Basic Elements of Supply and Demand

1. The analysis of supply and demand shows how a market mechanism solves the three problems of what,how, and for whom. A market blends together demands and supplies. Demand comes from consumers who are spreading their dollar votes among available goods and services, while businesses supply the goods and services with the goal of maximizing their profits.

A. The Demand Schedule

2. A demand schedule shows the relationship between the quantity demanded and the price of a commodity, other things held constant. Such a demand schedule, depicted graphically by a demand curve, holds constant other things like family incomes, tastes, and the prices of other goods. Almost all commodities obey the law of downward-sloping demand, which holds that quantity demanded falls as a good’s price rises. This law is represented by a downward-sloping demand curve.

3. Many influences lie behind the demand schedule for the market as a whole: average family incomes, population, the prices of related goods, tastes, and special influences. When these influences change, the demand curve will shift.

B. The Supply Schedule

4. The supply schedule (or supply curve) gives the relationship between the quantity of a good that producers desire to sell–other things constant–and that good’s price. Quantity supplied generally responds positively to price, so the supply curve is upward-sloping.

5. Elements other than the good’s price affect its supply. The most important influence is the commodity’s production cost, determined by the state of technology and by input prices. Other elements in supply include the prices of related goods, government policies, and special influences.

C. Equilibrium of Supply and Demand

6. The equilibrium of supply and demand in a competitive market occurs when the forces of supply and demand are in balance. The equilibrium price is the price at which the quantity demanded just equals the quantity supplied. Graphically, we find the equilibrium at the intersection of the supply and demand curves. At a price above the equilibrium, producers want to supply more than consumers want to buy, which results in a surplus of goods and exerts downward pressure on price. Similarly, too low a price generates a shortage, and buyers will therefore tend to bid price upward to the equilibrium.

7. Shifts in the supply and demand curves change the equilibrium price and quantity. An increase in demand, which shifts the demand curve to the right, will increase both equilibrium price and quantity. An increase in supply, which shifts the supply curve to the right, will decrease price and increase quantity demanded.

8. To use supply-and-demand analysis correctly, we must (a) distinguish a change in demand or supply (which produces a shift of a curve) from a change in the quantity demanded or supplied (which represents a movement along a curve); (b) hold other things constant, which requires distinguishing the impact of a change in a commodity’s price from the impact of changes in other influences; and (c) look always for the supply-and-demand equilibrium, which comes at the point where forces acting on price and quantity are in balance.

9. Competitively determined prices ration the limited supply of goods among those who demand them.