Supply, Demand, and Market Equilibrium
Core concepts
Law of demand: as price rises, quantity demanded falls (inverse relationship), other things equal. Law of supply: as price rises, quantity supplied rises. Equilibrium occurs where quantity demanded equals quantity supplied; at that price there is no tendency to change.
Critical distinctions:
- A change in quantity demanded/supplied is a movement along the curve, caused only by a price change.
- A change in demand/supply is a shift of the curve, caused by non-price factors.
Demand shifters: income (normal vs. inferior goods), prices of substitutes and complements, tastes, expectations, number of buyers. Supply shifters: input costs, technology, taxes/subsidies, expectations, number of sellers, weather (for agriculture).
Disequilibrium: a surplus (excess supply) pushes price down; a shortage (excess demand) pushes price up. Simultaneous shifts can make either price or quantity change ambiguous - analyze one shift at a time.
Common traps
- Shifting the demand curve when only price changes (that is a movement along the curve).
- Confusing a change in demand with a change in quantity demanded.
- Assuming a price change shifts supply; it only changes quantity supplied.
- Forgetting that "other things equal" is required for the laws to hold.
Worked example
New technology lowers the cost of producing smartphones. Supply shifts right; at the old price there is a surplus, so price falls and quantity rises. Demand is unchanged. Result: lower equilibrium price, higher equilibrium quantity.
Rule of thumb
Price changes move you along a curve; non-price factors shift the curve. Equilibrium price rises when demand rises or supply falls; quantity rises when demand rises or supply rises.