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💵principles of macroeconomics review

Supply and Demand Theory

Written by the Fiveable Content Team • Last updated September 2025
Written by the Fiveable Content Team • Last updated September 2025

Definition

Supply and demand theory is a fundamental economic concept that explains how the price and quantity of a good or service is determined by the interaction between the supply of that good or service and the demand for it. It is a widely used model to analyze and understand various economic issues.

5 Must Know Facts For Your Next Test

  1. The supply and demand theory states that the price of a good or service is determined by the interaction between the willingness of buyers to purchase (demand) and the willingness of sellers to supply that good or service.
  2. The law of supply states that as the price of a good or service increases, the quantity supplied also increases, and vice versa.
  3. The law of demand states that as the price of a good or service increases, the quantity demanded decreases, and vice versa.
  4. The equilibrium price is the price at which the quantity supplied and the quantity demanded are equal, resulting in a stable market condition.
  5. Shifts in the supply or demand curve can lead to changes in the equilibrium price and quantity, which can have significant implications for the market.

Review Questions

  • Explain how the supply and demand theory can be used to understand economic issues.
    • The supply and demand theory is a fundamental tool used by economists to analyze and understand various economic issues. By examining the factors that influence the supply and demand of a good or service, economists can predict how changes in these factors will affect the equilibrium price and quantity in the market. This understanding can then be applied to analyze the impact of government policies, technological advancements, changes in consumer preferences, and other economic events on the market.
  • Describe the relationship between the supply curve and the demand curve in determining the equilibrium price and quantity.
    • The equilibrium price and quantity are determined by the intersection of the supply curve and the demand curve. The supply curve represents the willingness of sellers to supply a good or service at different prices, while the demand curve represents the willingness of buyers to purchase the good or service at different prices. The point where the supply and demand curves intersect is the equilibrium, where the quantity supplied is equal to the quantity demanded, and the price is the equilibrium price. Any changes in the factors that influence supply or demand will shift the respective curve, leading to a new equilibrium price and quantity.
  • Analyze how the supply and demand theory can be used to understand the impact of a government policy, such as a price ceiling or a price floor, on the market equilibrium.
    • The supply and demand theory can be used to understand the impact of government policies, such as price ceilings and price floors, on the market equilibrium. A price ceiling, which is a legal maximum price set by the government, will create a shortage in the market if the ceiling is set below the equilibrium price. Conversely, a price floor, which is a legal minimum price set by the government, will create a surplus in the market if the floor is set above the equilibrium price. By analyzing the shifts in the supply and demand curves caused by these policies, economists can predict the changes in the equilibrium price and quantity, as well as the resulting effects on consumer and producer welfare.