Supply, Demand, and Market Equilibrium
Every February 14, the price of roses shoots up in the Xochimilco markets and at flower shops across the country; on the 15th, it drops again. Nobody decrees that change: it comes from the clash between how many flowers people want to buy and how many the producers are willing to sell. Understanding that clash is the foundation of microeconomics.
Demand and supply: definition, law, and determinants
An organized way to study each concept is to fill out a fact sheet with three pieces of information: what it is, what law it follows, and what else it depends on.
| Fact sheet | Demand | Supply |
|---|---|---|
| Who? | Buyers (households, firms) | Sellers (producers) |
| Law | Price ↑ → Qd ↓ | Price ↑ → Qs ↑ |
| Determinants (besides price) | Income, tastes, prices of related goods, number of buyers, expectations | Production costs, technology, number of sellers, weather, taxes and subsidies, expectations |
The determinants are analyzed under the ceteris paribus assumption ("all else held constant"): you change one thing at a time to see its effect.
Explain what the demand for a good is and state the law of demand. Illustrate it with an example: what happens to concert tickets if their price falls by half?
Explain what the demand for a good is and state the law of demand. Illustrate it with an example: what happens to concert tickets if their price falls by half?
Explain what supply is and state the law of supply. Why does a farmer bring more strawberries to the market when their price is high?
Explain what supply is and state the law of supply. Why does a farmer bring more strawberries to the market when their price is high?
From the table to the graph: equilibrium
A table with price, Qd, and Qs is the clearest way to see the market. Example: bouquets of flowers on Valentine's Day, bouquets per day (thousands).
| Price P (pesos per bouquet) | Qd | Qs | Situation |
|---|---|---|---|
| 60 | 20 | 80 | Surplus (Qs > Qd) |
| 50 | 30 | 60 | Surplus |
| 40 | 40 | 40 | Equilibrium |
| 30 | 50 | 20 | Shortage (Qd > Qs) |
| 20 | 60 | 0 | Shortage |
To graph it, you put price on the vertical axis and quantity on the horizontal axis. Each column (Qd and Qs) gives a series of points; connecting them produces the curves.
Move demand and supply and watch how the equilibrium changes.
The figure shows the supply and demand curves for the sandwich market in a city, with the price in monetary units and the quantity in thousands of sandwiches. a) Read…
The figure shows the supply and demand curves for the sandwich market in a city, with the price in monetary units and the quantity in thousands of sandwiches.
- a) Read the equilibrium price and quantity from the graph.
- b) Explain what the intersection point of the curves represents.
Movements along the curve and shifts of the curve
In a table, a shift shows up as two columns of quantity. If demand for flowers rises because of a fad:
| P | Qd before | Qd after | Qs |
|---|---|---|---|
| 50 | 30 | 50 | 60 |
| 40 | 40 | 60 | 40 |
| 30 | 50 | 70 | 20 |
New equilibrium: at $\$50$ there is Qd = 50 and Qs = 60 (still a surplus); at $\$40$ there is Qd = 60 and Qs = 40 (now a shortage). The price that equalizes both quantities lies between the two, close to $\$47$, with a quantity of about 53. Compared with the original equilibrium ($\$40$ and 40), the equilibrium price and quantity both rise.
Family income in a neighbourhood rises. Explain, using the supply and demand model, what will happen to the equilibrium in the market for restaurant dinners (a normal…
Family income in a neighbourhood rises. Explain, using the supply and demand model, what will happen to the equilibrium in the market for restaurant dinners (a normal good): which curve moves, in which direction, and what happens to the equilibrium price and quantity.
A frost destroys half of the strawberry crop just before the peak season. a) Analyse using the model which curve shifts, in which direction, and what happens to the new…
A frost destroys half of the strawberry crop just before the peak season.
- a) Analyse using the model which curve shifts, in which direction, and what happens to the new equilibrium.
- b) Who gains and who loses from the frost? Consider separately the farmers who saved their crop, those who lost it, and consumers.
Related goods and other determinants
At a price of $\$80$, students in a city demand $100$ smoothies a day; at $\$120$, only $60$. a) Plot these two points on price and quantity axes (you may draw them) and…
At a price of $\$80$, students in a city demand $100$ smoothies a day; at $\$120$, only $60$.
- a) Plot these two points on price and quantity axes (you may draw them) and explain whether they conform to the law of demand.
- b) State two factors, other than price, that could shift this demand and state in which direction they would do so.
Price ceilings and price floors
Sometimes the government steps in by setting a price (see its role as a regulator in economic systems).
Back to the beginning: the price of roses rises on February 14 because demand shifts to the right while supply, in the short run, hardly moves: the new equilibrium has a higher price.
The municipality sets the entrance fee for the municipal swimming pool at $\$40$ when the equilibrium price would be $\$100$. a) Explain, using the model, what imbalance…
The municipality sets the entrance fee for the municipal swimming pool at $\$40$ when the equilibrium price would be $\$100$.
- a) Explain, using the model, what imbalance occurs (shortage or surplus) and why.
- b) What rationing mechanisms might emerge in response to this imbalance? Name two and comment on them.
A festival sells out its $20,000$ tickets at $\$1\,200$ in a few hours and the next day they are resold for $\$3\,000$ on the internet. a) Analyse using supply and…
A festival sells out its $20,000$ tickets at $\$1\,200$ in a few hours and the next day they are resold for $\$3\,000$ on the internet.
- a) Analyse using supply and demand why reselling occurs.
- b) Assess two solutions (a higher initial price, named tickets) and their effects on fans and on the organisers.
Every September, thousands of students look for an apartment at the same time in the same university town and rents skyrocket; in June, many apartments are left empty.…
Every September, thousands of students look for an apartment at the same time in the same university town and rents skyrocket; in June, many apartments are left empty.
- a) Explain the two seasonal equilibria using shifts in supply or demand.
- b) Propose two measures (one public and one market-based) to ease the problem and analyze their effects.