Supply and Demand

Definition

Supply and demand are fundamental economic concepts that describe the relationship between the availability of a product (supply) and the desire for that product (demand). This interaction determines the price of goods and services in a market economy, illustrating how various economic agents, including consumers and producers, interact to establish market equilibrium.

5 Must Know Facts For Your Next Test

1. When demand increases and supply remains unchanged, prices tend to rise due to increased competition among consumers for limited goods.
2. Conversely, when supply increases without a corresponding increase in demand, prices usually decrease as producers compete to sell their excess inventory.
3. Shifts in supply and demand curves can result from factors such as changes in consumer preferences, technological advancements, or external economic conditions.
4. The law of demand states that, all else being equal, as the price of a good decreases, the quantity demanded increases, and vice versa.
5. Similarly, the law of supply indicates that an increase in price leads to an increase in quantity supplied, as producers are more willing to produce more at higher prices.

Review Questions

• How does an increase in consumer income affect the supply and demand for normal goods?
  • An increase in consumer income generally leads to a higher demand for normal goods because consumers have more money to spend. This shift in demand can result in an upward pressure on prices if supply remains constant. Producers may respond to this increased demand by raising prices or increasing production to meet the new level of demand.
• Analyze how government interventions, such as price controls, impact the natural dynamics of supply and demand.
  • Government interventions like price ceilings or floors disrupt the natural equilibrium established by supply and demand. For instance, a price ceiling set below the market equilibrium can lead to shortages because it encourages higher demand while discouraging supply. Conversely, a price floor above equilibrium can create surpluses since producers are willing to supply more than consumers are willing to purchase at that price.
• Evaluate the implications of elasticity on consumer behavior during periods of price fluctuations.
  • Elasticity measures how responsive the quantity demanded or supplied is to changes in price. In markets with high elasticity, small changes in price can lead to significant changes in quantity demanded. This responsiveness implies that during price fluctuations, consumers may quickly adjust their purchasing habits based on their perception of value. For example, if prices rise significantly for a luxury item with high elasticity, consumers might opt for substitutes or reduce overall spending on that item.

Related terms

Market Equilibrium: The point where the quantity supplied equals the quantity demanded, resulting in a stable market price.

Elasticity: A measure of how much the quantity demanded or supplied changes in response to a change in price.

Price Controls: Government-imposed limits on how high or low a price can be charged for a product, which can disrupt the natural balance of supply and demand.