FE - Supply and Demand (Lesson)

Supply and Demand

Introduction

The Push and Pull of the Economy

Supply and demand is a model of economics. It describes how a price is formed in a market economy.

As you go through this lesson, pay close attention to the following:

What is demand and how can it differ from person to person and business to business?
What is the law of demand and why does it make very basic sense?
What is the difference between a demand schedule and demand curve? (be able to put a schedule into a visual diagram)
What is the difference between a change in demand and change in quantity demanded?
What are some reasons demand would change?
How can substitutes and compliments alter demand?
What is elasticity and why is it important to demand?

Why do producers supply things and what factors can change supply?
What is a subsidy and does our government still provide them?

Supply and Demand

There are two determining factors on such a market, the number of things made available, called supply, and the number of things consumers want, called demand. Supply and demand shows how producers and consumers interact with each other. This relationship will fix the price for a certain type of good. In perfect competition, the quantity demanded (demand) and the quantity supplied will be equal. This will fix the price. There will be economic equilibrium.

Let’s first focus on what economists mean by demand, what they mean by supply, and then how demand and supply interact in a market.

Click on each section of the image below to learn more.

The Laws of Supply and Demand

The presentation below will cover the laws of supply and demand.

Let's look closer at the graphs.

Use the tabbed activity below to review supply and demand graphs.

Demand

Take Note - Demand and quantity demanded are NOT the same thing! Demand refers to the curve and quantity demanded refers to the (specific) point on the curve Economists use the term demand to refer to the amount of some good or service consumers are willing and able to purchase at each price. Demand is based on needs and wants—a consumer may be able to differentiate between a need and a want, but from an economist’s perspective they are the same thing. Demand is also based on ability to pay. If you cannot pay for it, you have no effective demand.

What a buyer pays for a unit of the specific good or service is called price. The total number of units purchased at that price is called the quantity demanded. A rise in price of a good or service almost always decreases the quantity demanded of that good or service. Conversely, a fall in price will increase the quantity demanded. When the price of a gallon of gasoline goes up, for example, people look for ways to reduce their consumption by combining several errands, commuting by carpool or mass transit, or taking weekend or vacation trips closer to home. Economists call this inverse relationship between price and quantity demanded the law of demand. The law of demand assumes that all other variables that affect demand are held constant.

Supply

Take Note -Supply and quantity supplied are NOT the same thing! Supply refers to the curve and quantity supplied refers to the (specific) point on the curve When economists talk about supply, they mean the amount of some good or service a producer is willing to supply at each price. Price is what the producer receives for selling one unit of a good or service. A rise in price almost always leads to an increase in the quantity supplied of that good or service, while a fall in price will decrease the quantity supplied. When the price of gasoline rises, for example, it encourages profit-seeking firms to take several actions: expand exploration for oil reserves; drill for more oil; invest in more pipelines and oil tankers to bring the oil to plants where it can be refined into gasoline; build new oil refineries; purchase additional pipelines and trucks to ship the gasoline to gas stations; and open more gas stations or keep existing gas stations open longer hours. Economists call this positive relationship between price and quantity supplied—that a higher price leads to a higher quantity supplied and a lower price leads to a lower quantity supplied—the law of supply. The law of supply assumes that all other variables that affect supply are held constant.

The word equilibrium means "balance." If a market is at its equilibrium price and quantity, then it has no reason to move away from that point. However, if a market is not at equilibrium, then economic pressures arise to move the market toward the equilibrium price and the equilibrium quantity.

Equilibrium

Where Demand and Supply Intersect

Because the graphs for demand and supply curves both have price on the vertical axis and quantity on the horizontal axis, the demand curve and supply curve for a particular good or service can appear on the same graph. Together, demand and supply determine the price and the quantity that will be bought and sold in a market.

Equilibrium is reached in the market when demand equals supply. Surpluses or shortages will result if equilibrium is disturbed and market forces will then lead the market back to equilibrium. Consumer and producer surpluses are generated at the point equilibrium, which implies that the market mechanism is to everyone’s advantage.

Watch the video below to learn more.

When Equilibrium Moves

When prices or quantities change, that can be because the market is moving from disequilibrium to equilibrium.

Typically, though, when prices or quantities change, economists seek an explanation in movements of the demand or supply curves. Economists like to assume that markets are naturally in equilibrium. If they see something change, they figure that supply or demand must have changed.

Demand Curve

This video shows the demand curve moves up and down while the supply curve stays still.

Supply Curve

This next video shows the supply curve moving while the demand curve holds still.

Equilibrium

If you raise demand, you can move the equilibrium quantity out to the "needed" level.

Review

Review what you have learned by completing the activity below.

In Summary . . .

What's Your takeaway? Icon A demand schedule is a table that shows the quantity demanded at different prices in the market. A demand curve shows the relationship between quantity demanded and price in a given market on a graph. The law of demand states that a higher price typically leads to a lower quantity demanded.

A supply schedule is a table that shows the quantity supplied at different prices in the market. A supply curve shows the relationship between quantity supplied and price on a graph. The law of supply says that a higher price typically leads to a higher quantity supplied.

The equilibrium price and equilibrium quantity occur where the supply and demand curves cross. The equilibrium occurs where the quantity demanded is equal to the quantity supplied. If the price is below the equilibrium level, then the quantity demanded will exceed the quantity supplied. Excess demand or a shortage will exist. If the price is above the equilibrium level, then the quantity supplied will exceed the quantity demanded. Excess supply or a surplus will exist. In either case, economic pressures will push the price toward the equilibrium level.

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