the quantity demanded equals to the quantity supplied. Diagrammatically, this is represented as below.
When price falls below equilibrium, demand for the good increases which in turn surpass supply. This creates a shortfall of the goods in the market. Suppliers respond to this shortage by increasing the price. The price would therefore be increased until it reaches the equilibrium point. The converse is true; If price gets beyond the equilibrium point, suppliers would supply more of the good (Law of Supply). There would be competition amongst the suppliers to sell surplus. The end result would be a reduction of prices until the point of equilibrium.
The theorist further came up with the phenomenon of movements and shifts. These occur along both the demand and supply curves.
Demand curve movements: They occur when the quantity demanded changes as a result of price changes only.
Supply curve movements: These occur when the quantity supplied changes as a result of price changes only.
In both cases, it is assumed that other factors remain constant.
Shifts on the other hand occur when other factors other than price affect demand and supply.
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