Learn It 2.3.3: Microeconomics

How Demand and Supply Interact to Determine Prices

In a stable economy, the number of coats that people demand depends on the coats’ price. Similarly, the number of coats that suppliers provide depends on price. But at what price will consumer demand for coats match the quantity suppliers will produce?

To answer this question, we need to look at what happens when demand and supply interact. By putting both the demand curve and the supply curve on the same graph below, we see that they cross at a certain quantity and price. At that point, labeled E, the quantity demanded equals the quantity supplied. This is the point of equilibrium. The equilibrium price is $80; the equilibrium quantity is 700 coats. At that point, there is a balance between the quantity consumers will buy and the quantity suppliers will make available.

Market equilibrium is achieved through a series of quantity and price adjustments that occur automatically. If the price increases to $160, suppliers produce more coats than consumers are willing to buy, and an excess, or surplus results. To sell more coats, prices will have to fall. The surplus pushes prices downward until equilibrium is reached. When the price falls to $60, the quantity of coats demanded rises above the available supply. The resulting shortage forces prices upward until equilibrium is reached at $80.

The x axis is labeled quantity, and the y axis is labeled price. The quantity demanded line, labeled D, falls from the upper left of the graph from approximate point 275, $160, to the bottom right of the graph at approximate point 1225, $45. The quantity supplied line, labeled S, rises from lower left to upper right, from approximate point 275, $40, to the upper right point 1200, $160. These lines intersect at a point labeled E, the point of equilibrium between supply and demand. Point E is at approximately 700, $80. Above point E, in between lines D and S, is labeled surplus at $160. Below point E, between lines D and S is labeled shortage at $60.
Figure 1. Where the quantity demanded equals the quantity supplied is the point of equilibrium.

The number of coats supplied and bought at $80 will tend to rest at equilibrium unless there is a shift in either demand or supply. If demand increases, more coats will be purchased at every price, and the demand curve shifts to the right (as illustrated by line D2 below). If demand decreases, less will be bought at every price, and the demand curve shifts to the left (D1). When demand decreased, people bought 500 coats at $80 instead of 700 coats. When demand increased, they purchased 800.

The graph shows 3 lines, each falls down and slightly left before hooking back to the right. The line labeled D is in the middle, and falls through the point 700, $80. The line to the left, labeled D 1, falls through the point 500, $80. This is labeled as decrease in demand. The line to the right, labeled D 2 falls through the point 800, $80. This is labeled as increase in demand.
Figure 2. An increase or decrease in demand shifts the entire demand curve.