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Define supply and demand.

Diagram of equilibrium price and quantity with non-linear supply and demand curves
Diagram of equilibrium price and quantity with non-linear supply and demand curves

Focus Question: How does supply and demand work in our economy?


Economics Basics: Supply and Demand
Khan Academy: Supply, Demand, and Market Equilibrium

The principles of supply and demand are among the most basic in economics, and are the foundation of a market economy. The British economist Alfred Marshall pioneered thought about supply and demand in his book //Principles of Economics//.

"By definition, supply is the amount of product that a producer is willing and able to sell at a specified price, while demand is the amount of product that a buyer is willing and able to buy at a specified price.

In layman's terms, the supply of a product is how much of a certain product that a producer wants to make, and the demand of a product is how much the consumer wants to buy.
  • Both quantities are related to price, and price is related to both scarcity (if a product is in limited quantity and is highly desirable or necessary) and the actual monetary cost of making that product.

Supply and demand are often displayed on a graph with price on the y-axis and quantity on the x-axis, as shown on the right or bottom left. Notice that as price goes up, demand goes down (consumers are less likely to buy a good when it costs them more), and supply goes up (producers are willing to produce more if there is more possible return from consumers). Marginal revenue represents the additional revenue producers will gain from each additional good produced. Notice that as supply begins to be higher than demand, producing an additional good will be costly to the producer.

A very basic graph of supply and demand.
A very basic graph of supply and demand.


From the definition and application of the supply and demand principles come a few relationships and concepts. The quantity demanded is the amount of a product that people will buy at a given price, and the relationship between the quantity demanded and the price is called the demand relationship. The quantity supplied is the amount producers will supply when given a certain price to sell, and the relationship between this price and the quantity supplied is called the supply relationship. (Heakal 1).

Demand has a direct impact on the supply, but supply does not necessarily have a direct impact on demand (if a manufacturer makes more than they sell, for instance). The point at which the supply and demand curves meet (PeQe) is also known as the point of equilibrium, which tells us when supply and demand equal each other exactly. At this point, there is no surplus in production (hence no sunk cost of production for the producer), and the consumer's demand is perfectly met. Hence, equilibrium represents the most efficient allocation of goods in the market economy. In market economy theories (classical economics), reaching of equilibrium will be the result of a free, unregulated market.

Multimedia.pngVideo explaining supply and demand.

game_icon.svg.pngInteractive Supply and Demand Graph

Multimedia.pngClick here for an interactive lecture on supply and demand. Requires the latest version of Java.

game_icon.svg.pngInteractive Supply and Demand Game-Manage a charcoal business by accurately applying the principles of supply and demand.

game_icon.svg.pngLearn about supply and demand by creating a lemonade stand!

To read a young reader's lemonade stand-themed book about supply and demand, look into Lemons and Lemonade by Nancy Loewen.

Historically, many economists have assumed that if markets are able to operate completely freely, the laws of supply and demand will self-regulate and result in a market where everyone's needs are met. Most economists today view economic systems as much more flawed and complicated than the simple laws of supply and demand would dictate. One of the major critics of the classical economic model was the British economist John Maynard Keynes. Click here to read about differences between classical and "Keynesian" economics.

Cartoon humorously displaying supply and demand in the milk industry.
Cartoon humorously displaying supply and demand in the milk industry.


Example:
Imagine that a special edition CD of your favorite band is released for $20.
  • Because the record company's previous analysis showed that consumers will not demand CDs at a price higher than $20, only ten CDs were released because the opportunity cost is too high for suppliers to produce more.
  • If, however, the ten CDs are demanded by 20 people, the price will subsequently rise because, according to the demand relationship, as demand increases, so does the price. Consequently, the rise in price should prompt more CDs to be supplied as the supply relationship shows that the higher the price, the higher the quantity supplied.
  • If, however, there are 30 CDs produced and demand is still at 20, the price will not be pushed up because the supply more than accommodates demand. In fact after the 20 consumers have been satisfied with their CD purchases, the price of the leftover CDs may drop as CD producers attempt to sell the remaining ten CDs. The lower price will then make the CD more available to people who had previously decided that the opportunity cost of buying the CD at $20 was too high.


Multimedia.pngThe principles of supply and demand can be applied to almost any market for any good. Read recent (2014) articles about supply and demand applied to coffee, fruit, fertilizer, oil, and video games.

lesson_plan_icon.jpgMultimedia.pngThe Market Forces of Supply and Demand featuring Calvin and Hobbes, a Supply and Demand Music Video and much more from Mr. Ski's AP Economics Wikispace! A wonderful resource.

lesson_plan_icon.jpgEconomics in theHeadlines "Students learn how to identify headlines in the news and current events as illustrations of problems in supply and demand. Students will be linked to news sites to create their own analysis of supply and demand issues in problems facing our society." from EconEdLink.com

lesson_plan_icon.jpgMultimedia.pngFemale_Rose.pngLowell Workers and Producers Respond to Incentives- Wonderful lesson plan explores embargoes, supply and demand utilizing the Embargo Act of 1807 and the Lowell Mills.


multicultural.pngIbn Khaldun on the Tunisian 10 dollar bill. Khaldun is recognized as an important scholar in economics, sociology, history, and many other fields.
external image 10_TND_obverse.jpg

Ibn Khaldun: Muslim Father of Economics. Ibn Khaldun (1332-1406) was a major Muslim scholar from the "Golden Age of Islam".
He was among the first to write about economics as a science, and among the first to explicitly realize the relation of supply and demand to price.





Supply and demand played a key role in the triangular trade across the Atlantic, much of which involved slavery.

Sources:

http://www.investopedia.com/university/economics/economics3.asp