Markets and Prices

Supply and Demand

By the end of this lesson, you will be able to explain the laws of supply and demand, identify the determinants that shift supply and demand curves, find equilibrium price and quantity, and analyze the effects of supply and demand shifts.

Demand

Law of Demand: all else equal, as price rises, quantity demanded falls; as price falls, quantity demanded rises. An inverse relationship.

Why?

• Substitution effect: higher price → consumers buy substitutes
• Income effect: higher price → real purchasing power falls → buy less

Demand curve: downward sloping; each point shows the quantity buyers wish to purchase at a given price, holding all else constant (ceteris paribus).

Shifts in Demand (Moving the Whole Curve)

A change in price causes movement along the demand curve. A change in any other determinant shifts the entire curve.

Demand shifters (TRIBE):

• Tastes/Preferences: if a product becomes more desirable (fashion, health trends), demand increases
• Related goods prices:
  • Substitutes (goods used in place of each other): if price of Pepsi rises, demand for Coke increases
  • Complements (goods used together): if price of cars rises, demand for gasoline falls
• Income:
  • Normal goods: income rises → demand increases
  • Inferior goods: income rises → demand decreases (e.g., instant ramen, bus rides)
• Buyers (number of): more buyers → higher demand
• Expectations: expect prices to rise in future → buy more now

Supply

Law of Supply: all else equal, as price rises, quantity supplied increases; as price falls, quantity supplied decreases. A direct relationship.

Why? Higher prices make production more profitable → existing firms produce more; new firms enter the market.

Supply curve: upward sloping; each point shows the quantity sellers wish to sell at a given price.

Shifts in Supply

Supply shifters:

• Input prices: if labor or raw materials become more expensive, supply decreases
• Technology: technological improvement reduces costs → supply increases