The FAMOUS Theory of SUPPLY AND DEMAND!

Demand is the ability and willingness of consumers to purchase a good or service at a particular price and given time. Because economics is dynamic, demand (and supply) change all the time, so to be perfectly precise, we should use quantity over time to indicate the given time period. When data on quantity demanded and price are gathered, we get a demand schedule. When we graph the demand schedule, we get a demand curve (same terminology for supply).

Supply is the ability and willingness of producers to produce a good or service at a particular price and given time. At price p*, quantity q* is both demanded and supplied. The law of demand states that as prices increase, quantity demanded decreases, ceteris paribus. The demand curve is downward-sloping because of the income effect (when price falls for a g/s, consumers can afford more of it) and the substitute effect (when the price of a g/s falls relative to a substitute good, consumers demand more of the former). Conversely, the law of supply states that as prices increase, quantity supplied also increases, ceteris paribus. The supply curve is upward-sloping because as the price increases, firms produce more product to maximize profits. Moreover, other firms might even enter the market and produce the product to capitalize on the higher prices.

Because the amount of apples that people wish to buy at price p* is equal to the amount that suppliers wish to sell at that price, we say the market is at equilibrium . This market will stay this way unless something happens to cause demand or supply to change. If simply the price changes, the result is a movement along the demand and supply curves. In the case above, if the price increases from p* to a higher price, we would move up to the left along the demand curve and see less quantity demanded. On the other hand, we would move up along the supply curve to the right and see more quantity supplied. This would lead to a temporary surplus in apples.

Factors that will shift a demand curve include but are not limited to changes in individual income, price of other goods (complements and substitutes), tastes and preferences, population, expectations of future price, and advertising. Factors that will shift a supply curve include but are not limited to changes in the costs of factors of production, price of producer substitutes (other products the firm can make, like Diet Coke and Cherry Coke), technological advancements, expectations of future price, and government intervention like taxes. It’s important to learn the direction these curves shift when demand and supply change.