Supply and Demand - The Basics

Supply and Demand analysis is relatively straight-forward once the terminology is understood. The important terms are as follows:

• Price
• Quantity
• Demand and Demand Curve
• Quantity Demanded
• Supply and Supply Curve
• Quantity Supplied
• Equilibrium
• Surplus
• Shortage

Basic supply and demand analysis is done one of two ways - either graphically or numerically. If done graphically, it is important to set up the graph in the 'standard' form.

The Graph

Traditionally economists have placed price (P) on the Y-axis and quantity (Q), as in quantity consumed or quantity purchased/sold on the X-axis. An easy way to remember how to label each axis is to remember 'P then Q', since the price (P) label occurs above and to the left of the quantity (Q) label. Next there are two curves to understand - the demand curve and the supply curve.

The Demand Curve

A demand curve is simply a demand function or demand schedule represented graphically. Note that demand is not simply a number - it is a one-to-one relationship between prices and quantities. The following is an example of a demand schedule:

Demand Schedule

$10 - 200 units
$20 - 145 units
$30 - 110 units
$40 - 100 units

Note that demand is not simply a number such as '145'. The quantity level associated with a particular price (such as 145 units @ $20) is known as a quantity demanded.

The Supply Curve

Supply curves, supply functions and supply schedules are not conceptually different than their demand counterparts. Once again, supply is never represented as a number. When considering the problem from the point of view of the seller the quantity level associated with a particular price is known as quantity supplied.

Equilibrium

Equilibrium occurs when at a specific price P', quantity demanded = quantity supplied. In other words, if there is some price where the amount buyers wish to buy is the same as the amount sellers wish to sell, then equilibrium occurs. Consider the following demand and supply schedules:

Demand Schedule

$10 - 200 units
$20 - 145 units
$30 - 110 units
$40 - 100 units

Supply Schedule

$10 - 100 units
$20 - 145 units
$30 - 180 units
$40 - 200 units

At a price of $20, consumers wish to purchase 145 units and sellers which to provide 145 units. Thus quantity supplied = quantity demanded and we have an equilibrium of ($20, 145 units)

Surplus

A surplus, from the supply and demand perspective, is a situation where, at the current price, quantity supplied exceeds quantity demanded. Consider the demand and supply schedules above. At a price of $30, quantity supplied is 180 units and quantity demanded is 110 units, leading to a surplus of 70 units (180-110=70). Our market, then, is out of equilibrium. The current price is unsustainable and must be lowered in order for the market to reach equilibrium.

Shortage

A shortage is simply the flip-side of a surplys. It is a situation where, at the current price, quantity demanded exceeds quantity supplied. At a price of $10, quantity supplied is 100 units and quantity demanded is 200 units, leading to a shortage of 100 units (200-100=100). Our market, then, is out of equilibrium. The current price is unsustainable and must be raised in order for the market to reach equilibrium.