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Supply and demand

СОДЕРЖАНИЕ: A theory of price. Analysis of Markets. Simple Supply and Demand curves. Demand curve shifts. Supply curve shifts. Effects of being away from the Equilibrium Point. Vertical Supply Curve. Other market forms. Discrete Example. Application: Subsidy.



Supply and demand








Supply and demand

1. A theory of price

What is it? The theory of supply and demand is a theory of price and output in competitive markets.

Adam Smith had argued that each good or service has a "natural price." If the price (of beer, for example), were above the natural price, then more resources would be attracted into the trade (brewing, in the example), and the price would return to its "natural" level. Conversely if the price began below its "natural" level.

The modern theory of supply and demand differs from Smith's theory in some important ways. Economists have made some progress in the last 200 years, and great economists such as John Stuart Mill and Alfred Marshall (and many others) have played their part in the growth of the modern theory of supply and demand. Nevertheless, the theory of supply and demand is the modern expression of Smith's great insight about "the natural price."

To make a long story short, before about the 1850's most economists accepted the Labor Theory of Value as the theory of the "natural price." But there were some cases it did not apply to: international trade, for example. John Stuart Mill suggested a "supply and demand" solution for prices in international trade. Other economists extended it to apply to prices in general.

Unlike the "natural price," a long-run theory only, the theory of supply and demand applies in the short run as well as the long.

2. Analysis of Markets

Our approach to market theory will be first analytic and then synthetic. To "analyze" something is to take it apart into its components. Common sense tells us that competitive markets work through an interaction of "supply and demand." Alfred Marshall compared the supply and demand sides to the two blades of scissors -- one won't cut by itself. You have to have both.

Accordingly, we will first "analyze" competitive markets, by discussing demand and supply separately. Then we will try to put them back together (synthesize them) in order to understand the working of competitive markets.

Thus, in the next few pages, we will look at

· demand

· supply

· equilibrium of demand and supply

3. Simple Supply and Demand curves

This can be illustrated with the following graph:

Supply and demand



4. Demand curve shifts



Supply and demand

5. Supply curve shifts


Conversely, if the supply increases, the opposite happens. If the supply curve starts at S1, and then shifts to S0, the price will increase and the quantity will decrease as there is a contraction in demand.

Supply and demand

6. Effects of being away from the Equilibrium Point


Supply and demand

7. Vertical Supply Curve


The below graph illustrates a vertical supply curve. When the demand 1 is in effect, the price will p1. When demand 2 is occurring, the price will be p2. Notice that at both values the quantity is Q. Since the supply is fixed, any shifts in demand will only effect price.

Supply and demand

8. Other market forms





9. Discrete Example











1 person is willing to pay $30 (Cathy).



The supply would be:




And here is the graphs:

Supply and demand

10. Application: Subsidy

A subsidy is a payment from the government to a firm or individual in the private sector, usually on the condition that the person or firm that receives the subsidy produce or do something, or to increase the income of a poor person.

For our example, we will think of a subsidy for the production of corn. (Some countries have paid subsidies for the production of grain in order to make food cheaper for poor people). Let us suppose the government pays corn farmers a dollar per bushel of corn, in addition to whatever price they get in the marketplace. Figure 11 shows the supply and demand for corn. A subsidy per unit of production works pretty much like an excise tax, except in reverse. In particular, we can look at the change from the point of view either of buyers or sellers. In this example, we will look at the subsidy from the point of view of the buyers. From their point of view, the subsidy is an increase in supply.

Supply and demand

A Subsidy

Accordingly, the figure shows the subsidy shifting the supply curve to the right, from S1 to S2. The vertical distance is the amount of the subsidy: one dollar per bushel. Demand is D, as usual. With supply S1 -- before the subsidy is given -- the market equilibrium price is p1 and the equilibrium production is Q1. With supply S2 -- when the subsidy is given -- the market equilibrium price is p2 and the equilibrium production is Q2. We may conclude that a subsidy per unit of production reduces the market price (though not quite by the full amount of the subsidy) and increases the production of the item subsidized.


How are we to understand the market for a good such as beer, potatos, or cheese? Common sense can tell us that the supply, demand, price and quantity produced are interdependent, but how do they depend on one another? The most general and important answer to that question in modern economics is encapsulated in the "Supply and Demand" model.

We have defined "demand" as a relation between the price of the good and the quantity consumers want to buy. Similarly, we have defined "supply" as the relation between the price and the quantity that producers want to sell. When we put these two concepts together, we identify the market "equilibrium" with the price and quantity at the intersection of the demand and supply relations -- that is, a price just high enough that quantity demanded is equal to quantity supplied, and the quantity corresponding to that price.

In a wide variety of historic and current examples, we find that we can explain changes in quantities and prices as the equilibria of supply and demand, with shifts in demand or in supply causing changes in price and quantity. The changes in price and quantity are coordinated in ways that can be understood and predicted, if we understand the theory of supply and demand.


1. AP APO System Administration by Liane Will. Principles for effective APO system Management. SAP press. 2007.

2. Lisa Knight, Meadow Glade Elementary, Battle Ground, WA. Supply and demand. 2004.

3. McConnel C.R., Brue S.L. Economics: Principles, Problems and Policies.-14 th ed.-Boston etc. : Irwin: McGraw-Hill, 1998.

4. Samuelson P. A., Nordhaus W. D. Economics.- 16 th ed.-Boston etc.: Irwin: McGraw-Hill, 2005.

5. Slavin S.L. Economics: a Self-Teaching Guide. - New York etc.: Wiley, 1988.

6. Walstad W. B., Bingham R. C. Study Guide to accompany McConnell and Brue Economics. - 14 th ed. - Boston etc.: McGraw-Hill, 2003.


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