MIC - Supply and Demand Lesson

Law of Demand

As a consumer, you want to get the best possible quality at the lowest possible price. Price and quantity move in opposite directions, an inverse relationship. The quantity demanded goes up as the price goes down. When identifying the law of demand, pay attention to two things: the relationship (inverse or different) and the phrase quantity demanded.

When price goes down, quantity demanded goes up

When price goes up, quantity demanded goes down

Law of Supply

Producers, in their ideal world, want to supply a lot of goods and services when the price is high and make profits. Examine the supply schedule and supply curve below to see how the concept works. Note that supply is a direct relationship. When the price of a good is high, more is supplied. When identifying the law of demand, pay attention to two things: the relationship (direct or the same) and the phrase quantity supplied.

When price goes down, quantity supplied goes down

When price goes up, quantity supplied goes up

Equilibrium

Above you see a supply and demand graph. Here are a few things to pay attention to on the graph. Equilibrium is the point at which quantity demanded and quantity supplied are equal; in other words, it is where supply and demand meet. Note that price is on the y-axis and quantity is on the x-axis. Px represents the equilibrium price; Qx represents the equilibrium quantity. Demand is always the curve that looks like it is sloping down; supply always looks like it is sloping up (sup or supply up).

Disequilibrium

Look at the graph above. Sometimes the price is not at equilibrium, where quantity supplied and quantity demanded are equal. You find quantity demanded (QD) by finding the quantity at which a price meets the demand curve. Quantity supplied (QS) is located wherever a price hits the supply curve. If the price is too high, producers will supply more of a good than consumers want to buy. Thus, high prices lead to surpluses. If a seller wants to fix a surplus, they simply have to lower the price of the goods. Sometimes, the government creates a surplus by setting a minimum price on a good or service; this price is known as a price floor. Notice the price floor has to be set ABOVE equilibrium.

Look at the graph above. If the price is too low, consumers will demand more of the good than producers are willing to supply. Thus, low prices lead to shortages. Remember shortages are different than scarcity because shortages are temporary; if a seller wants to solve a shortage, they simply need to raise the price of the good. Sometimes, the government creates a shortage by setting a maximum price on a good or service; this price is known as a price ceiling. Notice the price ceiling has to be set BELOW equilibrium.

Identifying Equilibrium Practice

Changes to Equilibrium

Often, a condition in the market for a good or service will change. This change will affect supply or demand. As the supply or demand curve shifts, the market reaches a new equilibrium point, which means equilibrium price and equilibrium quantity will change. Some of the determinants that can affect demand are number of consumers (population), tastes and preferences (popularity), the price of related goods (substitutes and complements), and changes in income. Supply can be affected by number of sellers, technology, the price and/or availability of resources (inputs), and government regulations, taxes, or subsidies.

It's not as hard to figure out what is happening when supply or demand shifts as you might think. Simply pay attention to the arrows and the letters. A right arrow always indicates an increase. A left arrow always indicates a decrease. If there are two S’s, supply had to have changed. If there are two D’s, demand is the curve that shifted. Look at the graph below. What curve shifted? Did it increase or decrease?

If you said demand decreased, you are correct! Two D’s show us the demand curve shifted. The arrow points left, and any left arrow indicates a decrease. The last observation you need to take from a supply and demand graph is how the shift affected equilibrium price and equilibrium quantity.

Look at each graph above:

• In graph 1, supply is increasing (two S’s and a right arrow). Pay attention to the x and y-axes to determine what happens to equilibrium price and quantity. The down arrow on the y-axis shows us equilibrium price decreases as supply increases, while the right arrow on the x-axis shows us equilibrium quantity increases when supply increases. Try to identify what happens to equilibrium price and quantity on graphs 2-4 before reading further.
• Graph 2: A decrease in supply (two S’s and a left arrow) leads equilibrium price to increase (up arrow) and equilibrium quantity to decrease (left arrow).
• Graph 3: An increase in demand (two D’s and a right arrow) leads equilibrium price to increase (up arrow) and equilibrium quantity to increase (right arrow).
• Graph 4: A decrease in demand (two D’s and a left arrow) leads equilibrium price to decrease (down arrow) and equilibrium quantity to decrease (left arrow).

Shifting Supply and Demand Practice

Supply and Demand Vocabulary Practice

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