Microeconomics/Supply and Demand
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The amount of a good in the market is the supply, and the amount people want to buy is the demand. Consider a certain commodity, such as gasoline. If there is a strong demand for gas, but there is less gasoline, then the price goes up. If conditions change and there is a smaller demand for gas, for instance if everyone started using electric cars, or the commodity becomes more available, for instance a new oil field is discovered, then the price of the commodity decreases.
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[edit] Supply
The availability of goods and services in the marketplace at any given point in time is defined as "supply". As we will see after, if the demand is greater than the supply, there is a shortage (more items are demanded at a lower price, less items are offered at this same price, therefore, there is a shortage). If the supply increases, the price decreases, and if the supply decreases, the price increases. This is called an indirect relationship, where if one variable goes up, the other variable goes down.
It is easy to see why this should be true; if 20 people have identical houses to sell, and only 15 people want to buy a house, then the buyers can pick the lowest price, so the sellers must try to satisfy the buyers. Of course, if the supply changes, and 5 sellers decide to stay, then there is one house for each buyer, and neither side can bully the other; each buyer will offer money for the house they want, and if the seller thinks it's not enough, he can refuse, since his house will probably be bought anyways. If 5 more of the sellers decide not to move, then the buyers need to offer more money, because the remaining sellers want to be able to sell their houses for as much money as they can, so they will pick the ten buyers who offer the most money.
The inverse is true as well; if the price of a home goes down, fewer people will sell, but if the price of a home goes up, more people will sell. This means that price and supply are closely linked, and changes in one are reflected in the other.
[edit] Factors affecting supply
Price-As the price of a product rises, its supply rises because producers are more willing to manufacture the product because it's more profitable now.
Price of other commodities-There are two types
- Competitive supply-If a producer switches from producing A to producing B, the price of A will fall and hence the supply will fall because it's less profitable to make A.
- Joint supply-A rise in one product may cause a rise in another. For instance, a rise in the price of wooden bedframes may cause a rise in the price of wooden desks and chairs. This means supply of wooden bedframes, chairs and desks will rise because it's more profitable.
Costs of production-If production costs rise, supply will fall because the manufacture of the product in question will become less profitable.
Change in availability of resources-If wood becomes scarce, fewer wooden bedframes can be made, so supply will fall.
[edit] Demand
A desire becomes demand when it meets the three important factors i.e. having a strong desire, having the necessary purchasing power, having the power to take decision to purchase.
Similar to supply, there is a relationship between price and demand; the more people want, the more it will cost, if the supply remains the same. To return to our example of houses, let's say there are 15 people selling houses, and 10 buying; the sellers have more influence on the buyers, and the prices will be high. If 5 more people decide to buy houses, then the price will go up, and if another 5 decide to buy one of these houses, the price will climb even further. thus when demand is high the price goes up and consequently the supply goes down and when the demand is low the supply goes up while the prices go down
The inverse here is true as well; if people will sell their house for less, they will find more people interested in buying. The reason why demand behaves this way is fairly obvious: people are more willing to buy more of a good, or buy the good more often if the good becomes cheaper. Likewise, when a good is on sale, or its prices drop, people will become more willing to spend money on it.
[edit] Consumer Behaviour
The way consumers behave can affect demand in many ways. Consumers gain satisfaction from the consumption of goods or services. This satisfaction is called utility.
The law of diminishing marginal utility is a theory in economics that says that with increased consumption, satisfaction decreases.
You are at a park on a winter's day, and someone is selling hot dogs for $1 each. You eat one. It tastes good and satisfies you, so you have another one, and another etc. Eventually, you eat so many, that your satisfaction from each hot dog you consume drops. You are less willing to pay the $1 you have to pay for a hot dog. You would only consume another if price drops. But that won't happen, so you leave, and demand for the hot dogs falls.
Consumer surplus is a term used to describe the difference between the price of a good and how much the consumer is willing to pay.
Back at the park, they are still selling hot dogs, but now for 80 cents. You are hungry, so you are willing to pay $1 for a hot dog, but since the price is cheap, you buy two. For each hot dog, you get 20 cents of consumer surplus
The income effect occurs when the incomes of consumers change.
You are still in the park, and someone is still selling hot dogs for $1. But over the weekend, you got a pay rise, and have more money in your pockets! But there's another hot dog stand selling hot dogs for $1.50 on the other side of the park. You have two choices;
- Buy more of the $1 hot dogs, because you can afford to.
- Go to the other side and buy the $1.50 hot dogs, because you believe they are of better quality, and you can afford to buy them now you've had a pay rise. In this case, the $1 hot dogs have become what we call an inferior good.
The substitution effect is similar.
On another day in the park, there is the same $1 hot dog stand. But, on the other side, the rival hot dog stand now sells hot dogs for only 50 cents. You are more likely to go to that stand because it is cheaper.
[edit] Demand Curve
A curve that shows the relationship between the price level of a good and the quantity of the good demanded at that price is called the demand curve (at any given point in time). Demand curves are graphed with the same axis as supply curves in order to allow the two curves to be combined into a single graph: the y-axis (vertical line) of the graph is price and the x-axis (horizontal line) is the quantity of houses. Demand curves usually slope downward because people are willing to buy larger quantities of a good as its price goes down. That is, low prices mean high quantities. Turning the relationship around, as price increases, the quantity demanded decreases.
[edit] Equilibrium
Since the demand curve slopes down and the supply curve slopes up, if they are put on the same graph, they eventually cross one another. Graphically, this consists of superimposing the two graphs that we have; at the point where the two lines, the supply line and the demand line, meet, is called the equilibrium point for houses in our market; in the end, if the price is $60,000 for a house, everyone who wants to buy will find a house, and everyone who wants to sell will find a buyer.
In general, for any good, it is at this point that quantity supplied equals quantity demanded at a set price. If there are more buyers than there are sellers at a certain price, the price will go up until either some of the buyers decide they are not interested, or some people who were previously not considering selling decide that they want to sell their houses. This process normally continues until there are sufficiently few buyers and sufficiently many sellers that the numbers balance out, which should happen at the equilibrium point.
Please note: The incorrect labeling of the diagram has been fixed. Also note, the curves need not be straight in a real situation.
