What is the law of supply and demand?
The law of supply and demand can be helpful to explain the relationship between buyers and producers of a good or service. It is also useful once you start investing, as it can help to understand the stock market.
Simply put, the law of supply and demand demonstrates that:
- the amount of a product or service available (supply)
compared with
- how many people are willing to pay for that product or service (demand)
= will determine its price.
For example…
Maybe there is an upcoming trend of people making healthy banana bread, which leads to people buying more and thus, demanding more bananas than usual. The suppliers of bananas will initially have less produce to sell and thus there will be less supply available. Recognising this trend, the suppliers will increase their prices to take advantage of it, since people are willing to pay a higher price for bananas.
Hence, as the demand of bananas increases, supply decreases, and therefore prices increase.
There are exceptions to the theory, such as when the price drops so low that people assume the quality of the product is poor so they don’t buy it. But generally speaking, the principle is assumed in economics.
How does it relate to investing?
There are two main ways the law of supply and demand affect investing.
- On the business/company level — if goods or services are sold that are popular, meaning there is high demand, the company is likely to increase their profit. When a company’s profit increases, and the company’s worth is greater and your investment value is also likely to go up. And vice versa.
- On the investment level — the same law applies directly to the prices of stocks and trading. So if one company becomes popular and the demand for their stock increases, the prices will likely rise too. And vice versa.
In this way, we also see the power that investors have to affect the value of companies — for example, if you want to support a company that aligns with your sustainability values. By investing your money in these companies, you are helping them grow their business, whilst making money in the process.
Kate Harris is a copywriter at MakeImpact, a Nordic Impact Fintech that helps individuals make sustainable investment decisions through their values.
