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Economics & Personal Finance
Supply and Demand
Supply and Demand
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Supply and demand is the basic model economists use to explain how prices and quantities are determined in a market. Demand shows how much buyers are willing and able to buy at different prices, while supply shows how much sellers are willing and able to sell. The intersection of the two curves gives the equilibrium price and quantity. This matters because it helps explain real market changes, from food prices to wages to housing costs.
Key Facts
- Demand curve: Qd = a - bP, where higher price usually lowers quantity demanded.
- Supply curve: Qs = c + dP, where higher price usually raises quantity supplied.
- Equilibrium occurs when Qd = Qs.
- A surplus occurs when Qs > Qd at a price above equilibrium.
- A shortage occurs when Qd > Qs at a price below equilibrium.
- A demand increase shifts the demand curve right, usually raising both equilibrium price and quantity.
Vocabulary
- Demand
- Demand is the quantity of a good or service that buyers are willing and able to purchase at different prices.
- Supply
- Supply is the quantity of a good or service that sellers are willing and able to offer at different prices.
- Equilibrium
- Equilibrium is the market point where quantity demanded equals quantity supplied.
- Surplus
- A surplus occurs when sellers offer more of a good than buyers want to purchase at the current price.
- Shortage
- A shortage occurs when buyers want more of a good than sellers offer at the current price.
Common Mistakes to Avoid
- Confusing a movement along a curve with a shift of the curve. A price change causes movement along supply or demand, while a change in income, costs, technology, tastes, or number of buyers can shift a curve.
- Thinking higher demand means a lower price. An increase in demand shifts the demand curve right and usually raises equilibrium price when supply is unchanged.
- Labeling the axes backward. Price belongs on the vertical axis and quantity belongs on the horizontal axis in the standard supply and demand graph.
- Assuming equilibrium means everyone gets what they want. Equilibrium means quantity demanded equals quantity supplied at that price, not that all consumers can afford the good or all sellers earn the same profit.
Practice Questions
- 1 A market has Qd = 100 - 2P and Qs = 20 + 2P. Find the equilibrium price and equilibrium quantity.
- 2 At a price of $8, quantity demanded is 50 units and quantity supplied is 80 units. Is there a shortage or surplus, and how many units is it?
- 3 A new technology lowers production costs for a product. Explain how the supply curve shifts and what is likely to happen to equilibrium price and quantity.