Supply and Demand
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The Law of Demand
The law of demand states that, all else being equal, as the price of a good increases, the quantity demanded decreases, and vice versa. This inverse relationship between price and quantity demanded is a fundamental principle of economics.
Definition: Demand
Demand refers to consumers' willingness and ability to purchase a good or service at various prices. A demand curve shows this relationship graphically, sloping downward from left to right.
The Law of Supply
The law of supply states that, all else being equal, as the price of a good increases, the quantity supplied increases, and vice versa. Producers are willing to supply more when they can earn higher prices.
Definition: Supply
Supply refers to producers' willingness and ability to offer a good or service at various prices. A supply curve slopes upward from left to right.
Market Equilibrium
Where the supply and demand curves intersect is called the equilibrium point. At this price, the quantity supplied equals the quantity demanded - there is no surplus or shortage.
Key Concept: Shifts vs. Movements
Movement along a curve: Caused by a change in price (moving from one point to another on the same curve)
Shift of the curve: Caused by non-price factors (the entire curve moves left or right)
Factors That Shift Demand
- Income: Higher income typically increases demand for normal goods
- Tastes and preferences: Changing trends affect demand
- Price of related goods: Substitutes and complements affect demand
- Expectations: Expected future prices or income changes
- Number of buyers: More buyers increases total market demand
Factors That Shift Supply
- Input costs: Higher costs reduce supply
- Technology: Better technology increases supply
- Number of sellers: More sellers increases supply
- Government policies: Taxes reduce supply; subsidies increase it
- Expectations: Expected future prices affect current supply
Examples
Example 1: Gasoline Prices
Scenario: A hurricane disrupts oil production in the Gulf of Mexico.
Analysis: This is a supply shock - the supply curve shifts left (decreases). With demand unchanged, the new equilibrium has a higher price and lower quantity. Consumers pay more for gas, and total consumption falls.
Example 2: Smartphone Market
Scenario: A new viral app makes a particular smartphone model extremely popular.
Analysis: This increases demand - the demand curve shifts right. With supply unchanged initially, price rises. Over time, producers may increase supply, eventually stabilizing at a new equilibrium.
Example 3: Calculating Equilibrium
Given:
- Demand: Qd = 100 - 2P
- Supply: Qs = 20 + 3P
Solution:
At equilibrium, Qd = Qs:
100 - 2P = 20 + 3P
80 = 5P
P = 16
Q = 100 - 2(16) = 68
Equilibrium: Price = $16, Quantity = 68 units
Practice
Solve these problems. Answers are provided below for self-checking.
1. What happens to the equilibrium price and quantity of coffee if the price of tea (a substitute) increases?
2. A new technology makes it cheaper to produce electric vehicles. How does this affect the EV market?
3. If Qd = 50 - P and Qs = 2P - 10, find the equilibrium price and quantity.
4. What is the difference between a change in demand and a change in quantity demanded?
5. The government imposes a tax on producers of sugary drinks. What happens to equilibrium price and quantity?
Click to reveal answers
- Demand for coffee increases (shifts right) as consumers switch from tea. Equilibrium price increases and quantity increases.
- Supply increases (shifts right) due to lower production costs. Equilibrium price decreases and quantity increases.
- Set Qd = Qs: 50 - P = 2P - 10. Solving: 60 = 3P, so P = 20. Q = 50 - 20 = 30. Equilibrium: Price = $20, Quantity = 30.
- Change in quantity demanded: Movement along the demand curve caused by a price change. Change in demand: Shift of the entire demand curve caused by non-price factors (income, tastes, etc.).
- The tax increases producer costs, so supply decreases (shifts left). Equilibrium price increases and quantity decreases. Consumers pay more, and less is sold.
Check Your Understanding
1. Why does the demand curve slope downward?
Show answer
The demand curve slopes downward because of the law of demand: as price increases, quantity demanded decreases. This happens because: (1) higher prices make goods less affordable, (2) consumers substitute cheaper alternatives, and (3) the marginal benefit of additional units decreases.
2. What happens in a market when price is above equilibrium?
Show answer
When price is above equilibrium, quantity supplied exceeds quantity demanded, creating a surplus. Producers have unsold inventory, which puts downward pressure on price. Price will fall toward equilibrium as sellers compete to sell their excess supply.
Next Steps
- Review any concepts that felt challenging
- Move on to the next lesson when ready
- Return to practice problems periodically for review