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Back to Basics: Supply & Demand

March 4, 2024
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Dont let the economists fool you. It is so simple, but so effective

I often get asked what is going to move a share price: 10/10 times my answer is Supply and Demand. We tend to ignore the most basic principles, yet they are the most powerful. The Supply and Demand principles are very basic, but it is critical to understand price movements.
 

Get a cup of coffee, relax and read this. It is simple, but critical in your journey to fully understanding price.

 

What is supply?

Supply is how much of a good or service producers are willing to provide to the market at a given price.

  • The lower the price, the lower the quantity supplied
  • The higher the price, the higher the quantity supplied

 

Factors that affect supply include:

  • Cost of production (e.g., wages and utilities)
  • Efficiency of production (e.g., thanks to better technology)
  • Price of inputs (e.g., for shoes, the cost of leather)
  • Number of producers (the more producers, the more supply)
  • Taxes, subsidies and regulation
  • Weather (e.g., great weather could mean a bumper crop)
  • Expectations of future prices (e.g., if suppliers think theyll get a better price in the future, theyll hold off producing until later).

 

What is demand?

Demand is how much of a good or service buyers are willing to purchase on the market at a given price.

  • The lower the price, the higher the quantity demanded
  • The higher the price, the lower the quantity demanded

 

Factors that affect demand include:

  • Income of buyers (the higher a buyers income, the more products she tends to demand)
  • Population of buyers (e.g., demand for lottery tickets would theoretically increase if a lot of people turned 18 one year)
  • Consumer tastes and preferences (e.g., one season skinny jeans are in next year, its wide-leg pants)
  • Prices of related goods
  • Expectations of future prices (e.g., if a customer expects petrol to be cheaper tomorrow, they wont fill up today)

 

How is price determined?

The optimal, or equilibrium, price is the price at which both buyers and sellers are happy.

 

If the price is too high, supply will be higher than demand. Suppliers think, We can make money! and produce a lot buyers think, Thats too expensive and dont buy. There will be market imbalance.

 

If the price is too low, demand will be higher than supply. Suppliers think, I cant make money at that price! and produce less buyers think, Sweet! A great deal, and want to buy more than whats been supplied. Again, there will be market imbalance.

 

Cool. So, what does this have to do with buying stocks Soul?

Stock prices are based on a combination of supply and demand factors, but theyre primarily demand-driven. The main reason stock supply increases (or decreases) is when a company issues more shares (or buys shares back).

 

Demand for a stock might increase (or decrease) if:

  • A company has a good (or bad) quarter
  • Economic conditions have improved (or deteriorated)
  • The company hires a better (or worse) CEO or management team or
  • Competitors stocks/companies are doing comparatively worse (or better)

 

Generally, when demand increases, prices rise when demand decreases, prices fall.

 

If you can spot what is going to change the demand for a share, I guarantee, you will know what the share price is going to do. Just start practicing slowly.


 


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