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How to Calculate Market Price Using Supply and Demand

Original post by Cindy Quarters of Demand Media

Basing market price on supply and demand is a formula for success.

Calculating market price is an important process that helps a company identify the best possible price for its products. By basing pricing decisions on the principles of supply and demand, a business will be able to sell what it produces and avoid inventory buildup. Determining the best price to charge and the correct quantity to produce requires an understanding of current market trends and the ability to project future trends. An analysis of supply and demand can help the company accurately gauge the future market for its goods and services.

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Supply

The term “supply” refers to the number of producers that will supply a particular product or service at a given price. Typically, the number of producers increases as the price of an item increases. For example, if the price of a widget is $0, the number of suppliers will be zero because no firm can survive by providing a product or a service free of charge. As the price increases to $10, the number of suppliers increases to 10 (in this example), which means 10 producers are willing to create widgets for $10 each. When graphed, the supply line starts at the 0,0 point of the axis and rises to the 10,10 point.

Demand

The term “demand” indicates how many buyers exist for a given product or service at a particular price. Generally, when the price is high, demand is low, but as the price drops, demand increases. As an example, when the price of widgets is $10 each, there are no buyers for them, but if the price drops to $8 each, the demand rises to four units, and if the price is lowered to $2, the demand jumps to 16 widgets. When graphed, the demand line starts high on the price axis, at the location 0,10 but slopes down through the points of 4,8 and ends at 16, 2 in this example. This downward-sloping line represents consumer demand for widgets at various prices.

Market Price

The appropriate market price for an item based on supply and demand can be determined by figuring out at what point the supply is equal to the demand. The basic way to calculate this is to use a graph with both the supply and demand lines on it. The point at which the two lines intersect is the optimal market price and quantity. In the widget example, the supply and demand lines cross at 6.67 units that cost $6.67 each, so 6.67 is the optimal quantity of widgets to produce at $6.67 each.

Considerations

When graphing supply and demand numbers, the resulting lines on the graph are not necessarily straight. They may curve or rise and fall, depending on the actual numbers involved. In some scenarios, the optimal numbers for supply and demand may be represented by a range rather than a single point. Additionally, graphs may contain multiple lines corresponding to various market conditions, but in all cases, the point at which the supply and demand lines cross represents the optimal quantities and price for a given item.


                   

References

About the Author

Cindy Quarters has been writing professionally since 1984, creating both user manuals and training documentation. She also writes travel, pet and gardening articles, with work published in "Radiance Magazine" and the "AKC Gazette." Quarters earned a Bachelor of Arts in English from Washington State University, as well as a master's degree in management information systems from West Coast University.

Photo Credits

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