Demand and Supply

Figure 1

Demand Curve

Demand curve is the graphical representation of the relationship between price and quantity demanded of a particular product or service.  Based on Figure 1, it is pretty clear that when price goes up, quantity demanded goes down and vice versa, other things remain constant. This shows that the price and quantity demanded are inversely related, as a result, demand curve is slopes downward to the right. This is consistent with the law of demand. The law of demand stated that:

                Quantity demanded falls when price rises, other things remain constant.

                Quantity demanded rises when price falls, other things remain constant.

The law of demand is fundamental to the invisible hand’s theory and shows its ability to coordinate individuals’ desires. For instance, as prices change, people tend to change their buying behaviors.

As mentioned above, economist have make an important assumption which is other things are held constant. The factors that are held constant include consumer income, tastes, expectations, prices of other goods, taxes and subsidies. These factors must remain constant because they will affect demand of a good besides the price effect.   

Figure 2

Supply Curve  

Supply curve is a graphical representation of the relationship between price and quantity supplied. The supply curve is shown in Figure 2. Notice that the supply curve is slopes upward to the right. The upward slope curve captures the law of supply which stated that the quantity supplied of a good or service is affected by the price of that good or service when other things remain constant. The law of supply states:

             Quantity supplied falls when price falls, other things remain constant.  

Quantity supplied rises when price rises, other things remain constant.

The law of supply is based on the firm’s ability to substitute its production of one good for another, or vice versa. When the price of a good rises, firms tend to supply more of that good to the market. The reason is the opportunity cost of not producing the good rises as its price rises. For instance, if the price of wheat rises and the price of corn remains the same, farmers sure will grow more wheat instead of corn, other things remain constant.    

Lastly, the other things that are held constant in supply include firm’s cost of production, technology level, expectations of future price movements, government taxes and subsidies. 

Figure 3

The Interaction of Demand and Supply Curves

Equilibrium

Figure 3 shows the equilibrium in an economy by combining both demand and supply curves together. In economics, equilibrium often refers to a situation when the upward pressure on price is exactly offset by the downward pressure on price. In other words, at the equilibrium price, quantity demanded must equals to the quantity supplied or the intersection point of demand and supply curves. Equilibrium quantity is the quantity of goods sold and bought at the equilibrium price. Equilibrium price is the price toward which the invisible hand drives the market. When equilibrium is achieved in economy, the allocation of goods and services is at its most efficient level since the quantity of goods being supplied is exactly same as the quantity of goods being demanded. This implies that every unit (countries, firms, and individuals) in an economy are satisfied with the current economic condition.     

Figure 4

Disequilibrium

Disequilibrium occurs in a country when the price (P) or quantity (Q) is not equal to the equilibrium price (P_e) or equilibrium quantity (Q_e). Disequilibrium happens either due to excess supply or demand of goods.

Excess Supply

Excess supply or surplus is a phenomenon when the quantity supplied is greater than quantity demanded in a market. As shown in Figure 4, when the price (P) is set too high or above the equilibrium price (P_e), some producers or suppliers in the market won’t be able to sell all their goods. For instance, at price P2, the quantity demanded by consumers is at Q₁, which is much lesser than quantity supplied by suppliers at Q₂. Since Q₂ is greater than Q₁, the goods in the market are over supplied or too much being produced and too little being consumed. As that happens, suppliers with excess goods will try to lower down their product’s price in order to create more demand. Thus, the price in the market will fall from P2 to P_e. Consumers will increase their consumption by buying more goods in the market when the price falls.  

Excess Demand

Similar with excess supply, excess demand in an economy will cause the disequilibrium. Excess demand or shortage is defined as a situation when the quantity demanded of a product is greater than quantity supplied of that product. Refer to Figure 5, shortage occurs when the price (P) is below the equilibrium price (P_e). For example, at price P1, the quantity of goods demanded by consumers is Q₂ but the quantity of goods supplied by producers is only at Q₁. Thus, there are more consumers who want the good than there are suppliers selling the same good. Since there are too little of goods in the market, consumers have to compete among themselves to buy the good at price P. The increase in demand will push the price upwards from P1 to P_e. Suppliers will be pleased and continue to supply more goods in the market. 

Demand and Supply

Figure 1

Demand Curve

Demand curve is the graphical representation of the relationship between price and quantity demanded of a particular product or service.  Based on Figure 1, it is pretty clear that when price goes up, quantity demanded goes down and vice versa, other things remain constant. This shows that the price and quantity demanded are inversely related, as a result, demand curve is slopes downward to the right. This is consistent with the law of demand. The law of demand stated that:

                Quantity demanded falls when price rises, other things remain constant.

                Quantity demanded rises when price falls, other things remain constant.

The law of demand is fundamental to the invisible hand’s theory and shows its ability to coordinate individuals’ desires. For instance, as prices change, people tend to change their buying behaviors.

As mentioned above, economist have make an important assumption which is other things are held constant. The factors that are held constant include consumer income, tastes, expectations, prices of other goods, taxes and subsidies. These factors must remain constant because they will affect demand of a good besides the price effect.   

Figure 2

Supply Curve  

Supply curve is a graphical representation of the relationship between price and quantity supplied. The supply curve is shown in Figure 2. Notice that the supply curve is slopes upward to the right. The upward slope curve captures the law of supply which stated that the quantity supplied of a good or service is affected by the price of that good or service when other things remain constant. The law of supply states:

             Quantity supplied falls when price falls, other things remain constant.  

Quantity supplied rises when price rises, other things remain constant.

The law of supply is based on the firm’s ability to substitute its production of one good for another, or vice versa. When the price of a good rises, firms tend to supply more of that good to the market. The reason is the opportunity cost of not producing the good rises as its price rises. For instance, if the price of wheat rises and the price of corn remains the same, farmers sure will grow more wheat instead of corn, other things remain constant.    

Lastly, the other things that are held constant in supply include firm’s cost of production, technology level, expectations of future price movements, government taxes and subsidies. 

Figure 3

The Interaction of Demand and Supply Curves

Equilibrium

Figure 3 shows the equilibrium in an economy by combining both demand and supply curves together. In economics, equilibrium often refers to a situation when the upward pressure on price is exactly offset by the downward pressure on price. In other words, at the equilibrium price, quantity demanded must equals to the quantity supplied or the intersection point of demand and supply curves. Equilibrium quantity is the quantity of goods sold and bought at the equilibrium price. Equilibrium price is the price toward which the invisible hand drives the market. When equilibrium is achieved in economy, the allocation of goods and services is at its most efficient level since the quantity of goods being supplied is exactly same as the quantity of goods being demanded. This implies that every unit (countries, firms, and individuals) in an economy are satisfied with the current economic condition.     

Figure 4

Disequilibrium

Disequilibrium occurs in a country when the price (P) or quantity (Q) is not equal to the equilibrium price (P_e) or equilibrium quantity (Q_e). Disequilibrium happens either due to excess supply or demand of goods.

Excess Supply

Excess supply or surplus is a phenomenon when the quantity supplied is greater than quantity demanded in a market. As shown in Figure 4, when the price (P) is set too high or above the equilibrium price (P_e), some producers or suppliers in the market won’t be able to sell all their goods. For instance, at price P2, the quantity demanded by consumers is at Q₁, which is much lesser than quantity supplied by suppliers at Q₂. Since Q₂ is greater than Q₁, the goods in the market are over supplied or too much being produced and too little being consumed. As that happens, suppliers with excess goods will try to lower down their product’s price in order to create more demand. Thus, the price in the market will fall from P2 to P_e. Consumers will increase their consumption by buying more goods in the market when the price falls.  

Excess Demand

Similar with excess supply, excess demand in an economy will cause the disequilibrium. Excess demand or shortage is defined as a situation when the quantity demanded of a product is greater than quantity supplied of that product. Refer to Figure 5, shortage occurs when the price (P) is below the equilibrium price (P_e). For example, at price P1, the quantity of goods demanded by consumers is Q₂ but the quantity of goods supplied by producers is only at Q₁. Thus, there are more consumers who want the good than there are suppliers selling the same good. Since there are too little of goods in the market, consumers have to compete among themselves to buy the good at price P. The increase in demand will push the price upwards from P1 to P_e. Suppliers will be pleased and continue to supply more goods in the market.