Demand and Supply Analysis
Demand and supply analysis is the study of how buyers and sellers
interact to determine transaction prices and quantities. As we will see, prices simultaneously reflect both the value to the buyer of the next (or marginal) unit and the
cost to the seller of that unit. In private enterprise market economies, which are the
chief concern of investment analysts, demand and supply analysis encompasses the
most basic set of microeconomic tools.
Traditionally, microeconomics classifies private economic units into two groups:
consumers (or households) and firms. These two groups give rise, respectively, to the
theory of the consumer and theory of the firm as two branches of study. The theory
of the consumer deals with consumption (the demand for goods and services) by
utility-maximizing individuals (i.e., individuals who make decisions that maximize
the satisfaction received from present and future consumption). The theory of the
firm deals with the supply of goods and services by profit-maximizing firms. The
theory of the consumer and the theory of the firm are important because they help
us understand the foundations of demand and supply. Subsequent readings will focus
on the theory of the consumer and the theory of the firm.
Investment analysts, particularly equity and credit analysts, must regularly analyze
products and services, their costs, prices, possible substitutes, and complements, to
reach conclusions about a company’s profitability and business risk (risk relating to
operating profits). Furthermore, unless the analyst has a sound understanding of the
demand and supply model of markets, he or she cannot hope to forecast how external
events—such as a shift in consumer tastes or changes in taxes and subsidies or other
intervention in markets—will influence a firm’s revenue, earnings, and cash flows.
Demand, in economics, is the willingness and ability of consumers to
purchase a given amount of a good or service at a given price. Supply is the willingness
of sellers to offer a given quantity of a good or service for a given price. Later, a study
on the theory of the firm will yield the supply curve.
The demand and supply model is useful in explaining how price and quantity
traded are determined and how external influences affect the values of those variables.
Buyers’ behavior is captured in the demand function and its graphical equivalent,
the demand curve. This curve shows both the highest price buyers are willing to pay for each quantity, and the highest quantity buyers are willing and able to purchase
at each price. Sellers’ behavior is captured in the supply function and its graphical
equivalent, the supply curve. This curve shows simultaneously the lowest price sellers
are willing to accept for each quantity and the highest quantity sellers are willing to
offer at each price.
If, at a given quantity, the highest price that buyers are willing to pay is equal to
the lowest price that sellers are willing to accept, we say the market has reached its
equilibrium quantity. Alternatively, when the quantity that buyers are willing and
able to purchase at a given price is just equal to the quantity that sellers are willing to
offer at that same price, we say the market has discovered the equilibrium price. So
equilibrium price and quantity are achieved simultaneously, and as long as neither
the supply curve nor the demand curve shifts, there is no tendency for either price
or quantity to vary from their equilibrium values.
Demand and Supply Analysis: Introduction
by Richard V. Eastin, PhD, and Gary L. Arbogast, CFA
Richard V. Eastin, PhD, is at the University of Southern California (USA). Gary L.
Arbogast, CFA (USA).
Prof. Amrita Jha
profamritacontent@gmail.com
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