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Supply and Demand

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Economics

When thinking of markets, you may wonder: what is the driving force behind the relationship between the production and consumption that makes up markets and ultimately economies? This explanation will introduce you to one of the foundational concepts of economics - supply and demand, which is essential in both basic and advanced economics, as well as in your everyday life. Ready? Then read on!

Supply and demand definition

Supply and demand is the relationship between the quantities of products or services that producers are willing to provide versus the quantities that consumers are willing to obtain at a range of various prices.

While the supply and demand definition may sound complex at first, it is a simple model that visualizes the behaviors of producers and consumers in a given market. This model is largely based on the three main elements:

  • Supply curve: the function that represents the relationship between the price and the quantity of products or services that producers are willing to supply at any given price point.
  • Demand curve: the function that represents the relationship between the price and the quantity of products or services that consumers are willing to purchase at any given price point.
  • Equilibrium: the point of intersection between the supply and demand curves, representing the price-quantity point where the market stabilizes.

These are the three core elements that you will need to keep in mind as you work on developing a more comprehensive understanding of the supply and demand model. Keep in mind that these elements are not just random numbers; they are representations of human behavior under the effect of various economic factors that ultimately determines prices and available quantities of commodities.

The law of supply and demand

Behind the interaction between consumers and producers is the theory known as the law of supply and demand. This law is defined by the relationship between the price of a product or service and the willingness of market actors to either provide or consume that product or service based off that price.

You may think of the law of supply and demand as a theory compounded by two complimentary laws, the law of demand and the law of supply. The law of demand states that the higher the price of a good, the lower the quantity consumers will wish to buy. The law of supply, on the other hand, states that the higher the price, the more of that good producers will want to supply. Together, these laws act to drive the price and quantity of goods in the market. The compromise between consumers and producers in price and quantity is known as the equilibrium.

The law of demand states that the higher the price of a good the lower the quantity consumers will wish to buy.

The law of supply states that the higher the price of a good the more producers will want to supply.

Some supply and demand examples include markets for physical goods, where producers supply the product and consumers then purchase it. Another example is markets for various services, where service providers are the producers and users of that service are the consumers.

Regardless of what the commodity that is being transacted, the supply and demand relationship between producers and consumers is what fine-tunes the price and quantity of that commodity available, thus allowing the market for it to exist.

Supply and demand graph

A typical supply and demand graph is easily recognizable by its "criss-cross" system of two functions, one representing supply and the other representing demand. In general, the supply function will have a positive slope, while the demand function will have a negative slope.

Supply and demand schedule

Since the supply and demand functions represent data in a market, you need data points to put on a graph to ultimately draw the functions. To make this process organized and easy to follow, you may want to enter your data points, which are different quantities of product or service demanded and supplied at a range of price points, into a table that you will refer to as a schedule. Take a look at Table 1 below for an example:

Price ($)Quantity SuppliedQuantity Demanded
2.00312
4.0069
6.0096
10.00123
Table 1: Example of a supply and demand schedule

Whether you are drawing your supply and demand graph by hand, using a graphing calculator, or even spreadsheets, having a schedule will not only help you stay organized with your data but insure that your graphs are as accurate as they can be.

Demand schedule is a table that shows different quantities of a good or product sought out by consumers at a range of given prices.

Supply schedule is a table that shows different quantities of a good or product that producers are willing to supply at a range of given prices.

Supply and demand curves

Now that you are familiar with supply and demand schedules, the next step is to put your data points into a graph, thus producing a supply and demand graph. You can do this either by hand on paper or let software do the task. Regardless of the method, the outcome will likely look similar to the graph you can see in Figure 1 provided below as an example:

Supply and Demand, Basic supply and demand graph, StudySmarterFigure 1. Basic supply and demand graph - StudySmarter

As you can see from Figure 1, demand is a downward-sloping function and supply slopes upward. Demand slopes downward mainly due to diminishing marginal utility, as well as the substitution effect, which is characterized by consumers seeking alternatives at cheaper prices as the price of the original product rises.

The Law of Diminishing Marginal Utility states that as consumption of a good or service increases, the utility derived from every additional unit will decrease.

Notice that while both the supply and demand functions in the graph above are linear for the sake of simplicity, you will often see that supply and demand functions can follow different slopes and can often look more like curves rather than simple straight lines, as shown in Figure 2 below. How the supply and demand functions look on a graph depends on what kind of equations provide the best fit for the data sets behind the functions.

Supply and Demand, Non-linear supply and demand graph, StudySmarterFigure 2. Non-linear supply and demand functions

Supply and Demand: Equilibrium

So why graph supply and demand in the first place? Besides visualizing data about consumers' and producers' behavior in a market, one important task that a supply and demand graph will help you with is finding and identifying the equilibrium quantity and price in the market.

Equilibrium is the quantity-price point where quantity demanded equals quantity supplied, and thus produce a stabilized balance between the price and quantity of a product or service in the market.

Looking back at the supply and demand graph provided above, you will notice that the point of intersection between the supply and demand functions is labeled as "equilibrium". The equilibrium equating to the point of intersection between the two functions ties into the fact that equilibrium is where consumers and producers (represented by the demand and supply functions, respectively) meet at a compromising price-quantity.

Refer to the mathematical representation of the equilibrium below, where Qs equals quantity supplied, and Qd equals quantity demanded.

There are many other valuable conclusions that you can gather from a supply and demand graph, such as surpluses and shortages.

To learn more about surpluses as well as get a deeper understanding of equilibrium, take a look at our explanation on Market Equilibrium and Consumer and Producer Surplus.

Determinants of demand and supply

Changes in the price of a good or a service will lead to a movement along the supply and demand curves. However, changes in the demand and supply determinants will shift either the demand or the supply curves respectively.

Determinants of demand include but are not limited to:

  • Changes in prices of related goods
  • Consumers' income
  • Consumers' tastes
  • Consumers' expectations
  • Number of consumers in the market

To learn more about how changes in demand determinants affect the demand curve check out our explanation - Shifts in Demand

Determinants of supply include but are not limited to:

  • Changes in input prices
  • Price of related goods
  • Changes in technology
  • Producers' expectations
  • Number of producers in the market

To learn more about how changes in supply determinants affect the supply curve check out our explanation - Shifts in Supply

Elasticity of supply and demand

As you become more familiar with supply and demand and interpreting their corresponding graphs, you will notice that different supply and demand functions vary in the steepness of their slopes and curvatures. The steepness of these curves reflects the elasticity of each supply and demand.

Elasticity of supply and demand is a measure that represents how responsive or sensitive each of the functions is to changes in various economic factors, such as price, income, expectations, and others.

While both supply and demand are subject to variation in elasticity, it is interpreted differently for each function.

Elasticity of demand

Elasticity of demand represents how sensitive demand is to a change in various economic factors in the market. The more the consumers are responsive to an economic change, in terms of how much that change affects the consumers' willingness to still purchase that good, the more elastic the demand. Alternatively, the less flexible the consumers are to economic fluctuations for a specific good, meaning they likely have to continue purchasing that good regardless of the changes, the more inelastic demand is.

You can calculate the price elasticity of demand, for example, simply by dividing the percentage change in quantity demanded by the percentage change in price, as shown by the formula below:

There are three main types of elasticity of demand that you will need to focus on for now:

  • Price elasticity: measures how much the quantity demanded of a good varies due to changes in the good's price. Learn more in our explanation on Price elasticity of demand.
  • Income elasticity: measures how much the quantity demanded of a specific good varies due to changes in income of the consumers of that good. Check out our explanation on Income Elasticity of Demand.
  • Cross elasticity: measures how much the quantity demanded of one good changes in response to a change in the price of another good. See more in our explanation for Cross Elasticity of Demand.

Elasticity of demand measures how sensitive demand is to changes in various economic factors in the market.

Elasticity of supply

Supply can also vary in elasticity. One specific type of elasticity of supply is price elasticity of supply, which measures how responsive producers of a certain commodity are to a change in market price for that commodity.

You can calculate price elasticity of supply by dividing the percentage change in quantity supplied by the percentage change in price, as shown by the formula below:

There are numerous factors that can affect price elasticity of supply, such as availability of resources needed for production, changes in demand for the product that the firm produces, and innovations in technology.

To learn more about these factors as well as how to interpret your results from calculating elasticity of supply, see our explanation on Price Elasticity of Supply.

Elasticity of supply measures how sensitive supply is to changes in various economic factors in the market.

Supply and Demand Examples

The concept of supply and demand is relevant throughout the entire field of economics, and that includes macroeconomics and economic government policies.

Effect of Government Policies on Supply and Demand

Governments may intervene in the course of economies in order to correct for undesirable effects of the current economic climates, as well as attempt to optimize future outcomes. There are three main tools that regulatory authorities may use to create targeted changes in the economy:

  • Regulations and policies
  • Taxes
  • Subsidies

Each of these tools may cause either positive or negative changes in the cost of production of various goods. These changes will impact the behavior of producers, which will ultimately affect the price in the market. You can learn more about the effects of these factors on supply in our explanation of Shift in Supply.

The change in market price, in turn, will likely have an effect on consumers' behavior and subsequently, demand. See more on what factors affect demand and how, as well the extent to which these factors will influence demand based on various circumstances, in our explanations on Shifts in Demand and Price Elasticity of Demand.

Thus, government policies can have a domino-like effect on supply and demand that can entirely change the state of markets. To find out more about this, check out our explanation on The Effects of Government Intervention in Markets.

Government policies may also affect property rights to various resources. Examples of property rights include copyright and patents, which can be applied to intellectual property as well as physical objects. Owning patents or copyrights grants enables exclusivity over the production of a good or service, which leaves consumers with fewer options in the market. This will likely result in the market price increasing, as consumers will have no other choice but to take the price and make a purchase.

Supply and Demand - Key takeaways

  • Supply and demand is the relationship between the quantities of products or services that producers are willing to provide versus the quantities that consumers are willing to obtain at a range of various prices.
  • The supply and demand model consists of three basic elements: the supply curve, the demand curve, and the equilibrium.
  • The equilibrium is the point where supply meets demand and is thus the price-quantity point where the market stabilizes.
  • The law of demand states that the higher the price of a good the lower the quantity consumers will wish to buy.
  • The law of supply states that the higher the price of a good the more producers will want to supply.
  • In order to graph the supply and demand functions, it is helpful to fill out a supply and demand schedule with any available points for the quantities that producers are willing to supply and consumers demand at different price points.
  • Supply and demand for various goods and services vary in elasticity due to various economic factors.
  • The more sensitive supply and/or demand for a certain good or service is to a change in another economic factor, such as price, the more elastic it is considered to be.
  • Governments may intervene in the course of economies in order to correct for undesirable effects of the current economic climates, as well as attempt to optimize future outcomes.

Supply and Demand

Supply and demand is the relationship between the quantities of products or services that producers are willing to provide versus the quantities that consumers are willing to obtain at a range of various prices.

When supply exceeds demand, prices will fall; inversely, when demand exceeds supply, prices will rise. Price and quantity of a given resource will stabilize at the point where supply and demand meet, which is known as the equilibrium.

Determinants of demand:

  • Changes in prices of related goods 
  • Consumers' income
  • Consumers' tastes
  • Consumers' expectations
  • Number of consumers in the market


Determinants of supply:

  • Changes in input prices
  • Price of related goods
  • Changes in technology
  • Producers' expectations
  • Number of producers in the market

The elasticity of supply and demand is the measure of how responsive either of the functions are to changes in other economic factors such as price, income, and price of substitutes or related goods.

Assuming that both the supply and demand functions follow the basic y=mx+b model, use the existing data points to calculate the slopes and intercepts of both functions. Then, plug in any quantity (x) or price (y) value in order to solve for the other corresponding variable at that point.

Final Supply and Demand Quiz

Question

What is the law of supply?

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Answer

The law of supply states that as the price of a good or service increases, the quantity of that good or service that producers are willing to offer will increase.

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Question

What is the law of demand?

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The law of demand states that as the price of a good or service increases, the quantity of that good or service that consumers are willing to seek will decrease.

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Question

What determines price elasticity of demand?

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Answer

Price elasticity of demand is determined by how responsive the quantity demanded of a good is to changes in its price.

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Question

Which of the following is NOT a type of elasticity of demand?

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Answer

Marginal elasticity

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How does the law of diminishing marginal utility affect demand?

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Answer

The more of a good or service is consumed, the utility derived from each additional unit will decrease, which means that consumers will be less willing to pay more as quantity of a good or service consumed increases.

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Question

What is income elasticity of demand?

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Answer

Income elasticity of demand measures the responsiveness to changes in consumers' income in terms of the quantity of a good or service sought out by consumers. 

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Name three tools that the government may use to influence the economy.

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Answer

  • Regulations and policies
  • Subsidies
  • Taxes

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Where can equilibrium be found in a supply and demand model?

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Equilibrium is the point of intersection between the supply and demand functions.

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What is equilibrium?

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Equilibrium is the quantity-price point where quantity demanded equals quantity supplied, and thus produce a stabilized balance between the price and quantity of a resource in the market.

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Question

Which of the following examples represent inelastic demand best?

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Emerging trend for a technology equipment the producer of which owns a patent on.

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What is a demand schedule?

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Demand schedule is a table of various quantities of a good or service that consumers are willing to seek out at various price levels.

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Question

Which of the following factors may affect price elasticity of supply?

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Answer

There are numerous factors that can affect price elasticity of supply, such as availability of resources needed for production, changes in demand for the product that the firm produces, and innovations in technology.

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Question

Which of the following is NOT a factor that may cause.a shift in demand for a good or service?

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Answer

Price of the good or service

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An increase in quantity demanded at every price level will translate on a graph as:

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Answer

Rightward shift of the demand curve

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A leftward shift of the demand curve means:

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Decrease in quantity demanded at each price level

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Shifts of the demand curve are described as:

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Leftward / rightward

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When the demand curve shifts rightward, all else held constant the price of the equilibrium point:

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Increases

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Which of the following is not an example of normal goods?

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Luxury cars

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If consumers' income falls, quantity demanded of normal goods will:

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Decrease

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Which of the following is NOT a category of related goods?

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Dependent goods

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If the price of a complement increases, the demand curve for a good that it complements will:

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Shift leftward

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What are substitute goods?

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Substitute goods or substitutes are goods that satisfy the same desires or needs for consumers as another good, thus serving as an alternative to the latter.

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Product B is a substitute for product A. Suppose that the price of product B falls below the price of product A. How will this affect the demand curve for product A?

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The demand curve for product A will shift leftward as the quantity demanded will decrease, since consumers will be more inclined to purchase product B instead.

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Which of the following is the best example of consumers' taste influencing a rightward shift in demand for a product?

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Fans of a popular celebrity purchasing a product after an endorsement by the celebrity

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If consumers expect prices for a certain product to decrease due to promises of future subsidies, the demand curve for that product will likely...

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Shift leftward, as consumers may prefer to postpone the purchase of that product in hopes to save money.

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Suppose a college experiences a sharp decrease in the number of students regularly attending classes in person in favor of online learning. Due to this decrease in population, the demand curve for parking spots on campus will:

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Shift leftward

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The extent to which quantity of any good or service demanded will fluctuate due to changes in any factors of influence depends on the measure of:

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Elasticity of demand

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Market disequilibrium occurs when...

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Quantity of a product or service demanded exceeds quantity supplied, or quantity supplied exceeds quantity demanded

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A shortage occurs when...

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Quantity demanded exceeds quantity supplied

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What does price elasticity of supply measure?

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PES measures the responsiveness of quantity of a good or service supplied to changes in market price.

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How do you calculate PES?

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PES is calculated by dividing percentage change in quantity supplied by the percentage change in price.

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When calculating price elasticity of supply, what would the result of your calculations have to be in order for supply to be considered price elastic?

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Price elasticity of supply would have to be greater than 1.

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What does it mean when supply is unit-elastic?

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Supply is unit elastic when PES equals 1, which means that quantity supplied changes proportionately to changes in price.

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Suppose you determine supply to be perfectly inelastic. What would the supply function look like on a graph?

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The function is a vertical line.

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Does the supply curve shift as a result of changes in price or quantity supplied?

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Answer

Supply curve does not shift when the price of a good changes. Supply curve shifts only if the economic factors other than the price change.

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Question

If the supply curve shifts _____, quantity supplied at every price level will increase.

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Rightward

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If the supply curve for a certain product/service shifts leftward, this means that the quantity supplied...

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Decreases

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True or false: price of the product or service is one of the factors that directly cause sideward shifts of its' supply curve.

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False. Changes in price of the product/service do not reflect in sideward shifts of the supply curve.

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Question

Which of the following is NOT one of the economic factors that may cause the supply curve to shift?

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Consumers' preferences

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Suppose there is a significant increase in the price of steel, which is one of the inputs that producers of cars use in their production. This increase in price of steel would likely shift the supply curve for cars...

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Leftward

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Suppose that the latest advances in technology allow producers of certain physical products to reduce their energy expenses in the production process. As a result, the supply curve of such producers would shift...

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Rightward

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When the price of a complementary good increases, quantity supplied of the complemented good will likely...

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Increase

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When the price of a substitute good decreases, the supply curve for the substituted good will likely shift...

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Rightward

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Since a higher number of producers in the market results in higher quantities of a good or service supplied, a decrease in the number of producers would shift the supply curve...

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Leftward

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If producers expect unfavorable market conditions for their good or service in the near future, what may happen to the quantity they supply and the respective supply curve?

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Answer

Supply curve will shift leftward causing the quantity supplied at every price level to decrease.

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Suppose producers have a reason to believe that the price for their good or service may increase in the near future. How will this affect the supply curve?

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Answer

Favorable market conditions would result in supply curve shifting rightward, resulting in more quantity supplied at every price level.

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If producers experience a raise in taxes on some of their inputs, the supply curve for their ultimate product will likely shift...

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Leftward

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If producers begin to receive subsidies for their product, this will likely compel them to...

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Answer

Increase quantity supplied

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Question

If a supply curve shifts rightward, how will the shift affect the price value that corresponds to the market equilibrium, all other things held constant?

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Answer

The new equilibrium price will decrease from the initial value before the shift.

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Question

Suppose you were to calculate price elasticity for a certain product and your result came out to be 1.2, what does this say about how price elastic the given supply is?

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Answer

Supply of the given product is price elastic.

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