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Supply and demand are the cornerstone interdependent variables in economics theory and practice. Supply is defined as the amount of goods and services available for customers to buy. Demand on the other hand is the number of people with the desire and willingness to pay for the available goods and services. These two variables are the ones which determine the price of goods and services.
Supply and demand are also the basis of the three foundation laws of economics theory. The first law states that, when at a price ruling demand exceeds supply, the price tends to rise. Conversely, when supply exceeds demand the price tends to fall. The second law asserts that an increase in price tends, sooner or later, to decrease demand and to increase supply. Conversely a fall in price tends, sooner or later, to increase demand and to decrease supply. The third law holds that price tends to be at equilibrium at the level at which demand is equal to supply.
Elasticity of demand is a measure of the responsiveness or sensitivity of consumers (demand) to a price change. The price elasticity of demand coefficient is the ratio of the percentage change in quantity demanded to the percentage change in price. The significance of price elasticity of demand for firms relates to the effect of price changes on total revenue and thus on profits (total revenue minus total costs). Factors which shift the elasticity of demand include availability of substitutes, degree of necessity or luxury, proportion of consumer’s income required by the item, the permanence or temporariness of price change, time period under consideration and the degree of price change.
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