 The law of supply and demand defines

the effect that the availability of a particular

product and the desire (or demand) for that
product has on price. Generally, if there is a
low supply and a high demand, the
price will be high. In contrast, the greater
the supply and the lower the demand, the
lower the price will be
 The law of supply and demand is not
an actual law but it is well confirmed
and understood realization that if you
have a lot of one item, the price for
that item should go down. At the
same time you need to understand the
interaction; even if you have a high
supply, if the demand is also high, the
price could also be high.
 Supply and demand is perhaps one of the
most fundamental concepts of economics
and it is the backbone of a market economy.
Demand refers to how much (quantity) of a
product or service is desired by buyers. The
quantity demanded is the amount of a
product people are willing to buy at a certain
price; the relationship between price and
quantity demanded is known as the demand
relationship.
 Supply represents how much the market can
offer. The quantity supplied refers to the
amount of a certain good producers are
willing to supply when receiving a certain
price. The correlation between price and how
much of a good or service is supplied to the
market is known as the supply relationship.
Price, therefore, is a reflection of supply and
demand.
 A. The Law of Demand
The law of demand states that, if all other factors
remain equal, the higher the price of a good, the less
people will demand that good. In other words, the
higher the price, the lower the quantity demanded.
The amount of a good that buyers purchase at a
higher price is less because as the price of a good
goes up, so does the opportunity cost of buying that
good. As a result, people will naturally avoid buying a
product that will force them to forgo the
consumption of something else they value more. The
chart below shows that the curve is a downward
slope.
 A, B and C are points on the demand curve.
Each point on the curve reflects a direct
correlation between quantity demanded (Q)
and price (P). So, at point A, the quantity
demanded will be Q1 and the price will be P1,
and so on. The demand relationship curve
illustrates the negative relationship between
price and quantity demanded. The higher the
price of a good the lower the quantity
demanded (A), and the lower the price, the
more the good will be in demand (C).
The Law of Demand states
that other things held
constant, as the price of a
good increases, the quantity
demanded will fall. Other
factors that can influence
demand include:
 1.Income - Generally, as income
increases, we are able to buy
more of most goods. When
demand for a good increases
when incomes increase, we call
that good a "normal good". When
demand for a good decreases
when incomes increase, then that
good is called an inferior good.
 2.Price of related products - Related goods
come in two types, the first of which are
"substitutes". Substitutes are similar products
that can be used as alternatives. Examples of
substitute goods are Coke/Pepsi, and
butter/margarine. Usually, people substitute
away to the less expensive good. Other
related products are classified as
"complements". Complements are products
that are used in conjunction with each other.
Examples of complements are pencil/eraser,
left/right shoes, and coffee/sugar.
 3.Tastes and preferences - Tastes are
a major determinant of the demand
for products, but usually does not
change much in the short run.
 4.Expectations - When you expect the

price of a good to go up in the future,

you tend to increase your demand
today. This is another example of the
rule of substitution, since you are
substituting away from the expected
relatively more expensive future
consumption.
 Demand curves isolate the relationship between
quantity demanded and the price of the product,
while holding all other influences constant (in
latin: ceteris paribus). These curves show how
many of a product will be purchased at different
prices. Note that demand is represented by the
entire curve, not just one point on the curve, and
represents all the possible price-quantity choices
given the ceteris paribus assumptions. When the
price of the product changes, quantity demanded
changes, but demand does not change. Price
changes involve a movement along the existing
demand curve.
 Market demand is the summation
of all the individual demand
curves of those in the market. It is
the horizontal sum of individual
curves and add up all the
quantities demanded at each
price. The main interest is in
market demand curves, because
they are averages of individual
behavior tend to be well-behaved.
 When any influence other than the
price of the product changes, such as
income or tastes, demand changes,
and the entire demand curve will shift
(either upward or downward). A shift
to the right (and up) is called an
increase in demand, while a shift to
the left (and down) is called a
decrease in demand. For example,
there are two ways to discourage
smoking: raise the price through taxes
or; make the taste less desirable.
Like the law of demand, the law of supply
demonstrates the quantities that will be
sold at a certain price. But unlike the law of
demand, the supply relationship shows an
upward slope. This means that the higher
the price, the higher the quantity supplied.
Producers supply more at a higher price
because selling a higher quantity at a higher
price increases revenue.
 Asthe price of a product rises,
ceteris paribus, suppliers will
offer more for sale. This implies
that price and quantity supplied
are positively related. The major
factor that influences supply is
the "cost of production", and
includes:
 Input prices - As the prices of inputs such as
labour, raw materials, and capital increase,
production tends to be less profitable, and
less will be produced. This leads to a
decrease in supply.
 Technology - Technology relates to methods

of transforming inputs into outputs.

Improvements in technology will reduce the
costs of production and make sales more
profitable so it tends to increase the supply.
 Expectations - If firms expect prices to rise in

the future, may try to product less now and

more later.
 The relationship between the price of a
product and the quantity supplied, holding all
other things constant is generally sloping
upwards. Supply is represented by the entire
curve and not just one point on the curve.
When the price of the product changes, the
quantity supplied changes, but supply does
not change. When cost of production
changes, supply changes, and the entire
supply curve will shift.
 Market Supply is the summation of all
the individual supply curves, and is
the horizontal sum of individual
supply curves. It is influenced by the
factors that determine individual
supply curves, such as cost of
production, plus the number of
suppliers in the market. In general,
the more firms producing a product,
the greater the market supply.
 When quantity supplied at a given price
decreases, the whole curve shifts to the left
as there is a decrease in supply. This is
generally caused by an increase in the cost
of production or decrease in the number of
sellers. An increase in wages, cost of raw
materials, cost of capital, ceteris paribus,
will decrease supply. Sometimes weather
may also affect supply, if the raw materials
are perishable or unattainable due to
transportation problems.
A, B and C are points on the
supply curve. Each point on
the curve reflects a direct
correlation between quantity
supplied (Q) and price (P). At
point B, the quantity supplied
will be Q2 and the price will be
P2, and so on.
 Time and Supply
Unlike the demand relationship, however, the
supply relationship is a factor of time. Time
is important to supply because suppliers
must, but cannot always, react quickly to a
change in demand or price. So it is important
to try and determine whether a price change
that is caused by demand will be temporary
or permanent.
 Let's say there's a sudden increase in the
demand and price for umbrellas in an
unexpected rainy season; suppliers may
simply accommodate demand by using their
production equipment more intensively. If,
however, there is a climate change, and the
population will need umbrellas year-round,
the change in demand and price will be
expected to be long term; suppliers will have
to change their equipment and production
facilities in order to meet the long-term
levels of demand.
 C. Supply and Demand Relationship
Now that we know the laws of supply and demand, let's turn to an
example to show how supply and demand affect price.
Imagine that a special edition CD of your favorite band is
released for $20. Because the record company's previous analysis
showed that consumers will not demand CDs at a price higher
than $20, only ten CDs were released because the opportunity cost
is too high for suppliers to produce more. If, however, the ten CDs
are demanded by 20 people, the price will subsequently rise
because, according to the demand relationship, as demand
increases, so does the price. Consequently, the rise in price should
prompt more CDs to be supplied as the supply relationship shows
that the higher the price, the higher the quantity supplied.
 If, however, there are 30 CDs produced and
demand is still at 20, the price will not be
pushed up because the supply more than
accommodates demand. In fact after the 20
consumers have been satisfied with their
CD purchases, the price of the leftover CDs
may drop as CD producers attempt to sell
the remaining ten CDs. The lower price will
then make the CD more available to people
who had previously decided that the
opportunity cost of buying the CD at $20
was too high.
 When supply and demand are equal (i.e. when the supply
function and demand function intersect) the economy is
said to be at equilibrium. At this point, the allocation of
goods is at its most efficient because the amount of goods
being supplied is exactly the same as the amount of goods
being demanded. Thus, everyone (individuals, firms, or
countries) is satisfied with the current economic condition.
At the given price, suppliers are selling all the goods that
they have produced and consumers are getting all the
goods that they are demanding.
 As you can see on the chart, equilibrium occurs
at the intersection of the demand and supply
curve, which indicates no allocative inefficiency.
At this point, the price of the goods will be P*
and the quantity will be Q*. These figures are
referred to as equilibrium price and quantity.
In the real market place equilibrium can only
ever be reached in theory, so the prices of
goods and services are constantly changing in
relation to fluctuations in demand and supply.
 We can analyze how markets behave by matching
(or combining) the supply and demand curves.
Equilibrium is defined as the intersection of
supply and demand curves. The equilibrium price
is the price where the quantity demanded
matches the quantity supplied. The equilibrium
quantity is the quantity where price has adjusted
so that QD = QS. At the equilibrium price, the
quantity that buyers are willing to purchase
exactly equals the quantity the producers are
willing to sell. Actions of buyers and sellers
naturally tend to move a market towards the
equilibrium.
 Excess Supply is where Quantity supplied >
Quantity demanded, and results in
surpluses at the current price. A large
surplus is known as a "glut". In cases of
excess supply:
 price is too high to be at equilibrium
 suppliers find that inventories increase
 suppliers react by lowering prices
 this continues until price falls to equilibrium
 Excess Demand occurs when Quantity
demanded > Quantity supplied, and results in
shortages at current prices. In cases of
excess demand:
 buyers cannot buy all they want at the going
price
 sellers find that their inventories are
decreasing
 sellers can raise prices without losing sales
 prices increase until market reaches
equilibrium
 Disequilibrium occurs whenever the price
or quantity is not equal to P* or Q*.
1. Excess Supply
If the price is set too high, excess supply
will be created within the economy and
there will be allocative inefficiency.
 At price P1 the quantity of goods that the
producers wish to supply is indicated by Q2. At
P1, however, the quantity that the consumers
want to consume is at Q1, a quantity much less
than Q2. Because Q2 is greater than Q1, too
much is being produced and too little is being
consumed. The suppliers are trying to produce
more goods, which they hope to sell to
increase profits, but those consuming the
goods will find the product less attractive
and purchase less because the price is too
high.
 2.Excess Demand
Excess demand is created when
price is set below the equilibrium
price. Because the price is so
low, too many consumers want
the good while producers are not
making enough of it.
 In this situation, at price P1, the quantity of
goods demanded by consumers at this price
is Q2. Conversely, the quantity of goods that
producers are willing to produce at this price
is Q1. Thus, there are too few goods being
produced to satisfy the wants (demand) of
the consumers. However, as consumers have
to compete with one other to buy the good at
this price, the demand will push the price up,
making suppliers want to supply more and
bringing the price closer to its equilibrium.
For economics, the
“movements” and “shifts” in
relation to the supply and
demand curves represent very
different market phenomena:
 1. Movements
A movement refers to a change along a curve. On
the demand curve, a movement denotes a change
in both price and quantity demanded from one
point to another on the curve. The movement
implies that the demand relationship remains
consistent. Therefore, a movement along the
demand curve will occur when the price of the
good changes and the quantity demanded
changes in accordance to the original demand
relationship. In other words, a movement occurs
when a change in the quantity demanded is
caused only by a change in price, and vice versa.
 Like a movement along the demand curve, a
movement along the supply curve means that the
supply relationship remains consistent. Therefore,
a movement along the supply curve will occur when
the price of the good changes and the quantity
supplied changes in accordance to the original
supply relationship. In other words, a movement
occurs when a change in quantity supplied is
caused only by a change in price, and vice versa.
 A shift in a demand or supply curve occurs when
a good's quantity demanded or supplied changes
even though price remains the same. For
instance, if the price for a bottle of beer was $2
and the quantity of beer demanded increased
from Q1 to Q2, then there would be a shift in the
demand for beer. Shifts in the demand curve
imply that the original demand relationship has
changed, meaning that quantity demand is
affected by a factor other than price. A shift in
the demand relationship would occur if, for
instance, beer suddenly became the only type of
alcohol available for consumption.
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 Conversely, if the price for a bottle of beer was
$2 and the quantity supplied decreased from
Q1 to Q2, then there would be a shift in the
supply of beer. Like a shift in the demand
curve, a shift in the supply curve implies that
the original supply curve has changed, meaning
that the quantity supplied is effected by a
factor other than price. A shift in the supply
curve would occur if, for instance, a natural
disaster caused a mass shortage of hops; beer
manufacturers would be forced to supply less
beer for the same price.