by Chris Pearce

Created on: July 10, 2011

Supply and demand is used to determine prices of goods and services and is one of the basic principles in economics. Producers are willing to supply varying quantities of a good or service depending on the price they can obtain for it. Consumers will demand different amounts of the good or service based on the price they have to pay. At the price where the volume produced equals the quantity purchased, with neither a surplus nor any unmet demand, this is the equilibrium price paid and quantity produced for that good or service.

Supply and demand curves

Economists show the relationship between supply and demand on a graph. Price is shown on the vertical axis while quantity is on the horizontal axis. The supply curve for a good or service always slopes upward from left to right. This is because producers will want to supply more of a product the higher the price. By contrast, the demand curve nearly always slopes downward from left to right. The lower the price of the product, the more of it will be demanded by consumers.

Thus the supply curve and the demand curve will form a cross on the graph. Where they intersect will be the price at which all units of the good or service will be sold. In other words, the market is cleared at that price. The model assumes perfect competition with no firm or consumer having an influence on the price.

Changes in demand and supply

For just about any good or service, the quantity demanded by consumers is likely to change over time. Factors leading to a change in the quantity demanded include changes in income, prices of related products, tastes and preferences, and expectations of future prices. An increase in income levels due to a wage rise or tax cuts will usually result in consumers demanding a greater quantity of goods and services.

If the price of a particular good comes down, consumers are likely to demand a greater quantity of any complementary goods. For example, if computer prices fall, not only will demand for computers increase but so too will demand for goods such as computer accessories, printers, and electronic games. Conversely, if two products are clear substitutes, such as butter and margarine, a fall in the price of one will lead to a decrease in demand for the other.

Changes in tastes and preferences will result in shifts in the quantity demanded of various goods over time, for example, different styles of clothing. Expectations of price changes will play a role too. If people feel that the price of a product

• 1
• 2
• 3
• Next Page >>