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Supply and demand curves are graphs used in economics and business theory to explain how optimal prices are reached and how consumers behave. These curves, and the relationship between supply and demand that is expressed within them, are often used as a justification for supporting the free market system. The curves attempt to graph the behavior that people exhibit when buying and selling a product in order to illustrate how a change in price can affect the market.
Understanding supply and demand curves involves understanding how and why the curves are drawn and what the curves represent. The supply line on the curve represents the availability of a given type of product. The demand line on the curve represents the overall number of potential buyers for the product, or the demand for the product.
Assume for example that a computer is produced. If the computer cost $1 US Dollar (USD), then essentially almost everyone with $1 USD would want the computer because the price was so low. Demand for the product would thus be very high. On the other hand, assume a computer was produced that cost $1,000,000 USD. Because the vast majority of people who wanted the computer would be unable to afford it, the demand would be very low.
The supply and demand curves chart this relationship, showing how supply can affect demand. As a product becomes less and less expensive, eventually the demand for it will rise. When the demand rises, the price of the product will in turn go up and demand will thus fall.
Therefore, on all supply and demand curves, an optimal point is eventually reached. That point is reached when the supply equals the demand and when making a change would create a less than optimal environment. Advocates of a free market system who believe that people behave rationally argue that the market will set a fair price for goods at the point where the supply and demand curves meet at the most optimal level.
If a product is priced too low, people who don't really have a need for the product are likely to buy it. Although this may result in more sales for the manufacturer, this would not necessarily be a good thing since the system would be inefficient in the sense that people would be buying a product they did not need. Likewise, the manufacturer would not be making as much money as he could because he could potentially charge a higher price.
If the product is priced too high, those who really want the product will be unable to purchase it. The manufacturer will thus be losing out on money in that situation as well. As a result, the manufacturer of a product will price it at the level where his profit is maximized.