Why do concert tickets for a famous singer cost hundreds of dollars on resale sites, while tickets for a local band are cheap? Why do strawberries cost less in July than in January? The answer is a tug-of-war between buyers and sellers. Buyers want to pay less; sellers want to earn more. The price ends up where the two sides balance. Understanding this tug-of-war tells a business how to set prices and what will happen when the market changes.
The laws of demand and supply
Demand is the amount of a product that buyers are willing and able to buy at each possible price. The law of demand says that when the price goes up, people buy less, and when the price goes down, people buy more. That makes sense: a $5 phone case is an easy impulse buy, but at $40 many students decide their old case is fine. Supply is the amount of a product that sellers are willing and able to sell at each possible price. The law of supply says that when the price goes up, sellers offer more, because selling becomes more profitable. If phone cases sell for $40, more students will start making and selling them.
- Price up, quantity demanded down
- Price down, quantity demanded up
- Demand curve slopes downward
- Buyers' point of view
- Price up, quantity supplied up
- Price down, quantity supplied down
- Supply curve slopes upward
- Sellers' point of view
Equilibrium, surplus and shortage
The equilibrium price is the price at which the quantity buyers want to buy equals the quantity sellers want to sell. On a graph, it is where the supply curve and the demand curve cross. At equilibrium the market clears: nothing is left over and no buyer who will pay that price is turned away. If the price is set above equilibrium, sellers offer more than buyers want, creating a surplus (extra unsold goods). Sellers then cut prices to clear their stock. If the price is set below equilibrium, buyers want more than sellers offer, creating a shortage. Products sell out, line-ups form, and sellers can raise the price. To read a supply–demand table, find the row where the two quantity columns are equal: that price is the equilibrium. The size of a surplus or shortage is the larger quantity minus the smaller one.
| Price per case | Quantity demanded | Quantity supplied | Result |
|---|---|---|---|
| $5 | 160 | 40 | Shortage of 120 |
| $10 | 120 | 60 | Shortage of 60 |
| $15 | 80 | 80 | Equilibrium |
| $20 | 40 | 100 | Surplus of 60 |
Solving for equilibrium with equations
Sometimes demand and supply are given as equations. stands for quantity demanded, for quantity supplied and for price in dollars. Suppose and . At equilibrium the two quantities are equal, so write . Add to both sides and subtract 20 from both sides to collect the terms.
So the equilibrium price is $10. Put it back into the demand equation to get the quantity: . Always check with the other equation: . Both give 80, so 80 units are bought and sold.
Shifts versus movements along a curve
This is the idea students mix up most. When the product's own price changes, buyers and sellers simply move along the curves they already have: that is a change in quantity demanded or quantity supplied. When something other than the price changes, the whole curve shifts: that is a change in demand or a change in supply. A shift to the right means more is bought or sold at every price; a shift to the left means less.
| Factor | Curve it shifts | Example and direction |
|---|---|---|
| Income | Demand | Students get summer jobs and have more to spend on sneakers: demand shifts right |
| Trends and tastes | Demand | A celebrity is seen wearing a brand of sneakers: demand shifts right |
| Prices of related goods | Demand | Consoles drop in price, so demand for games shifts right (complements); coffee prices jump, so demand for tea shifts right (substitutes) |
| Number of buyers | Demand | A new subdivision opens near a bakery: demand shifts right |
| Expectations | Demand | Buyers expect prices to rise next month, so they buy now: demand shifts right |
| Input costs | Supply | The price of flour rises, so bakeries make fewer loaves at each price: supply shifts left |
| Technology | Supply | A faster oven means more loaves at each price: supply shifts right |
| Number of sellers | Supply | Two bakeries in town close: supply shifts left |
| Weather | Supply | A drought or early frost ruins part of the apple crop: supply shifts left |