Introduction To Demand and Supply

INTRODUCTION TO DEMAND AND SUPPLY
When economists talk about prices, they are less interested in making judgments than in gaining a practical
understanding of what determines prices and why prices change. Consider a price most of us contend with
weekly: that of a gallon of gas. Why was the average price of gasoline in the United States $3.71 per gallon in
June 2014? Why did the price for gasoline fall sharply to $1.96 per gallon by January 2016? To explain these
price movements, economists focus on the determinants of what gasoline buyers are willing to pay and what
gasoline sellers are willing to accept.
As it turns out, the price of gasoline in June of any given year is nearly always higher than the price in January
of that same year. Over recent decades, gasoline prices in midsummer have averaged about 10 cents per gallon
more than their midwinter low. The likely reason is that people drive more in the summer, and are also willing
to pay more for gas, but that does not explain how steeply gas prices fell. Other factors were at work during
those 18 months, such as increases in supply and decreases in the demand for crude oil.
This chapter introduces the economic model of demand and supply—one of the most powerful models in all of
economics. The discussion here begins by examining how demand and supply determine the price and the
quantity sold in markets for goods and services, and how changes in demand and supply lead to changes in
prices and quantities.
Demand for Goods and Services

Economists use the term demand to refer to the amount of some good or service consumers are willing and
able to purchase at each price. Demand is fundamentally based on needs and wants—if you have no need or
want for something, you won't buy it. While a consumer may be able to differentiate between a need and a
want, but from an economist’s perspective they are the same thing. Demand is also based on ability to pay. If
you cannot pay for it, you have no effective demand. By this definition, a homeless person probably has no
effective demand for shelter.
What a buyer pays for a unit of the specific good or service is called price. The total number of units that
consumers would purchase at that price is called the quantity demanded. A rise in price of a good or service
almost always decreases the quantity demanded of that good or service. Conversely, a fall in price will increase
the quantity demanded. When the price of a gallon of gasoline increases, for example, people look for ways to
reduce their consumption by combining several errands, commuting by carpool or mass transit, or taking
weekend or vacation trips closer to home. Economists call this inverse relationship between price and quantity
demanded the law of demand. The law of demand assumes that all other variables that affect demand (which
we explain in the next module) are held constant.
We can show an example from the market for gasoline in a table or a graph. Economist call a table that shows
the quantity demanded at each price, such as Table 3.1, a demand schedule. In this case we measure price in
dollars per gallon of gasoline. We measure the quantity demanded in millions of gallons over some time period
(for example, per day or per year) and over some geographic area (like a state or a country). A demand
curve shows the relationship between price and quantity demanded on a graph like Figure 3.2, with quantity
on the horizontal axis and the price per gallon on the vertical axis. (Note that this is an exception to the normal
rule in mathematics that the independent variable (x) goes on the horizontal axis and the dependent variable (y)
goes on the vertical. Economics is not math.)
Table 3.1 shows the demand schedule and the graph in Figure 3.2 shows the demand curve. These are two
ways to describe the same relationship between price and quantity demanded.
Demand curves will appear somewhat different for each product. They may appear relatively steep or flat, or
they may be straight or curved. Nearly all demand curves share the fundamental similarity that they slope
down from left to right. Demand curves embody the law of demand: As the price increases, the quantity
demanded decreases, and conversely, as the price decreases, the quantity demanded increases.
Is demand the same as quantity demanded?
In economic terminology, demand is not the same as quantity demanded. When economists talk about demand,
they mean the relationship between a range of prices and the quantities demanded at those prices, as illustrated
by a demand curve or a demand schedule. When economists talk about quantity demanded, they mean only a
certain point on the demand curve, or one quantity on the demand schedule. In short, demand refers to the
curve and quantity demanded refers to the (specific) point on the curve.
Supply of Goods and Services
When economists talk about supply, they mean the amount of some good or service a producer is willing to
supply at each price. Price is what the producer receives for selling one unit of a good or service. A rise in
price almost always leads to an increase in the quantity supplied of that good or service, while a fall in price
will decrease the quantity supplied. When the price of gasoline rises, for example, it encourages profit-seeking
firms to take several actions: expand exploration for oil reserves; drill for more oil; invest in more pipelines
and oil tankers to bring the oil to plants for refining into gasoline; build new oil refineries; purchase additional
pipelines and trucks to ship the gasoline to gas stations; and open more gas stations or keep existing gas
stations open longer hours. Economists call this positive relationship between price and quantity supplied—
that a higher price leads to a higher quantity supplied and a lower price leads to a lower quantity supplied—
the law of supply. The law of supply assumes that all other variables that affect supply (to be explained in the
next module) are held constant.
Is supply the same as quantity supplied?
In economic terminology, supply is not the same as quantity supplied. When economists refer to supply, they
mean the relationship between a range of prices and the quantities supplied at those prices, a relationship that
we can illustrate with a supply curve or a supply schedule. When economists refer to quantity supplied, they
mean only a certain point on the supply curve, or one quantity on the supply schedule. In short, supply refers to
the curve and quantity supplied refers to the (specific) point on the curve.
The shape of supply curves will vary somewhat according to the product: steeper, flatter, straighter, or curved.
Nearly all supply curves, however, share a basic similarity: they slope up from left to right and illustrate the
law of supply: as the price rises, say, from $1.00 per gallon to $2.20 per gallon, the quantity supplied increases
from 500 gallons to 720 gallons. Conversely, as the price falls, the quantity supplied decreases.

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INTRODUCTION TO DEMAND AND SUPPLY

Demand for Goods and Services

Is demand the same as quantity demanded?

Is supply the same as quantity supplied?

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