The Law of Demand

Law of demand and how its applied to fundamental analysis in commodities rests upon an understanding of the economics of consumer behavior. The factors, which drive consumer choices, and how these individuals respond in the marketplace, are key components of this economic theory. Understanding which factors have affected demand in the past can help develop expectations about future demand and its impact on market price.

Demand represents how much people are willing to purchase at various prices. Thus, demand is a relationship between price and quantity, with all other factors remaining constant. The following chart illustrates Demand as a downward curve with price ascending upward on the vertical axis and quantity increasing on the horizontal.

The relationship between price and supply is generally negative. Meaning that the higher the price climbs, the lower amount of the supply is demanded. Conversely, the lower the price, the greater the supply is demanded. Market demand is the total demand sum of the marketplace. Market demand is affected by other economic variables in addition to price, such as various brokerage services including handling, packaging, location, delivery, and financing. Demand for an agricultural commodity is typically derived from the demand for a finished product. In other words, the demand for coffee beans might be strongly influenced by the demand for coffee-based beverages sold by retailers such as Starbucks.

It's important to understand that consumers, not producers, drive market economics. Market value for any good or service is determined by its value to the consumer. Increasing demand leads to higher prices. Higher pricing mean more profits, and more profits provide companies with incentives and the means to production more of those particular products and services that consumer's value. Profit driven expansion is the market's response to stronger buyer demand. On the other hand, when consumers are unwilling to buy what is offered at the current price, the seller will have to lower the price ultimately resulting in fewer profits. Losses reduce incentives to produce things for which demand is weak, which ultimately force production cuts as producers lose money.

This is the discipline of the marketplace. Those who produce things that consumers are willing and able to buy are rewarded. Those who produce things that consumers don't want or can't buy are penalized. Suppliers must produce for the markets. They cannot expect to find or create a profitable market for whatever they choose to produce.

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