Introduction to Supply and Demand

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Introduction to Microeconomics

1. A Practical Guide to Microeconomics
2. Economists' Assumptions in their Economic Models
3. 5 Nobel Prize-Winning Economic Theories
4. Understanding Positive vs. Normative Economics
5. What Factors Influence Competition in Microeconomics?
6. How Does Government Policy Impact Microeconomics?

Microeconomics vs. Macroeconomics

1. Understanding Microeconomics vs. Macroeconomics
2. Differentiate Between Micro and Macro Economics
3. Microeconomics vs. Macroeconomics Investments

Supply and Demand Basics

1. Elasticity
2. Price Elasticity of Demand
3. Understanding Elasticity vs. Inelasticity of Demand
4. Inelastic
5. Factors Determining the Demand Elasticity of a Good
6. What Factors Influence a Change in Demand Elasticity?

1. Utility
2. What Is the Concept of Utility in Microeconomics?
3. What Is the Utility Function and How Is it Calculated?
4. Total Utility
5. Marginal Utility
6. Law Of Diminishing Marginal
7. What Does the Law of Diminishing Marginal Utility Explain?

1. Economic Equilibrium
2. Income Effect
3. Indifference Curve
4. Consumer Surplus
5. Comparative Advantage
6. Economies of Scale: What Are They and How Are They Used?
7. Perfect Competition
8. Invisible Hand
9. Market Failure

The law of supply and demand is a fundamental concept of economics and a theory popularized by Adam Smith in 1776. The principles of supply and demand are effective in predicting market behavior. Whether an individual is a manufacturer or a consumer, the supply and demand equilibrium is relevant in daily market transactions.

Key Takeaways

• The law of supply and demand was popularized by Adam Smith in 1776.
• Consumer demand for a good commonly decreases as its price rises.
• As prices of a good increase, producers manufacture more to realize more profits.

Consumer Demand

Consumer demand for a good commonly decreases as its price rises. The figure below depicts the relationship between the price of a good and its demand from the consumer's standpoint. The demand curve is portrayed from the view of the consumer, whereas supply graphs are drawn from the producer's perspective.

If televisions were priced at $5 each, then consumers would purchase them and probably buy more TVs than they need based on price. The demand will remain high. If the price is $50,000, this good would likely be considered a luxury good, and demand would be low.

Demand is the quantity of a good that consumers are willing and able to purchase at various prices at a given time.

This example assumes that product differentiation does not exist. There is only one type of product sold at a single price to every consumer. In this closed scenario, the item is not an essential human necessity such as food or shelter, does not have a substitute, and consumers expect prices to remain stable.

Explaining Supply

The supply curve considers the relationship between the price and available supply of an item from the producer's perspective rather than the consumer's.

When prices of a product increase, producers are willing to manufacture more of the product to realize greater profits. Falling prices depress production as producers may not recover input costs. If the costs to produce a TV are $50, production would be unprofitable when the selling price of the TV falls below $50.

If television prices are $1,000, manufacturers will focus on producing television sets over ventures and provide incentives to build more TVs. The behavior to seek maximum profits forces the supply curve to be upward-sloping.

An underlying assumption of the theory lies in the producer taking on the role of a price taker. Rather than dictating the prices of the product, this input is determined by the market, and suppliers only face the decision of how much to produce, given the market price. Optimal scenarios are not always the case, such as in monopolistic markets.

Finding Equilibrium

Consumers typically look for the lowest cost, and producers test their products at the highest price. When prices become unreasonable, consumers change their preferences and move away from the product.

A proper balance must be achieved where both parties engage in ongoing business transactions to benefit consumers and producers. In supply and demand theory, the optimal price that results in producers and consumers achieving the maximum combined utility occurs where the supply and demand lines intersect.

In What Types of Economies Are Laws of Supply and Demand Less Reliable?

If the economic environment is not a free market, supply and demand are not influential factors. In socialist economic systems, the government typically sets commodity prices regardless of the supply or demand conditions.

Does the Law of Supply and Demand Determine Market Conditions?

Multiple factors affect markets on both a microeconomic and a macroeconomic level. Supply and demand guide market behavior but do not determine it. Supply and demand are important factors, and Adam Smith referred to them as the invisible hand that guides a free market.

Does the Law of Supply and Demand Apply Only to Consumer Goods?

The theory of supply and demand relates not only to physical products such as television sets but also to wages and labor. More advanced theories of microeconomics and macroeconomics often adjust the assumptions and appearance of the supply and demand curve to illustrate concepts like economic surplus, monetary policy, aggregate supply and demand, fiscal stimulation, elasticity, and shortfalls.

The Bottom Line

The market theory of supply and demand was popularized by Adam Smith in 1776. Consumer demand for a good decreases as its price rises. As prices rise, producers manufacture more to gain more profits. The optimal price that shows an equilibrium between supply and demand is where the supply and demand lines intersect on a graph.

Introduction to Microeconomics

1. A Practical Guide to Microeconomics
2. Economists' Assumptions in their Economic Models
3. 5 Nobel Prize-Winning Economic Theories
4. Understanding Positive vs. Normative Economics
5. What Factors Influence Competition in Microeconomics?
6. How Does Government Policy Impact Microeconomics?

Microeconomics vs. Macroeconomics

1. Understanding Microeconomics vs. Macroeconomics
2. Differentiate Between Micro and Macro Economics
3. Microeconomics vs. Macroeconomics Investments

Supply and Demand Basics

1. Elasticity
2. Price Elasticity of Demand
3. Understanding Elasticity vs. Inelasticity of Demand
4. Inelastic
5. Factors Determining the Demand Elasticity of a Good
6. What Factors Influence a Change in Demand Elasticity?

1. Utility
2. What Is the Concept of Utility in Microeconomics?
3. What Is the Utility Function and How Is it Calculated?
4. Total Utility
5. Marginal Utility
6. Law Of Diminishing Marginal
7. What Does the Law of Diminishing Marginal Utility Explain?

1. Economic Equilibrium
2. Income Effect
3. Indifference Curve
4. Consumer Surplus
5. Comparative Advantage
6. Economies of Scale: What Are They and How Are They Used?
7. Perfect Competition
8. Invisible Hand
9. Market Failure

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