Let's begin by defining supply, which is the idea that there is a fixed quantity of goods and services available for a range of price levels at any given point in time.
EXAMPLE
For example, let's look at a farmer's willingness to supply apples. Here is a chart that outlines the different prices of apples and the quantity that he is willing to supply.| Price of Granny Smith Apples | Quantity of Granny Smith Apples Each Week |
|---|---|
| $2.00 | 7 |
| $1.75 | 6 |
| $1.50 | 5 |
| $1.25 | 4 |
| $1.00 | 3 |
| $0.75 | 2 |
| $0.50 | 1 |
| $0.25 | 0 |
This is basically the law of supply. Notice that price and the quantity being supplied move in the same direction, so there is a positive relationship between them for supply.
This is known as movement along a supply curve--or demand curve, as you will see later in the tutorial. When the price of a product changes, it is going to impact the quantity being supplied or the quantity being demanded, because we are moving up and down that curve.
However, this assumes a Latin phrase called ceteris paribus, which means "holding all other things constant." The idea here is that as the price of apples falls, we can expect the farmer to produce fewer apples because it is not worth his time as much.
However, what ceteris paribus assumes is that the price of apples is the only thing that changed. For instance, it assumes that the price of their resources, or inputs, did not change, nor did their technology. Only the price of the apples changed, which correlates to that movement along the curve.
However, we know that things in the world are always changing. For instance, what if fertilizer suddenly gets more expensive, or the farmer has to pay his workers more money because wages rose, or new technology is developed that makes apple picking much more efficient?
These things will not just be movements along the supply curve. The farmer will not be supplying the same amount of apples, yet the price of the product -- the apples -- is not changing. So, now we need to shift the supply curve, and note, the same rules will apply for demand.
When there is a shifting of the supply (or demand) curve, this means that a different quantity is going to be supplied or demanded at all prices. For supply, the shift is occurring due to more or less resource access, a decrease or increase in the price of inputs, or changes in regulation like taxes and subsidies.
EXAMPLE
If there is an increased cost to the farmer, like his fertilizer getting more expensive, he now cannot supply as many apples at every price level.| Price of Granny Smith Apples | Quantity of Granny Smith Apples Each Week |
|---|---|
| $2.00 | 5 |
| $1.75 | 4 |
| $1.50 | 3 |
| $1.25 | 2 |
| $1.00 | 1 |
| $0.75 | 0 |
| $0.50 | 0 |
| $0.25 | 0 |
As a reference, here is a list of factors that cause a shift in supply:
EXAMPLE
As a reminder, a change in input price like an increased cost for fertilizer will cause a decrease in supply and shift to the left.
Now let's shift our focus to a discussion of demand. Demand is easier for most people to think about because we are consumers who are purchasing stuff almost every day of our lives.
Demand is the quantity of goods and services that may be purchased at a given time, specific to a set income and range of price levels.
EXAMPLE
Sticking with our apple example, here is a chart detailing the prices and quantities of Granny Smith apples. Notice, though, that there is a different relationship this time, because even though producers want to sell their product for high prices, we, as consumers, do not want to buy them for high prices. We are not paying $2 for one apple!| Price of Granny Smith Apples | Quantity of Granny Smith Apples Each Week |
|---|---|
| $2.00 | 0 |
| $1.75 | 1 |
| $1.50 | 2 |
| $1.25 | 3 |
| $1.00 | 4 |
| $0.75 | 5 |
| $0.50 | 6 |
| $0.25 | 7 |
| $0.00 | 8 |
This represents the law of demand. As prices fall, the quantity demanded rises; we want to buy more. As prices rise, we want to buy less.
Again, this is assuming ceteris paribus. As the price of Granny Smith apples goes up, yes, we want to buy fewer Granny Smith apples, but ceteris paribus assumes that only the price of green apples has changed. For instance, the price of Gala apples did not change, the price of oranges or bananas did not change, and our income did not change.
Again, we know that things are always changing. For instance, if you have to take a significant pay cut, or perhaps you read an article saying Granny Smith apples are the least healthy apple, you likely are not going to buy the same amount of Granny Smith apples now, even though the price of Granny Smith apples did not change.
Therefore, we need a new curve.
A shifting of the demand curve occurs because something else other than the price has changed, causing a new relationship between price and quantity.
So, if you took that significant pay cut, you are now buying a different quantity at all prices.
| Price of Granny Smith Apples | Quantity of Granny Smith Apples Each Week |
|---|---|
| $2.00 | 0 |
| $1.75 | 0 |
| $1.50 | 0 |
| $1.25 | 0 |
| $1.00 | 1 |
| $0.75 | 2 |
| $0.50 | 3 |
| $0.25 | 4 |
| $0.00 | 5 |
Notice how demand, or the quantity being bought, fell at every single price level, which required a new demand curve, shifting to the left, to show the decrease in demand.
As a reference, these are the things that would cause a shift in the demand curve:
EXAMPLE
If you make less money, you cannot afford as many apples. So the curve shifts to the left to account for the decrease in demand.
Changes in taste and preferences are huge in the demand world. When the toy "Tickle Me Elmo" became very popular, they experienced an increase in demand. Conversely, anytime there are negative news reports, like an E. coli breakout in spinach, people buy less spinach at all prices.
Finally, let's turn our attention to discuss equilibrium, which is the point at which the quantity supplied at a given quantity/price combination equals the quantity demanded. This is where the supply and demand curves intersect.
Here is a graph that combines the quantity of apples supplied and the quantity of apples demanded.
Graphed in this manner, you can see that at any price above $1, the quantity of apples supplied exceeded the quantity of apples demanded.
However, at any price below $1, the quantity of apples demanded was much greater than the quantity of apples supplied.
There is only one price, and one price only, where the quantity supplied equals the quantity demanded.
It is the only price where there is no tendency for change. If the price is too high, sellers would recognize this and lower their price, and there would be downward movement along the supply curve. As prices would lower, the quantity demanded would increase. If price were too low, suppliers would also recognize this, raise their price, and the quantity supplied would rise. As prices go up, the quantity demanded would fall, and again, it would meet in the middle at equilibrium.
In this case, equilibrium gets us to our equilibrium price of a dollar and a quantity of 3,000 bushels.
Source: Adapted from Sophia instructor Kate Eskra.
