Dashboard For Cost of Construction Projects Course

Laws of Supply and Demand 

Law of Demand 

The external drivers of demand for a product or service start with the laws of supply and demand. The law of demand states that there is an inverse relationship between price and the quantity of a good or service demanded. This law relates to relative prices: 

What is considered an increase or decrease is measured only relative to the prices of substitute goods or services (e.g., a competitor’s offering). A price that stays the same is effectively a price increase if all competitors’ drop their prices. Two other forces reinforce this law: 

● Diminishing marginal utility—Each additional unit purchased has less  utility than the last. 

● The income effect—Lower prices enable people with limited funds to buy more units. More broadly, demand can be determined by the following forces: 

● Consumer preferences 

● Number of potential buyers in the market 

● Income levels of consumers 

● Prices of substitute goods 

● Prices of complementary goods (goods demanded together) 

● Consumer expectations Law of Supply The law of supply states that as the price rises, more quantity will be supplied and, as it falls, less quantity will be supplied. In other words, higher prices result in more incentive to produce products and services while lower prices reduce profit margins and prevent producers from profitably producing more supply. 

Organizations will produce goods or services only while the marginal benefit exceeds the marginal cost. In addition to cost, other determinants of supply include: 

● Number of competitors in the market 

● Prices for necessary raw materials and resources 

● Technology 

● Subsidies and taxes 

● Prices of production substitutes (other things a supplier could alternately produce without major rework) 

● Producer expectations (e.g., anticipated resource costs) Equilibrium Together, the forces of supply and demand tend toward an equilibrium price and an equilibrium quantity. Exhibit I.A.7-1 shows how the laws of supply and demand interact until a point at which the intentions of buyers and sellers reach equilibrium. In the chart, this occurs at 32,000 units, a price of $12 per unit, and only at that point will there be neither a surplus nor a shortage. 

Competitive forces drive prices to this point, and only disruptive forces to supply and/or demand will cause it to shift from this point. If one of the curves increases or decreases, for example, if there is increased overall demand due to a technology innovation, then that curve can shift up as a whole and there will be a new equilibrium price and quantity (a new point at which the curves intersect). In another example, product obsolescence will lower the demand curve and thus the equilibrium price. The forces that bring supply and demand into balance are observed so reliably that this equilibrium also has become a law of economics. The law of supply and demand states that the price of any good will adjust until the quantity supplied and quantity demanded are in balance. If there is a surplus, suppliers are motivated to cut prices to increase sales. If there is a shortage, suppliers are motivated to increase prices because of the scarcity of their offering. However, this process occurs faster with some types of goods than with others. Exhibit I.A.7-1 also shows the inputs, calculations, and outputs of the model. This model studies the impact of changing prices for a product on the demand curve just shown. 

Exhibit I.A.7-1 – Pricing Impact Model