All goods and services are subject to scarcity at some level. Scarcity means that society must develop some allocation mechanism – rules to determine who gets what. Most countries use market based allocation systems. In markets, prices act as rationing devices, encouraging or discouraging production and encouraging or discouraging consumption in such a way as to find an equilibrium allocation of resources.
Law of demand: If the price of something goes up, people are going to buy less of it.
- The law of demand states that a higher price leads to a lower quantity demanded and that a lower price leads to a higher quantity demanded.
- Demand curves and demand schedules are tools used to summarize the relationship between demand and price.
- A demand schedule is a table that shows the quantity demanded at each price.
- A demand curve is a graph that shows the quantity demanded at each price.
The difference between demand and quantity demanded
What factors change demand?
Price isn’t the only factor that affects quantity demanded.
- Demand curves can shift: Changes in factors like average income and preferences can cause an entire demand curve to shift right or left. This causes a higher or lower quantity to be demanded at a given price.
- Ceteris paribus assumption: Demand curves relate the prices and quantities demanded assuming no other factors change. This is called the ceteris paribus assumption.
What factors affect demand?
We defined demand as the amount of some product a consumer is willing and able to purchase at each price. That suggests at least two factors in addition to price that affect demand. Willingness to purchase suggests a desire, based on what economists call tastes and preferences. If you neither need nor want something, you will not buy it. Ability to purchase suggests that income is important.
How does income affect demand?
Normal and inferior goods
Other factors that shift demand curves
Changing tastes or preferences
Changes in the composition of the population
Related goods: The demand for a product can also be affected by changes in the prices of related goods such as substitutes or complements. A substitute is a good or service that can be used in place of another good or service. As electronic resources, like this one, become more available, you would expect to see a decrease in demand for traditional printed books. A lower price for a substitute decreases demand for the other product. Other goods are complements for each other, meaning that the goods are often used together, because consumption of one good tends to enhance consumption of the other.
Changes in expectations about future prices or other factors that affect demand: it is also true that expectations about the future price (or expectations about tastes and preferences, income, and so on) can affect demand.
Law of supply: If the price of something goes up, companies are willing (and able) to produce more of it.
- The law of supply states that a higher price leads to a higher quantity supplied and a lower price leads to a lower quantity supplied.
- Supply curves and supply schedules are tools used to summarize the relationship between supply and price.
- A supply schedule is a table that shows the quantity supplied at each price.
- A supply curve is a graph that shows the quantity supplied at each price.
The difference between supply and quantity supplied
What factors change supply?
- Supply curves can shift: Changes in production cost and related factors can cause an entire supply curve to shift right or left. This causes a higher or lower quantity to be supplied at a given price.
- The ceteris paribus assumption: Supply curves relate the prices and quantities supplied assuming no other factors change. This is called the ceteris paribus assumption.
How production costs affect supply
Other factors that affect supply
Natural conditions: A drought decreases the supply of agricultural products, which means that at any given price, a lower quantity will be supplied. Conversely, especially good weather would shift the supply curve to the right.
New technology: When a firm discovers a new technology that allows the firm to produce at a lower cost, the supply curve will shift to the right as well.
Government policies: Government policies can affect the cost of production and the supply curve through taxes, regulations, and subsidies. Taxes are treated as costs by businesses. Higher costs decrease supply for the reasons discussed above. Other examples of policy that can affect cost are the wide array of government regulations that require firms to spend money to provide a cleaner environment or a safer workplace; complying with regulations increases costs.
Market equilibrium: The actual price you see in the world is a balancing act between supply and demand.
- Supply and demand curves intersect at the equilibrium price. This is the price at which the market will operate.