- Supply and demand are the two words that economists use most often.
- Supply and demand are the forces that make market economies work.
- These concepts work most efficiently in COMPETITIVE markets.
- In general, economists say “prices and output” rise or fall not because of price, but because of other factors not related to price--- the forces of supply and demand.
- Supply changes are driven by changes in costs of production, taxes and subsidies, and the number of people or firms producing a good or service.
- Demand changes are driven by changes in people’s tastes, the number of buyers in the market, changes in income, and changes the costs of related goods (substitutes [hot dogs and hamburgers] and complements [hot dogs and mustard]).
A specific scenario might help make the relationship clearer. How do we answer this question, “Why does a gallon of gas cost $3.00 this week, $3.50 next week and then $3.25 the following week.”
From a Producer’s perspective
- Gasoline is a scarce resource.
- Producers of gasoline would be willing and able to provide gasoline at certain prices. The higher the price, the more gasoline producers are willing and able to supply. A supply graph looks like this:
Market for Gasoline
From a Consumer’s perspective
- Consumers want gasoline, but have limited resources with which they can obtain gasoline. At lower prices, they want more gasoline, and at higher prices they want less. A demand curve is typically drawn like this:
Market for Gasoline
By combining those two graphs, we find the equilibrium priceand quantity ($3 and 9M Barrels) of gasoline:
Equilibrium, however, is short-lived. Non-price factors push the price of a good or service up or down. To continue our scenario, assume a new nation enters the market for fuel and energy. This pushes the demand curve for gasoline rightward or outward, (Demand II below) raising the price of gasoline ($3.50), and increasing quantity supplied by gasoline producers. (12M Barrels)
Then, engineers develop a new technology that generates more gasoline out of each barrel of crude This causes the supply curve for gasoline to shift rightward or outward (Supply II below) This new technology improves productive capacity which pushes the equilibrium quantity demanded of gasoline up (13 M Barrels) and the price of gasoline down. ($3.25)
This example illustrates the fluidity of the market and some of the forces which can drive change. Depending on the good, service, or factor, numerous forces may operate simultaneously in conflicting directions, all of which impact the price at any given moment.
