In microeconomics, supply and demand is an economic model of pricedetermination in a market. It concludes that in a competitive market, theunit price for a particular good will vary until it settles at a point wherethe quantity demanded by consumers (at current price) will equal thequantity supplied by producers (at current price), resulting in aneconomic equilibrium for price and quantity.The four basic laws of supply and demand are:1.If demand increases and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price.2.If demand decreases and supply remains unchanged, a surplus occurs, leading to a lower equilibrium price.3.If demand remains unchanged and supply increases, a surplus occurs, leading to a lower equilibrium price.4.If demand remains unchanged and supply decreases, a shortage occurs, leading to a higher equilibrium price. Contents [hide] 1 Graphical representation of supply and demand 1.1 Supply schedule 1.2 Demand schedule 2 Microeconomics 2.1 Equilibrium 2.2 Partial equilibrium 3 Other markets 4 Empirical estimation 5 Macroeconomic uses of demand and supply 6 History 7 Criticisms 8 See also 9 References 10 External linksGraphical representation of supply and demandAlthough it is normal to regard the quantity demanded and the
quantity supplied as functions of the price of the good, the standardgraphical representation, usually attributed to Alfred Marshall, has priceon the vertical axis and quantity on the horizontal axis, the opposite ofthe standard convention for the representation of a mathematicalfunction.Since determinants of supply and demand other than the price of thegood in question are not explicitly represented in the supply-demanddiagram, changes in the values of these variables are represented bymoving the supply and demand curves (often described as "shifts" inthe curves). By contrast, responses to changes in the price of the goodare represented as movements along unchanged supply and demandcurves.Supply scheduleA supply schedule is a table that shows the relationship between theprice of a good and the quantity supplied. A supply curve is a graph thatillustrates that relationship between the price of a good and the quantitysupplied .Under the assumption of perfect competition, supply is determined bymarginal cost. Firms will produce additional output while the cost ofproducing an extra unit of output is less than the price they wouldreceive.By its very nature, conceptualizing a supply curve requires the firm to bea perfect competitor, namely requires the firm to have no influence overthe market price. This is true because each point on the supply curve isthe answer to the question "If this firm is faced with this potential price,how much output will it be able to and willing to sell?" If a firm hasmarket power, its decision of how much output to provide to the marketinfluences the market price, then the firm is not "faced with" any price,and the question is meaningless.Economists distinguish between the supply curve of an individual firmand between the market supply curve. The market supply curve isobtained by summing the quantities supplied by all suppliers at eachpotential price. Thus, in the graph of the supply curve, individual firms
supply curves are added horizontally to obtain the market supply curve.Economists also distinguish the short-run market supply curve from thelong-run market supply curve. In this context, two things are assumedconstant by definition of the short run: the availability of one or morefixed inputs (typically physical capital), and the number of firms in theindustry. In the long run, firms have a chance to adjust their holdings ofphysical capital, enabling them to better adjust their quantity supplied atany given price. Furthermore, in the long run potential competitors canenter or exit the industry in response to market conditions. For both ofthese reasons, long-run market supply curves are flatter than theirshort-run counterparts.The determinants of supply are:1.Production costs, how much a good costs to be produced2.The technology used in production, and/or technological advances3.Firms expectations about future prices4.Number of suppliersDemand scheduleA demand schedule, depicted graphically as the demand curve,represents the amount of some good that buyers are willing and able topurchase at various prices, assuming all determinants of demand otherthan the price of the good in question, such as income, tastes andpreferences, the price of substitute goods, and the price ofcomplementary goods, remain the same. Following the law of demand,the demand curve is almost always represented as downward-sloping,meaning that as price decreases, consumers will buy more of thegood.Just like the supply curves reflect marginal cost curves, demand curvesare determined by marginal utility curves. Consumers will be willing tobuy a given quantity of a good, at a given price, if the marginal utility ofadditional consumption is equal to the opportunity cost determined bythe price, that is, the marginal utility of alternative consumption choices.The demand schedule is defined as the willingness and ability of aconsumer to purchase a given product in a given frame of time.
It is aforementioned, that the demand curve is generally downward-sloping, there may be rare examples of goods that have upward-slopingdemand curves. Two different hypothetical types of goods with upward-sloping demand curves are Giffen goods (an inferior but staple good)and Veblen goods (goods made more fashionable by a higher price).By its very nature, conceptualizing a demand curve requires that thepurchaser be a perfect competitor—that is, that the purchaser has noinfluence over the market price. This is true because each point on thedemand curve is the answer to the question "If this buyer is faced withthis potential price, how much of the product will it purchase?" If a buyerhas market power, so its decision of how much to buy influences themarket price, then the buyer is not "faced with" any price, and thequestion is meaningless.Like with supply curves, economists distinguish between the demandcurve of an individual and the market demand curve. The marketdemand curve is obtained by summing the quantities demanded by allconsumers at each potential price. Thus, in the graph of the demandcurve, individuals demand curves are added horizontally to obtain themarket demand curve.The determinants of demand are:1.Income2.Tastes and preferences3.Prices of related goods and services4.Consumers expectations about future prices and incomes that can be checked5.Number of potential consumersMicroeconomicsEquilibriumEquilibrium is defined to be the price-quantity pair where the quantitydemanded is equal to the quantity supplied, represented by theintersection of the demand and supply curves.
Market Equilibrium: A situation in a market when the price is such thatthe quantity that consumers demand is correctly balanced by thequantity that firms wish to supply.Comparative static analysis: Examines the likely effect on theequilibrium of a change in the external conditions affecting the market.Changes in market equilibrium: Practical uses of supply and demandanalysis often center on the different variables that change equilibriumprice and quantity, represented as shifts in the respective curves.Comparative statics of such a shift traces the effects from the initialequilibrium to the new equilibrium.Demand curve shifts:Main article: Demand curveWhen consumers increase the quantity demanded at a given price, it isreferred to as an increase in demand. Increased demand can berepresented on the graph as the curve being shifted to the right. At eachprice point, a greater quantity is demanded, as from the initial curve D1to the new curve D2. In the diagram, this raises the equilibrium pricefrom P1 to the higher P2. This raises the equilibrium quantity from Q1 tothe higher Q2. A movement along the curve is described as a "changein the quantity demanded" to distinguish it from a "change in demand,"that is, a shift of the curve. there has been an increase in demand whichhas caused an increase in (equilibrium) quantity. The increase indemand could also come from changing tastes and fashions, incomes,price changes in complementary and substitute goods, marketexpectations, and number of buyers. This would cause the entiredemand curve to shift changing the equilibrium price and quantity. Notein the diagram that the shift of the demand curve, by causing a newequilibrium price to emerge, resulted in movement along the supplycurve from the point (Q1, P1) to the point Q2, P2).If the demand decreases, then the opposite happens: a shift of thecurve to the left. If the demand starts at D2, and decreases to D1, theequilibrium price will decrease, and the equilibrium quantity will alsodecrease. The quantity supplied at each price is the same as before thedemand shift, reflecting the fact that the supply curve has not shifted;but the equilibrium quantity and price are different as a result of the
change (shift) in demand.The movement of the demand curve in response to a change in a non-price determinant of demand is caused by a change in the x-intercept,the constant term of the demand equation.Supply curve shifts:Main article: Supply (economics)When technological progress occurs, the supply curve shifts. Forexample, assume that someone invents a better way of growing wheatso that the cost of growing a given quantity of wheat decreases.Otherwise stated, producers will be willing to supply more wheat atevery price and this shifts the supply curve S1 outward, to S2—anincrease in supply. This increase in supply causes the equilibrium priceto decrease from P1 to P2. The equilibrium quantity increases from Q1to Q2 as consumers move along the demand curve to the new lowerprice. As a result of a supply curve shift, the price and the quantity movein opposite directions.If the quantity supplied decreases, the opposite happens. If the supplycurve starts at S2, and shifts leftward to S1, the equilibrium price willincrease and the equilibrium quantity will decrease as consumers movealong the demand curve to the new higher price and associated lowerquantity demanded. The quantity demanded at each price is the sameas before the supply shift, reflecting the fact that the demand curve hasnot shifted. But due to the change (shift) in supply, the equilibriumquantity and price have changed.The movement of the supply curve in response to a change in a non-price determinant of supply is caused by a change in the y-intercept, theconstant term of the supply equation. The supply curve shifts up anddown the y axis as non-price determinants of demand change.
Economics Basics: Supply and DemandFiled Under » Alfred Marshall, Macroeconomics,Microeconomics, Monetary PolicySupply and demand is perhaps one of the most fundamentalconcepts of economics and it is the backbone of a marketeconomy. Demand refers to how much (quantity) of a productor service is desired by buyers. The quantity demanded is theamount of a product people are willing to buy at a certainprice; the relationship between price and quantity demandedis known as the demand relationship. Supply represents howmuch the market can offer. The quantity supplied refers to theamount of a certain good producers are willing to supply whenreceiving a certain price. The correlation between price andhow much of a good or service is supplied to the market isknown as the supply relationship. Price, therefore, is areflection of supply and demand.The relationship between demand and supply underlie theforces behind the allocation of resources. In market economytheories, demand and supply theory will allocate resources inthe most efficient way possible. How? Let us take a closer lookat the law of demand and the law of supply.A. The Law of DemandThe law of demand states that, if all other factors remainequal, the higher the price of a good, the less people willdemand that good. In other words, the higher the price, thelower the quantity demanded. The amount of a good thatbuyers purchase at a higher price is less because as the priceof a good goes up, so does the opportunity cost of buying thatgood. As a result, people will naturally avoid buying a productthat will force them to forgo the consumption of somethingelse they value more. The chart below shows that the curve isa downward slope.
A, B and C are points on the demand curve. Each point on thecurve reflects a direct correlation between quantity demanded(Q) and price (P). So, at point A, the quantity demanded willbe Q1 and the price will be P1, and so on. The demandrelationship curve illustrates the negative relationship betweenprice and quantity demanded. The higher the price of a goodthe lower the quantity demanded (A), and the lower the price,the more the good will be in demand (C).B. The Law of SupplyLike the law of demand, the law of supply demonstrates thequantities that will be sold at a certain price. But unlike thelaw of demand, the supply relationship shows an upwardslope. This means that the higher the price, the higher thequantity supplied. Producers supply more at a higher pricebecause selling a higher quantity at a higher price increasesrevenue.
A, B and C are points on the supply curve. Each point on thecurve reflects a direct correlation between quantity supplied(Q) and price (P). At point B, the quantity supplied will be Q2and the price will be P2, and so on. (To learn how economicfactors are used in currency trading, read Forex Walkthrough:Economics.)Time and SupplyUnlike the demand relationship, however, the supplyrelationship is a factor of time. Time is important to supplybecause suppliers must, but cannot always, react quickly to achange in demand or price. So it is important to try anddetermine whether a price change that is caused by demandwill be temporary or permanent.Lets say theres a sudden increase in the demand and pricefor umbrellas in an unexpected rainy season; suppliers maysimply accommodate demand by using their productionequipment more intensively. If, however, there is a climatechange, and the population will need umbrellas year-round,the change in demand and price will be expected to be longterm; suppliers will have to change their equipment and
production facilities in order to meet the long-term levels ofdemand.C. Supply and Demand RelationshipNow that we know the laws of supply and demand, lets turnto an example to show how supply and demand affect price.Imagine that a special edition CD of your favorite band isreleased for $20. Because the record companys previousanalysis showed that consumers will not demand CDs at aprice higher than $20, only ten CDs were released because theopportunity cost is too high for suppliers to produce more. If,however, the ten CDs are demanded by 20 people, the pricewill subsequently rise because, according to the demandrelationship, as demand increases, so does the price.Consequently, the rise in price should prompt more CDs to besupplied as the supply relationship shows that the higher theprice, the higher the quantity supplied.If, however, there are 30 CDs produced and demand is still at20, the price will not be pushed up because the supply morethan accommodates demand. In fact after the 20 consumershave been satisfied with their CD purchases, the price of theleftover CDs may drop as CD producers attempt to sell theremaining ten CDs. The lower price will then make the CDmore available to people who had previously decided that theopportunity cost of buying the CD at $20 was too high.D. EquilibriumWhen supply and demand are equal (i.e. when the supplyfunction and demand function intersect) the economy is saidto be at equilibrium. At this point, the allocation of goods is atits most efficient because the amount of goods being suppliedis exactly the same as the amount of goods being demanded.Thus, everyone (individuals, firms, or countries) is satisfiedwith the current economic condition. At the given price,
suppliers are selling all the goods that they have produced andconsumers are getting all the goods that they are demanding.As you can see on the chart, equilibrium occurs at theintersection of the demand and supply curve, which indicatesno allocative inefficiency. At this point, the price of the goodswill be P* and the quantity will be Q*. These figures arereferred to as equilibrium price and quantity.In the real market place equilibrium can only ever be reachedin theory, so the prices of goods and services are constantlychanging in relation to fluctuations in demand and supply.E. DisequilibriumDisequilibrium occurs whenever the price or quantity is notequal to P* or Q*.1. Excess SupplyIf the price is set too high, excess supply will be created withinthe economy and there will be allocative inefficiency.
At price P1 the quantity of goods that the producers wish tosupply is indicated by Q2. At P1, however, the quantity thatthe consumers want to consume is at Q1, a quantity much lessthan Q2. Because Q2 is greater than Q1, too much is beingproduced and too little is being consumed. The suppliers aretrying to produce more goods, which they hope to sell toincrease profits, but those consuming the goods will find theproduct less attractive and purchase less because the price istoo high.2. Excess DemandExcess demand is created when price is set below theequilibrium price. Because the price is so low, too manyconsumers want the good while producers are not makingenough of it.In this situation, at price P1, the quantity of goods demandedby consumers at this price is Q2. Conversely, the quantity ofgoods that producers are willing to produce at this price is Q1.Thus, there are too few goods being produced to satisfy thewants (demand) of the consumers. However, as consumershave to compete with one other to buy the good at this price,the demand will push the price up, making suppliers want tosupply more and bringing the price closer to its equilibrium.F. Shifts vs. MovementFor economics, the "movements" and "shifts" in relation to the
supply and demand curves represent very different marketphenomena:1. MovementsA movement refers to a change along a curve. On the demandcurve, a movement denotes a change in both price andquantity demanded from one point to another on the curve.The movement implies that the demand relationship remainsconsistent. Therefore, a movement along the demand curvewill occur when the price of the good changes and the quantitydemanded changes in accordance to the original demandrelationship. In other words, a movement occurs when achange in the quantity demanded is caused only by a changein price, and vice versa.Like a movement along the demand curve, a movement alongthe supply curve means that the supply relationship remainsconsistent. Therefore, a movement along the supply curve willoccur when the price of the good changes and the quantitysupplied changes in accordance to the original supplyrelationship. In other words, a movement occurs when achange in quantity supplied is caused only by a change inprice, and vice versa.
2. ShiftsA shift in a demand or supply curve occurs when a goodsquantity demanded or supplied changes even though priceremains the same. For instance, if the price for a bottle of beerwas $2 and the quantity of beer demanded increased from Q1to Q2, then there would be a shift in the demand for beer.Shifts in the demand curve imply that the original demandrelationship has changed, meaning that quantity demand isaffected by a factor other than price. A shift in the demandrelationship would occur if, for instance, beer suddenly becamethe only type of alcohol available for consumption.Conversely, if the price for a bottle of beer was $2 and thequantity supplied decreased from Q1 to Q2, then there wouldbe a shift in the supply of beer. Like a shift in the demandcurve, a shift in the supply curve implies that the originalsupply curve has changed, meaning that the quantity suppliedis effected by a factor other than price. A shift in the supplycurve would occur if, for instance, a natural disaster caused a
mass shortage of hops; beer manufacturers would be forced tosupply less beer for the same price.