Source: Image of Demand Graph created by Kate Eskra, Image of Supply Graph created by Kate Eskra, Image of Equilibrium Graph created by Kate Eskra
Hi. Welcome to Macroeconomics. This is Kate. This tutorial is called The Impact of Price on Quantity Supplied or Quantity Demanded. As always, my key terms are in red and my examples are in green. In this tutorial, we'll review the laws of supply and demand to start. Then you'll understand that a change in price causes movement along a demand or supply curve. And we'll talk about how that's known as a change in quantity demanded or a change in quantity supplied.
So the law of demand is the inverse relationship between price and quantity with everything else fixed. So here's my demand for Granny Smith apples. This is a demand schedule. You can see that at all the prices I've responded how many apples I would purchase a week. At high prices, I don't want to purchase as many, and as the price falls, I decide I would like to purchase more.
If we chart those numbers, if we graph them, you can see that we get a downward-sloping demand curve. This shows us that there is that inverse or negative relationship between price and quantity with demand. As prices fall, we want to purchase more. As prices rise, we want to purchase less, which would make sense.
So here's the thing with this, though. We have to talk about this idea of Ceteris Paribus. So as the price of Granny Smith apples, in my example, was going up, we certainly can expect that people will buy fewer Granny Smith apples. But the idea of Ceteris Paribus means "everything else held constant." So it assumes that only the price of Granny Smith apples has changed. So for example, we're not changing the price of anything else related to Granny Smith apples like Gala apples or the price of oranges and bananas. We're also not changing people's income, because those things could certainly impact how many Granny Smith apples I buy, but we're not talking about those things. We're only talking about me buying more or less because the price of Granny Smith apples went up or down.
So we refer to this as a movement along the curve as the price changes. So as the price of Granny Smith apples drops, obviously we've already talked about, I buy more. This is only involving a relationship between the two axes that comprise this graph-- the price of Granny Smith apples and the quantity that I'm purchasing of Granny Smith apples. So we don't need a new demand curve. We just move from one point to the next to show as price goes up, I'm up here on the demand curve. As price falls, now I'm purchasing over here on the demand curve. That's why it's called movement along the demand curve.
And we say that this is a change in quantity demanded, not a change in demand itself. Very often people will make the mistake of saying, oh, price went up, so demand goes down. For demand to go down, that means that this whole curve has a new relationship-- that people would buy less at every single price. And that's not what's happening here. So we say that as price changes, it's a change in quantity demanded.
We're going to talk about the same thing with supply, so let's review supply. If the price of a good decreases, the quantity supplied decreases. And vice versa. If the prices of the good would increase, so would the quantity supplied. So if we look at the same prices of apples, you can see that there's a different relationship between the price and a farmer's willingness to supply apples. A farmer does not want to supply apples at very low prices. He probably can't even cover those costs at that low price. But as the price rises, now he has more of an incentive, an ability, and a willingness to supply. So there's a positive relationship between price and quantity with supply.
Again we look at Ceteris Paribus. As the price of apples falls, we can expect that farmers will produce fewer apples. Some of them don't want to produce apples anymore. Maybe they'll produce something else, because, like I said, it's just not worth their while or they can't even cover their costs with that new lower price. With Ceteris Paribus, we're holding everything else constant. We're assuming again that only the price of apples has changed.
So we're not changing the price of how expensive it is for them to produce. We're not changing the price of their resources or their other land, labor, or capital. We're not changing their technology. We're not making it easier or more difficult for them to produce. We're just changing the market price of apples.
So again, a change in price will cause movements along the supply curve. So as the price of Granny Smith apples increases, farmers want to supply more. Again, this is only involving a relationship between price and quantity. We don't need a new curve. We just move along the curve to see the new price and quantity combination. So we say that as price goes up, the quantity supplied goes up, and as price goes down, the quantity supplied goes down. We don't say that the supply itself has changed.
So, just very quickly, because this will be the subject of another tutorial, if we're looking at these movements along the curve, you can see that at certain prices, so at prices above $1 where these two curves converge, you can see that the quantity supplied exceeds the quantity demanded. When that's the case, there's an incentive. There's a gap between the supply and demand curves.
So there'll be an incentive for grocers to lower the price. And as we lower the price, what did we learn? We learned that we don't get a new curve from that. We just move along the curve. So here as we lower price, the quantity supplied would fall, the quantity demanded would rise, and they would meet in the middle. If price was too low, then there's a gap, but it's now where the quantity demanded exceeds the quantity supplied. So there's a whole lot of people buying but not a lot of people producing. What do grocers do? They raise prices.
As prices go up, we see the quantity demanded fall, and at the same time we see the quantity supplied rise. That's what those laws of supply and demand tell us-- until we meet in the middle at an equilibrium price. It's the only price where there's no tendency for change, and it's the only price that clears the market, where the quantity supplied equals exactly the quantity demanded. And so equilibrium is defined as the price and quantity pair at which supply and demand intersect. It's the price and quantity at which the market clears.
So in this tutorial, we looked at the laws of supply and demand again and the relationship between price and quantity. And we talked about how a change in price will only cause movement along the demand or supply curve, and we'll talk about that as being a change in quantity demanded or quantity supplied. Thanks so much for listening. Have a great day.
Law of Supply
If the price of a good decreases, the quantity supplied decreases.
Law of Demand
The inverse correlation between price and quantity with all other variables fixed.
The price and quantity pair at which supply and demand intersect; price and quantity at which the market clears.