For other uses, see Supply and demand (disambiguation).

The price P of a product is determined by a balance between production at each price

(supply S) and the desires of those with purchasing power at each price (demand D). The
diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price
(P) and quantity sold (Q) of the product.

Supply and demand is an economic model of price determination

in a market. It concludes that in a competitive market, the unit
price for a particular good will vary until it settles at a point where
the quantity demanded by consumers (at current price) will equal
the quantity supplied by producers (at current price), resulting in
an economic equilibrium of price and quantity.

The four basic laws of supply and demand are [1]

1. If demand increases and supply remains

unchanged then higher equilibrium price and quantity.
2. If demand decreases and supply remains
unchanged then lower equilibrium price and quantity.
3. If supply increases and demand remains
unchanged then lower equilibrium price and higher
quantity.
4. If supply decreases and demand remains
unchanged then higher price and lower quantity.

Contents
[hide]

• 1 The graphical representation of supply and demand

o 1.1 Supply schedule
o 1.2 Demand schedule
• 2 Microeconomics
o 2.1 Equilibrium
• 3 Changes in market equilibrium
o 3.1 Demand curve shifts
o 3.2 Supply curve shifts
• 4 Elasticity
o 4.1 Vertical supply curve (perfectly inelastic supply)
• 5 Other markets
• 6 Empirical estimation
• 7 Macroeconomic uses of demand and supply
• 8 History
• 9 Criticism
o 9.1 Economies of scale: Mass production
• 10 See also
• 11 References

• 12 External links

[edit] The graphical representation of supply and

demand
The supply-demand model is a partial equilibrium model representing the determination
of the price of a particular good and the quantity of that good which is traded. Although it
is normal to regard the quantity demanded and the quantity supplied as functions of the
price of the good, the standard graphical representation, usually attributed to Alfred
Marshall, has price on the vertical axis and quantity on the horizontal axis, the opposite
of the standard convention for the representation of a mathematical function.

Determinants of supply and demand other than the price of the good in question, such as
consumers' income, input prices and so on, are not explicitly represented in the supply-
demand diagram. Changes in the values of these variables are represented by shifts in the
supply and demand curves. By contrast, responses to changes in the price of the good are
represented as movements along unchanged supply and demand curves.

[edit] Supply schedule

The supply schedule, depicted graphically as the supply curve,

represents the amount of some good that producers are willing and
able to sell at various prices, assuming ceteris paribus, that is,
assuming all determinants of supply other than the price of the
good in question, such as technology and the prices of factors of
production, remain the same.

Under the assumption of perfect competition, supply is determined

by marginal cost. Firms will produce additional output as long as
the cost of producing an extra unit of output is less than the price
they will receive.

By its very nature, conceptualizing a supply curve requires that the

firm be a perfect competitor—that is, that the firm has no influence
over the market price. This is because each point on the supply
curve is the answer to the question "If this firm is faced with this
potential price, how much output will it be able to and willing to
sell?" If a firm has market power, so its decision of how much
output to provide to the market influences the market price, then
the firm is not "faced with" any price, and the question is
meaningless.

Economists distinguish between the supply curve of an individual

firm and the market supply curve. The market supply curve is
obtained by summing the quantities supplied by all suppliers at
each potential price. Thus in the graph of the supply curve,
individual firms' supply curves are added horizontally to obtain the
market supply curve.

Economists also distinguish the short-run market supply curve

from the long-run market supply curve. In this context, two things
are assumed constant by definition of the short run: the availability
of one or more fixed inputs (typically physical capital), and the
number of firms in the industry. In the long run, firms have a
chance to adjust their holdings of physical capital, enabling them
to better adjust their quantity supplied at any given price.
Furthermore, in the long run potential competitors can enter or exit
the industry in response to market conditions. For both of these
reasons, long-run market supply curves are flatter than their short-
run counterparts.

The determinants of supply follow:

1. Production costs
2. The technology of production
3. The price of related goods
4. Firm's expectations about future prices
5. Number of suppliers
[edit] Demand schedule

The demand schedule, depicted graphically as the demand curve, represents the amount
of some good that buyers are willing and able to purchase at various prices, assuming all
determinants of demand other than the price of the good in question, such as income,
tastes and preferences, the price of substitute goods, and the price of complementary
goods, remain the same. Following the law of demand, the demand curve is almost
always represented as downward-sloping, meaning that as price decreases, consumers
will buy more of the good.[2]

Just as the supply curves reflect marginal cost curves, demand curves are determined by
marginal utility curves.[3] Consumers will be willing to buy a given quantity of a good, at
a given price, if the marginal utility of additional consumption is equal to the opportunity
cost determined by the price, that is, the marginal utility of alternative consumption
choices. The demand schedule is defined as the willingness and ability of a consumer to
purchase a given product in a given frame of time.

As described above, the demand curve is generally downward-sloping. There may be rare
examples of goods that have upward-sloping demand curves. Two different hypothetical
types of goods with upward-sloping demand curves are Giffen goods (an inferior but
staple good) and Veblen goods (goods made more fashionable by a higher price).

By its very nature, conceptualizing a demand curve requires that the purchaser be a
perfect competitor—that is, that the purchaser has no influence over the market price.
This is because each point on the demand curve is the answer to the question "If this
buyer is faced with this potential price, how much of the product will it purchase?" If a
buyer has market power, so its decision of how much to buy influences the market price,
then the buyer is not "faced with" any price, and the question is meaningless.

As with supply curves, economists distinguish between the demand curve of an

individual and the market demand curve. The market demand curve is obtained by
summing the quantities demanded by all consumers at each potential price. Thus in the
graph of the demand curve, individuals' demand curves are added horizontally to obtain
the market demand curve.

The determinants of demand follow:

1. Income

2. Tastes and preferences

3. Prices of related goods and services

4. Expectations

5. Number of Buyers

[edit] Microeconomics
[edit] Equilibrium

Equilibrium is defined to the price-quantity pair where the quantity

demanded is equal to the quantity supplied, represented by the
intersection of the demand and supply curves.

Market Equilibrium:

A situation in a market when the price is such that the quantity that
consumers wish to demand is correctly balanced by the quantity
that firms wish to supply.

Comparative static analysis:

Examines the likely effect on the equilibrium of a change in the

external conditions affecting the market.

[edit] Changes in market equilibrium

Practical uses of supply and demand analysis often center on the

different variables that change equilibrium price and quantity,
represented as shifts in the respective curves. Comparative statics
of such a shift traces the effects from the initial equilibrium to the
new equilibrium.

[edit] Demand curve shifts

Main article: Demand curve

An outward (rightward) shift in demand increases both equilibrium

price and quantity

When consumers increase the quantity demanded at a given price,

it is referred to as an increase in demand. Increased demand can be
represented on the graph as the curve being shifted to the right. At
each price point, a greater quantity is demanded, as from the initial
curve D1 to the new curve D2. In the diagram, this raises the
equilibrium price from P1 to the higher P2. This raises the
equilibrium quantity from Q1 to the higher Q2. A movement along
the curve is described as a "change in the quantity demanded" to
distinguish it from a "change in demand," that is, a shift of the
curve. In the example above, there has been an increase in demand
which has caused an increase in (equilibrium) quantity. The
increase in demand could also come from changing tastes and
fashions, incomes, price changes in complementary and substitute
goods, market expectations, and number of buyers. This would
cause the entire demand curve to shift changing the equilibrium
price and quantity. Note in the diagram that the shift of the demand
curve, by causing a new equilibrium price to emerge, resulted in
movement along the supply curve from the point (Q1, P1) to the
point Q2, P2).

If the demand decreases, then the opposite happens: a shift of the

curve to the left. If the demand starts at D2, and decreases to D1,
the equilibrium price will decrease, and the equilibrium quantity
will also decrease. The quantity supplied at each price is the same
as before the demand shift, reflecting the fact that the supply curve
has not shifted; but the equilibrium quantity and price are different
as a result of the change (shift) in demand.

The movement of the demand curve in response to a change in a

non-price determinant of demand is caused by a change in the x-
intercept, the constant term of the demand equation.
[edit] Supply curve shifts

Main article: Supply (economics)

An outward (rightward) shift in supply reduces the equilibrium price but

increases the equilibrium quantity

When the suppliers' unit input costs change, or when technological progress
occurs, the supply curve shifts. For example, assume that someone invents a
better way of growing wheat so that the cost of growing a given quantity of
wheat decreases. Otherwise stated, producers will be willing to supply more
wheat at every price and this shifts the supply curve S1 outward, to S2—an
increase in supply. This increase in supply causes the equilibrium price to
decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2
as consumers move along the demand curve to the new lower price. As a
result of a supply curve shift, the price and the quantity move in opposite
directions.

If the quantity supplied decreases, the opposite happens. If the supply curve
starts at S2, and shifts leftward to S1, the equilibrium price will increase
and the equilibrium quantity will decrease as consumers move along the
demand curve to the new higher price and associated lower quantity
demanded. The quantity demanded at each price is the same as before the
supply shift, reflecting the fact that the demand curve has not shifted. But
due to the change (shift) in supply, the equilibrium quantity and price have
changed.

The movement of the supply curve in response to a change in a non-price

determinant of supply is caused by a change in the y-intercept, the constant
term of the supply equation. The supply curve shifts up and down the y axis
as non-price determinants of demand change.

[edit] Elasticity
Main article: Elasticity (economics)

Elasticity is a central concept in the theory of supply and demand.

In this context, elasticity refers to how strongly the quantities
supplied and demanded respond to various factors, including price
and other determinants. One way to define elasticity is the
percentage change in one variable (the quantity supplied or
demanded) divided by the percentage change in the causative
variable. For discrete changes this is known as arc elasticity, which
calculates the elasticity over a range of values. In contrast, point
elasticity uses differential calculus to determine the elasticity at a
specific point. Elasticity is a measure of relative changes.

Often, it is useful to know how strongly the quantity demanded or

supplied will change when the price changes. This is known as the
price elasticity of demand or the price elasticity of supply,
respectively. If a monopolist decides to increase the price of its
product, how will this affect the amount of their good that
customers purchase? This knowledge helps the firm determine
whether the increased unit price will offset the decrease in sales
volume. Likewise, if a government imposes a tax on a good,
thereby increasing the effective price, knowledge of the price
elasticity will help us to predict the size of the resulting effect on
the quantity demanded.

Elasticity is calculated as the percentage change in quantity

divided by the associated percentage change in price. For example,
if the price moves from $1.00 to $1.05, and as a result the quantity
supplied goes from 100 pens to 102 pens, the quantity of pens
increased by 2%, and the price increased by 5%, so the price
elasticity of supply is 2%/5% or 0.4.

Since the changes are in percentages, changing the unit of

measurement or the currency will not affect the elasticity. If the
quantity demanded or supplied changes by a greater percentage
than the price did, then demand or supply is said to be elastic. If
the quantity changes by a lesser percentage than the price did,
demand or supply is said to be inelastic. If supply is perfectly
inelastic;that is, has zero elasticity, then there is a vertical supply
curve.

Short-run supply curves are not as elastic as long-run supply

curves, because in the long run firms can respond to market
conditions by varying their holdings of physical capital, and
because in the long run new firms can enter or old firms can exit
the market.

Elasticity in relation to variables other than price can also be

considered. One of the most common to consider is income. How
strongly would the demand for a good change if income increased
or decreased? The relative percentage change is known as the
income elasticity of demand.
Another elasticity sometimes considered is the cross elasticity of
demand, which measures the responsiveness of the quantity
demanded of a good to a change in the price of another good. This
is often considered when looking at the relative changes in demand
when studying complements and substitute goods. Complements
are goods that are typically utilized together, where if one is
consumed, usually the other is also. Substitute goods are those
where one can be substituted for the other, and if the price of one
good rises, one may purchase less of it and instead purchase its
substitute.

Cross elasticity of demand is measured as the percentage change in

demand for the first good divided by the causative percentage
change in the price of the other good. For an example with a
complement good, if, in response to a 10% increase in the price of
fuel, the quantity of new cars demanded decreased by 20%, the
cross elasticity of demand would be -2.0.

In a frictionless economy, the price and quantity in any market

would be able to move to a new equilibrium position instantly,
without spending any time away from equilibrium. Any change in
market conditions would cause a jump from one equilibrium
position to another at once. In real economic systems, markets
don't always behave in this way, and markets take some time
before they reach a new equilibrium position. This is due to
asymmetric, or at least imperfect, information, where no one
economic agent could ever be expected to know every relevant
condition in every market. Ultimately both producers and
consumers must rely on trial and error as well as prediction and
calculation to find the true equilibrium of a market.
[edit] Vertical supply curve (perfectly inelastic supply)
When demand D1 is in effect, the price will be P1. When D2 is occurring, the price will be
P2. The equilibrium quantity is always Q, and any shifts in demand will only affect price.

If the quantity supplied is fixed in the very short run no matter what the price, the supply
curve is a vertical line, and supply is called perfectly inelastic.

[edit] Other markets

The model of supply and demand also applies to various specialty markets.

The model is commonly applied to wages, in the market for labor. The typical roles of
supplier and demander are reversed. The suppliers are individuals, who try to sell their
labor for the highest price. The demanders of labor are businesses, which try to buy the
type of labor they need at the lowest price. The equilibrium price for a certain type of
labor is the wage rate.[4]

A number of economists (for example Pierangelo Garegnani[5], Robert L. Vienneau[6], and

Arrigo Opocher & Ian Steedman[7]), building on the work of Piero Sraffa, argue that that
this model of the labor market, even given all its assumptions, is logically incoherent.
Michael Anyadike-Danes and Wyne Godley [8] argue, based on simulation results, that
little of the empirical work done with the textbook model constitutes a potentially
falsifying test, and, consequently, empirical evidence hardly exists for that model.
Graham White [9] argues, partially on the basis of Sraffianism, that the policy of increased
labor market flexibility, including the reduction of minimum wages, does not have an
"intellectually coherent" argument in economic theory.

This criticism of the application of the model of supply and demand generalizes,
particularly to all markets for factors of production. It also has implications for monetary
theory[10] not drawn out here.

In both classical and Keynesian economics, the money market is analyzed as a supply-
and-demand system with interest rates being the price. The money supply may be a
vertical supply curve, if the central bank of a country chooses to use monetary policy to
fix its value regardless of the interest rate; in this case the money supply is totally
inelastic. On the other hand,[11] the money supply curve is a horizontal line if the central
bank is targeting a fixed interest rate and ignoring the value of the money supply; in this
case the money supply curve is perfectly elastic. The demand for money intersects with
the money supply to determine the interest rate.[12]

[edit] Empirical estimation