Supply and Demand

According to the Law of Demand, as the price of a good or service increases, consumer demand for it will decrease, and vice versa.

For example, when shirts go on sale, you might buy three shirts instead of just one. The number of shirts you want (the quantity demanded) increases because the price of shirts has decreased. Conversely, if the price of your favorite brand of pizza increases from $10 to $15, you may not purchase as many pizzas as usual.

There is only one price and quantity on which consumers and producers agree. This point is called market equilibrium, or the market clearing price. It is at the market clearing price that the producers make the exact number of a product that the consumers are willing and able to buy. The market "clears" itself, or the market is at "equilibrium."

 

The problems you will see in relation to supply and demand will require you to start with a product at equilibrium. To do this draw a supply and demand graph and label the equilibrium price and equilibrium quantity.

Remembering the non-price determinants for both supply and demand (INSECT and PESTSTRIP), you will be asked to determine which curve is moving, which direction it ismoving, and what happens to the equilibrium price and quantity.

When only a single curve is shifting, there are only four possible ways the graphs and equilibrium point can change. Those answers are drawn in the chart on the next slide.

 

The graphs show the four possible moves. In Graph A, demand increases, shifting the demand curve (which slopes downward) to the right. When demand increases, equilibrium price increases and the equilibrium quantity increases as well. In Graph B, demand decreases, shifting the demand curve (which slopes downward) to the left. When demand decreases, equilibrium price decreases and the equilibrium quantity decreases as well. In Graph C, supply increases, shifting the supply curve (which slopes upward) to the right. When supply increases, equilibrium price decreases but the equilibrium quantity increases. In Graph D, supply decreases, shifting the supply curve (which slopes upward) to the left. When supply decreases, equilibrium price increases but the equilibrium quantity decreases.

 

What happens when the market does not have the right price? Sometimes the price of a product can be too high or too low.

According to the Law of Demand, if the price of a product is too high, consumers will buy less of it. So, there is a surplus of the product. To motivate consumers to buy the product, producers will have to lower its price. According to the Law of Demand, as the price of a product decreases, consumers will buy more of it. However, according to the Law of Supply, as the price of a product decreases, producers will offer less of it for sale. This lowering of the price will occur until equilibrium is reached.

 

What if the market price for a product is too low? Remember, according to the Law of Supply, as the price of a product decreases, producers will offer less of it for sale. However, according to the Law of Demand, as the price of a product decreases, consumers will want to buy more of it. So, there will be a shortage of the product.

In a shortage situation, stores won't be able to keep it in stock. In order to get the product, consumers will have to bid up its price. According to the Law of Demand, as the price of a product increases, consumers will want to buy less of it. However, according to the Law of Supply, as the price of a product increases, producers will want to offer more of it for sale. This rising of price will continue until the equilibrium price is reached.

A market economy is said to be very efficient because the tendency will be for the market to gravitate towards equilibrium.