Supply & Demand

The concept of supply and demand is often called the heart and soul of economics. It is the foundation for much of what is studied in the field, and understanding how supply and demand affect the economy can help us to recognize economics everywhere in our daily lives. (The British classical economist J.R. McCulloch is attributed with the famous saying that you can make a parrot an economist if you only teach it to say “supply and demand.”)

When the supply and demand curves intersect, the market is in equilibrium. This is where the quantity demanded and quantity supplied are equal. The corresponding price is the equilibrium price or market-clearing price, the quantity is the equilibrium quantity.

If a market is not at equilibrium, market forces tend to move it to equilibrium. Let's break this concept down.

If the market price is above the equilibrium value, there is an excess supply in the market (a surplus), which means there is more supply than demand. In this situation, sellers will tend to reduce the price of their good or service to clear their inventories. They probably will also slow down their production or stop ordering new inventory. The lower price entices more people to buy, which will reduce the supply further. This process will result in demand increasing and supply decreasing until the market price equals the equilibrium price.

If the market price is below the equilibrium value, then there is excess in demand (supply shortage). In this case, buyers will bid up the price of the good or service in order to obtain the good or service in short supply. As the price goes up, some buyers will quit trying because they don't want to, or can't, pay the higher price. Additionally, sellers, more than happy to see the demand, will start to supply more of it. Eventually, the upward pressure on price and supply will stabilize at market equilibrium.

The equilibrium price is the only price where the plans of consumers and the plans of producers agree—that is, where the amount consumers want to buy of the product, quantity demanded, is equal to the amount producers want to sell, quantity supplied. This common quantity is called the equilibrium quantity. At any other price, the quantity demanded does not equal the quantity supplied, so the market is not in equilibrium at that price.

The word equilibrium means balance. If a market is at its equilibrium price and quantity, then it has no reason to move away from that point. However, if a market is not at equilibrium, then economic pressures arise to move the market toward the equilibrium price and the equilibrium quantity.

Market Equilibrium (mjmfoodie Episode 14)

• There is a four-step process that allows us to predict how an event will affect the equilibrium price and quantity using the supply and demand framework.
  1. Step one of this process is to draw a demand and supply model representing the situation before the economic event took place.
  2. Step two of this process is to decide whether the economic event being analyzed affects demand or supply.
  3. Step three of this process is to decide whether the effect on demand or supply causes the curve to shift to the right or to the left and to sketch the new demand or supply curve on the diagram.
  4. Step four of this process is to identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.

Step 1. Draw a demand and supply model representing the situation before the economic event took place.

In this case, we want our demand and supply model to represent the time before many Americans began using digital and online sources for their news. You'll notice in this demand and supply model—above—that the analysis was performed without specific numbers on the price and quantity axes.

Step 2. Decide whether the economic event being analyzed affects demand or supply.

A change in tastes from traditional news sources—print, radio, and television—to digital sources caused a change in demand for the former.

Step 3. Decide whether the effect on demand or supply causes the curve to shift to the right or to the left, and sketch the new demand or supply curve on the diagram.

A shift to digital news sources will tend to mean a lower quantity demanded of traditional news sources at every given price, causing the demand curve for print and other traditional news sources to shift to the left.

Step 4. Identify the new equilibrium and then compare the original equilibrium price and quantity to the new equilibrium price and quantity.

The new equilibrium—occurs at a lower quantity and a lower price than the original equilibrium.

So, what do we know now about the effect of the increased use of digital news sources? We know—based on our four-step analysis—that fewer people desire traditional news sources, and that these traditional news sources are being bought and sold at a lower price.

Student Activity - Attached Below

Sources:

• https://www.khanacademy.org/economics-finance-domain/microeconomics/supply-demand-equilibrium/market-equilibrium-tutorial/v/market-equilibrium