Demand and supply are the building blocks of market economics. These concepts explain how prices are determined and how markets respond to changes in consumer preferences, production costs, and other factors.

Understanding demand and supply curves helps predict market behavior. By analyzing shifts in these curves, we can anticipate changes in equilibrium prices and quantities, providing insights into real-world economic scenarios and policy implications.

Demand and Supply

Concepts of demand and supply

• Demand
  • Quantity of a good or service consumers willing and able to purchase at various prices
  • Law of demand: Price increases, quantity demanded decreases; price decreases, quantity demanded increases
  • Demand curve: Graphical representation showing downward-sloping relationship between price and quantity demanded
  • Price elasticity of demand: Measure of responsiveness of quantity demanded to changes in price
• Supply
  • Quantity of a good or service producers willing and able to offer for sale at various prices
  • Law of supply: Price increases, quantity supplied increases; price decreases, quantity supplied decreases
  • Supply curve: Graphical representation showing upward-sloping relationship between price and quantity supplied
  • Price elasticity of supply: Measure of responsiveness of quantity supplied to changes in price

Interpretation of demand-supply curves

• Demand curve
  • Inverse relationship between price and quantity demanded
  • Movements along demand curve: Changes in quantity demanded due to price changes, other factors constant (ceteris paribus)
  • Shifts in demand curve: Changes in demand due to non-price factors (income, preferences, prices of related goods)
• Supply curve
  • Positive relationship between price and quantity supplied
  • Movements along supply curve: Changes in quantity supplied due to price changes, other factors constant
  • Shifts in supply curve: Changes in supply due to non-price factors (production costs, technology, government regulations)

Market Equilibrium and Changes

Market conditions and equilibrium

• Market equilibrium
  • Point where quantity demanded equals quantity supplied
  • Equilibrium price: Price at which quantity demanded equals quantity supplied
  • Equilibrium quantity: Quantity bought and sold at equilibrium price
  • Consumer surplus: Difference between what consumers are willing to pay and the actual price paid
  • Producer surplus: Difference between the price received by producers and their cost of production
• Changes in market conditions
  • Shifts in demand
    1. Increase in demand: Shifts demand curve right, higher equilibrium price and quantity (higher income for normal goods)
    2. Decrease in demand: Shifts demand curve left, lower equilibrium price and quantity (lower price of substitute goods)
  • Shifts in supply
    1. Increase in supply: Shifts supply curve right, lower equilibrium price, higher equilibrium quantity (improved production technology)
    2. Decrease in supply: Shifts supply curve left, higher equilibrium price, lower equilibrium quantity (higher input costs)

Applications of demand-supply laws

• Scenarios involving demand changes
  • Higher consumer income for normal goods increases demand, higher equilibrium price and quantity (organic food, luxury cars)
  • Lower price of substitute goods decreases demand for original good, lower equilibrium price and quantity (Pepsi vs Coca-Cola)
  • Changes in demand for complementary goods affecting each other (cars and gasoline)
• Scenarios involving supply changes
  • Improved production technology increases supply, lower equilibrium price, higher equilibrium quantity (smartphones, solar panels)
  • Higher input costs decrease supply, higher equilibrium price, lower equilibrium quantity (oil prices impact plastic products)
• Scenarios involving simultaneous demand and supply changes
  • Increased demand and decreased supply: Unambiguous increase in equilibrium price, ambiguous change in equilibrium quantity (housing market during economic boom)
  • Increased demand and supply: Unambiguous increase in equilibrium quantity, ambiguous change in equilibrium price (e-commerce growth during pandemic)

Special Cases

• Inferior goods: Goods for which demand decreases as income increases
• Complementary goods: Goods that are used together, where an increase in the price of one good leads to a decrease in demand for the other
• Ceteris paribus: Latin phrase meaning "all other things being equal," used to isolate the effect of one variable on another in economic analysis