Supply And Demand

Laws of

Supply and Demand

The market price of a good is determined by both the supply and demand for it. In the world today supply and demand is perhaps one of the most fundamental principles that exists for economics and the backbone of a market economy. Supply is represented by how much the market can offer. The quantity supplied refers to the amount of a certain good that producers are willing to supply for a certain demand price. What determines this interconnection is how much of a good or service is supplied to the market or otherwise known as the supply relationship or supply schedule which is graphically represented by the supply curve. In demand the schedule is depicted graphically as the demand curve which represents the amount of goods that buyers are willing and able to purchase at various prices, assuming all other non-price factors remain the same. The demand curve is almost always represented as downwards-sloping, meaning that as price decreases, consumers will buy more of the good. Just as the supply curves reflect marginal cost curves, demand curves can be described as marginal utility curves. The main determinants of individual demand are the price of the good, level of income, personal tastes, the population, government policies, the price of substitute goods, and the price of complementary goods.

When a suppliers' costs changes for a given output, the supply curve shifts in the same direction. For example, assume that someone invents a better way of growing corn so that the cost of corn that can be grown for a given quantity will decrease. Basically producers will be willing to supply more corn at every price and this shifts the supply curve outward, an increase in supply. This increase in supply will cause the equilibrium price to decrease. The equilibrium quantity increases as the quantity demanded increases at the new lower prices. This causes the price and the quantity move in opposite directions in a supply curve shift. Also, if the quantity supplied decreases at any given price the opposite will happen.

A sudden increase or decrease in the supply of a particular good is also known as a supply shock. A supply shock is an event that suddenly changes the price of a product or service. This sudden change affects the equilibrium price. The two types of supply shocks that exist are the Negative Supply shock and the Positive Supply shock. A negative supply shock, which is a sudden supply decrease, will raise the prices and shift the aggregate supply curve to the left. A negative supply shock can cause stagflation due to the combination of raising prices and the falling output. Meanwhile a positive supply shock, an increase in supply, will lower the price of a good and shift the aggregate supply curve to the right. A positive supply shock could be advancement in technology which most certainly makes production more efficient which thus increases output. For example a positive supply shock could be shown in the early 1990s when communication and information technology exploded which resulted directly in productivity increase, and an example of a negative supply shock would be that of the high oil prices associated with Arab oil embargo of the early 70s is the classic example of this occurrence. Any other factor could also produce this effect. Such as if the sudden doubling of the Federal minimum wage and all being equal could cause a supply shock.

Occasionally, supply curves do slope upwards, for example the backward bending supply curve of labor. As a worker’s wage increases, that worker is willing to supply a greater amount of labor since the higher wage increases the marginal utility of working. The backwards bending supply curve has also been observed in non-labor markets such as the market for oil. During the 1973 oil crisis many oil-exporting countries decreased their production of oil. Also in some cases the supply curve can be vertical. Which represents that the quantity supplied is fixed, no matter what the market price is. For instance, the surface area or land of the world is fixed. It does not matter how much someone would be willing to offer for an additional piece, the extra piece cannot be produced, and vice versa, even if no one wanted the land, it still would exist. Land therefore has a vertical supply curve, giving it zero elasticity. It does not matter how much the change in price is, the quantity supplied will not change regardless.

One of the most important building blocks of economic analysis is the concept of demand. The most famous law in economics, and the one that economists are most sure of, is the law of demand. The law of demand states that when the price of a good rises, the amount demanded falls, and when the price falls, the amount demanded rises. When economists refer to demand, they usually have in mind not just a single quantity demanded, but what is called a demand curve. A demand curve traces the quantity of a good or service that is demanded at successively different prices.

Some of the modern evidence for the law of demand is from econometric studies which show that, all other things being equal, when the price of a good rises, the amount of it demanded decreases. How do we know that there are no instances in which the amount demanded rises and the price rises? A few instances have been cited, but they almost always have an explanation that takes into account something other than price. Nobel Laureate George Stigler responded years ago that if any economist found a true counterexample, he would be "assured of immortality, professionally speaking, and rapid promotion." And because, wrote Stigler, most economists would like either reward, the fact that no one has come up with an exception to the law of demand shows how rare the exceptions must be. But the reality is that if an economist reported an instance in which consumption of a good rose as its price rose, other economists would assume that some factor other than price caused the increase in demand.

The main reason economists believe so strongly in the law of demand is that it is so plausible, even to non-economists. Indeed, the law of demand is ingrained in our way of thinking about everyday things. Shoppers buy more strawberries when they are in season and the price

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