Supply and demand

Supply and demand

Overview
Supply and demand is an economic model of price determination in a market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...

. It concludes that in a competitive market
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...

, the unit price
Unit price
Average prices represent, quite simply, total sales revenue divided by total units sold. Many products, however, are sold in multiple variants, such as bottle sizes. In these cases, managers face a challenge: they must determine “comparable” units. Average prices can be calculated by weighting...

 for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...

 of price and quantity.

The four basic laws of supply and demand are:
  1. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and quantity.
  2. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and quantity.
  3. If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
  4. If supply decreases and demand remains unchanged, then it leads to higher price and lower quantity.


Although it is normal to regard the quantity demanded and the quantity supplied as functions
Function (mathematics)
In mathematics, a function associates one quantity, the argument of the function, also known as the input, with another quantity, the value of the function, also known as the output. A function assigns exactly one output to each input. The argument and the value may be real numbers, but they can...

 of the price of the good, the standard graphical representation, usually attributed to Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function.

Since determinants of supply and demand other than the price of the good in question are not explicitly represented in the supply-demand diagram, changes in the values of these variables are represented by moving the supply and demand curves (often described as "shifts" in the curves).
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Supply and demand is an economic model of price determination in a market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...

. It concludes that in a competitive market
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...

, the unit price
Unit price
Average prices represent, quite simply, total sales revenue divided by total units sold. Many products, however, are sold in multiple variants, such as bottle sizes. In these cases, managers face a challenge: they must determine “comparable” units. Average prices can be calculated by weighting...

 for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...

 of price and quantity.

The four basic laws of supply and demand are:
  1. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and quantity.
  2. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and quantity.
  3. If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
  4. If supply decreases and demand remains unchanged, then it leads to higher price and lower quantity.

The graphical representation of supply and demand


Although it is normal to regard the quantity demanded and the quantity supplied as functions
Function (mathematics)
In mathematics, a function associates one quantity, the argument of the function, also known as the input, with another quantity, the value of the function, also known as the output. A function assigns exactly one output to each input. The argument and the value may be real numbers, but they can...

 of the price of the good, the standard graphical representation, usually attributed to Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function.

Since determinants of supply and demand other than the price of the good in question are not explicitly represented in the supply-demand diagram, changes in the values of these variables are represented by moving the supply and demand curves (often described as "shifts" in the curves). By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves.

Supply schedule


A supply schedule is a table that shows the relationship between the price of a good and the quantity supplied. A supply curve is a graph that shows the same relationship.

Under the assumption of perfect competition, supply is determined by marginal cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...

. Firms will produce additional output as long as the cost of producing an extra unit of output is less than the price they will receive.

By its very nature, conceptualizing a supply curve requires that the firm be a perfect competitor—that is, that the firm has no influence over the market price. This is because each point on the supply curve is the answer to the question "If this firm is faced with this potential price, how much output will it be able to and willing to sell?" If a firm has market power, so its decision of how much output to provide to the market influences the market price, then the firm is not "faced with" any price, and the question is meaningless.

Economists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the market supply curve.

Economists also distinguish the short-run market supply curve from the long-run market supply curve. In this context, two things are assumed constant by definition of the short run: the availability of one or more fixed inputs (typically physical capital
Physical capital
In economics, physical capital or just 'capital' refers to any already-manufactured asset that is applied in production, such as machinery, buildings, or vehicles. In economic theory, physical capital is one of the three primary factors of production, also known as inputs in the production function...

), and the number of firms in the industry. In the long run, firms have a chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long run potential competitors can enter
Market entry strategy
A market entry strategy is the planned method of delivering goods or services to a target market and distributing them there. When importing or exporting services, it refers to establishing and managing contracts in a foreign country.- Factors :...

 or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-run counterparts.

The determinants of supply follow:
  1. Production costs, how much a good costs to be produced
  2. The technology used in production, and/or technological advances
  3. The price of related goods
  4. Firms' expectations about future prices
  5. Number of suppliers

Demand schedule


A demand schedule, depicted graphically as the demand curve
Demand curve
In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule...

, represents the amount of some
good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, tastes and preferences, the price of substitute good
Substitute good
In economics, one way we classify goods is by examining the relationship of the demand schedules when the price of one good changes. This relationship between demand schedules leads economists to classify goods as either substitutes or complements. Substitute goods are goods which, as a result...

s, and the price of complementary goods, remain the same. Following the law of demand
Law of demand
In economics, the law of demand is an economic law that states that consumers buy more of a good when its price decreases and less when its price increases ....

, the demand curve is almost always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good.

Just as the supply curves reflect marginal cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...

 curves, demand curves are determined by marginal utility
Marginal utility
In economics, the marginal utility of a good or service is the utility gained from an increase in the consumption of that good or service...

 curves. Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

 determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time.

As described above, the demand curve is generally downward-sloping, there may be rare examples of goods that have upward-sloping demand curves. Two different hypothetical types of goods with upward-sloping demand curves are Giffen goods (an inferior but staple
Staple food
A staple food is one that is eaten regularly and in such quantities that it constitutes a dominant portion of a diet, and that supplies a high proportion of energy and nutrient needs. Most people live on a diet based on one or more staples...

 good) and Veblen goods
Veblen goods
In economics, Veblen goods are a group of commodities for which people's preference for buying them increases as their price increases, as greater price confers greater status, instead of decreasing according to the law of demand. A Veblen good is often also a positional good...

 (goods made more fashionable by a higher price).

By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitor—that is, that the purchaser has no influence over the market price. This is because each point on the demand curve is the answer to the question "If this buyer is faced with this potential price, how much of the product will it purchase?" If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not "faced with" any price, and the question is meaningless.

As with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus in the graph of the demand curve, individuals' demand curves are added horizontally to obtain the market demand curve.

The determinants of demand follow:
  1. Income
  2. Tastes and preferences
  3. Prices of related goods and services
  4. Consumers' expectations about future prices and incomes
  5. Number of potential consumers

Equilibrium


Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves.

Market Equilibrium:

A situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply.

Comparative static analysis:

Examines the likely effect on the equilibrium of a change in the external conditions affecting the market.

Changes in market equilibrium:-
Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics
Comparative statics
In economics, comparative statics is the comparison of two different economic outcomes, before and after a change in some underlying exogenous parameter....

 of such a shift traces the effects from the initial equilibrium to the new equilibrium.

Demand curve shifts:

When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of the curve. there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market expectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point Q2, P2).

If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the change (shift) in demand.


The movement of the demand curve in response to a change in a non-price determinant of demand is caused by a change in the x-intercept, the constant term of the demand equation.

Supply curve shifts:

When technological progress occurs, the supply curve shifts. For example, assume that someone invents a better way of growing wheat
Wheat
Wheat is a cereal grain, originally from the Levant region of the Near East, but now cultivated worldwide. In 2007 world production of wheat was 607 million tons, making it the third most-produced cereal after maize and rice...

 so that the cost of growing a given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2—an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the price and the quantity move in opposite directions.

If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed.

The movement of the supply curve in response to a change in a non-price determinant of supply is caused by a change in the y-intercept, the constant term of the supply equation. The supply curve shifts up and down the y axis as non-price determinants of demand change.

Partial equilibrium



Partial equilibrium as the name suggests takes into consideration only a part of the market, ceteris paribus to attain equilibrium.

As defined by Prof. Stigler: “ A partial equilibrium is one which is based on only a restricted range of data, a standard example is price of a single product, the prices of all other products being held fixed during the analysis.”

The supply-and-demand model is a partial equilibrium model of economic equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...

, where the clearance on the market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...

 of some specific goods is obtained independently from prices and quantities in other markets. In other words, the prices of all substitutes
Substitute good
In economics, one way we classify goods is by examining the relationship of the demand schedules when the price of one good changes. This relationship between demand schedules leads economists to classify goods as either substitutes or complements. Substitute goods are goods which, as a result...

 and complements
Complement good
A complementary good, in contrast to a substitute good, is a good with a negative cross elasticity of demand. This means a good's demand is increased when the price of another good is decreased. Conversely, the demand for a good is decreased when the price of another good is increased...

, as well as income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...

 levels of consumers
Consumer
Consumer is a broad label for any individuals or households that use goods generated within the economy. The concept of a consumer occurs in different contexts, so that the usage and significance of the term may vary.-Economics and marketing:...

 are constant. This makes analysis much simpler than in a general equilibrium
General equilibrium
General equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...

 model which includes an entire economy.

Here the dynamic process is that prices adjust until supply equals demand. It is a powerfully simple technique that allows one to study equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...

, efficiency
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...

 and comparative statics
Comparative statics
In economics, comparative statics is the comparison of two different economic outcomes, before and after a change in some underlying exogenous parameter....

. The stringency of the simplifying assumptions inherent in this approach make the model considerably more tractable, but may produce results which, while seemingly precise, do not effectively model real world economic
phenomena.

Partial equilibrium analysis examines the effects of policy action in creating equilibrium only in that particular sector or market which is directly affected, ignoring its effect in any other market or industry assuming that they being small will have little impact if any.

Hence this analysis is considered to be useful in constricted markets.
Léon Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...

 first formalized the idea of a one-period economic equilibrium of the general economic system, but it was French economist Antoine Augustin Cournot
Antoine Augustin Cournot
Antoine Augustin Cournot was a French philosopher and mathematician.Antoine Augustin Cournot was born at Gray, Haute-Saone. In 1821 he entered one of the most prestigious Grande École, the École Normale Supérieure, and in 1829 he had earned a doctoral degree in mathematics, with mechanics as his...

 and English political economist Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

 who developed tractable models to analyze an economic system.

Other markets


The model of supply and demand also applies to various specialty markets.

The model is commonly applied to wage
Wage
A wage is a compensation, usually financial, received by workers in exchange for their labor.Compensation in terms of wages is given to workers and compensation in terms of salary is given to employees...

s, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate.

A number of economists (for example Pierangelo Garegnani, Robert L. Vienneau, and Arrigo Opocher & Ian Steedman), building on the work of Piero Sraffa
Piero Sraffa
Piero Sraffa was an influential Italian economist whose book Production of Commodities by Means of Commodities is taken as founding the Neo-Ricardian school of Economics.- Early life :...

, argue that that this model of the labor market, even given all its assumptions, is logically incoherent. Michael Anyadike-Danes and Wyne Godley argue, based on simulation results, that little of the empirical work done with the textbook model constitutes a potentially falsifying test, and, consequently, empirical evidence hardly exists for that model. Graham White argues, partially on the basis of Sraffianism, that the policy of increased labor market flexibility, including the reduction of minimum wages, does not have an "intellectually coherent" argument in economic theory.

This criticism of the application of the model of supply and demand generalizes
Cambridge capital controversy
The Cambridge capital controversy – sometimes simply called "the capital controversy" – refers to a theoretical and mathematical debate during the 1960s among economists concerning the nature and role of capital goods and the critique of the dominant neoclassical vision of aggregate...

, particularly to all markets for factors of production. It also has implications for monetary theory not drawn out here.

In both classical
Classical economics
Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Malthus and John Stuart Mill....

 and Keynesian
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...

 economics, the money market
Money market
The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...

 is analyzed as a supply-and-demand system with interest rates being the price. The money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...

 may be a vertical supply curve, if the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...

 of a country chooses to use monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

 to fix its value regardless of the interest rate; in this case the money supply is totally inelastic. On the other hand, the money supply curve is a horizontal line if the central bank is targeting a fixed interest rate and ignoring the value of the money supply; in this case the money supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the interest rate.

Empirical estimation


Demand and supply relations in a market can be statistically estimated from price, quantity, and other data
Data
The term data refers to qualitative or quantitative attributes of a variable or set of variables. Data are typically the results of measurements and can be the basis of graphs, images, or observations of a set of variables. Data are often viewed as the lowest level of abstraction from which...

 with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics
Econometrics
Econometrics has been defined as "the application of mathematics and statistical methods to economic data" and described as the branch of economics "that aims to give empirical content to economic relations." More precisely, it is "the quantitative analysis of actual economic phenomena based on...

. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in "structural estimation." Typically, data on exogenous
Exogenous
Exogenous refers to an action or object coming from outside a system. It is the opposite of endogenous, something generated from within the system....

 variables (that is, variables other than price and quantity, both of which are endogenous
Endogeneity (economics)
In an econometric model, a parameter or variable is said to be endogenous when there is a correlation between the parameter or variable and the error term. Endogeneity can arise as a result of measurement error, autoregression with autocorrelated errors, simultaneity, omitted variables, and sample...

 variables) are needed to perform such an estimation. An alternative to "structural estimation" is reduced-form
Reduced form
In statistics, and particularly in econometrics, the reduced form of a system of equations is the result of solving the system for the endogenous variables. This gives the latter as a function of the exogenous variables, if any...

 estimation, which regresses each of the endogenous variables on the respective exogenous variables.

Macroeconomic uses of demand and supply


Demand and supply have also been generalized to explain macroeconomic variables in a market economy
Market economy
A market economy is an economy in which the prices of goods and services are determined in a free price system. This is often contrasted with a state-directed or planned economy. Market economies can range from hypothetically pure laissez-faire variants to an assortment of real-world mixed...

, including the quantity of total output
Real GDP
Real Gross Domestic Product is a macroeconomic measure of the value of output economy adjusted for price changes . The adjustment transforms the money-value measure, called nominal GDP, into an index for quantity of total output...

 and the general price level
Price level
A price level is a hypothetical measure of overall prices for some set of goods and services, in a given region during a given interval, normalized relative to some base set...

. The Aggregate Demand-Aggregate Supply model
AD-AS model
The AD-AS or Aggregate Demand-Aggregate Supply model is a macroeconomic model that explains price level and output through the relationship of aggregate demand and aggregate supply. It is based on the theory of John Maynard Keynes presented in his work The General Theory of Employment, Interest,...

 may be the most direct application of supply and demand to macroeconomics, but other macroeconomic models also use supply and demand. Compared to microeconomic uses of demand and supply, different (and more controversial) theoretical considerations apply to such macroeconomic counterparts as aggregate demand
Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...

 and aggregate supply
Aggregate supply
In economics, aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period...

. Demand and supply are also used in macroeconomic theory to relate money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...

 and money demand to interest rates, and to relate labor supply and labor demand to wage rates.

History


The power of supply and demand was understood to some extent by several early Muslim economists
Islamic economics in the world
Islamic economics in practice, or economic policies supported by self-identified Islamic groups, has varied throughout its long history. Traditional Islamic concepts having to do with economics included...

, such as Ibn Taymiyyah who illustrates:
John Locke
John Locke
John Locke FRS , widely known as the Father of Liberalism, was an English philosopher and physician regarded as one of the most influential of Enlightenment thinkers. Considered one of the first of the British empiricists, following the tradition of Francis Bacon, he is equally important to social...

's 1691 work Some Considerations on the Consequences of the Lowering of Interest and the Raising of the Value of Money. includes an early and clear description of supply and demand and their relationship. In this description demand is rent
Economic rent
Economic rent is typically defined by economists as payment for goods and services beyond the amount needed to bring the required factors of production into a production process and sustain supply. A recipient of economic rent is a rentier....

: “The price of any commodity rises or falls by the proportion of the number of buyer and sellers” and “that which regulates the price... [of goods] is nothing else but their quantity in proportion to their rent.”

The phrase "supply and demand" was first used by James Denham-Steuart
James Denham-Steuart
Sir James Steuart, 3rd Baronet of Goodtrees and eventually 7th Baronet of Coltness; late in life Sir James Steuart Denham, also called Sir James Denham Steuart was a prominent Jacobite, who wrote one of the first noteworthy books in English about economics...

 in his Inquiry into the Principles of Political Oeconomy, published in 1767. Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

 used the phrase in his 1776 book The Wealth of Nations
The Wealth of Nations
An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

, and David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

 titled one chapter of his 1817 work Principles of Political Economy and Taxation "On the Influence of Demand and Supply on Price".

In The Wealth of Nations, Smith generally assumed that the supply price was fixed but that its "merit" (value) would decrease as its "scarcity" increased, in effect what was later called the law of demand. Ricardo, in Principles of Political Economy and Taxation, more rigorously laid down the idea of the assumptions that were used to build his ideas of supply and demand. Antoine Augustin Cournot
Antoine Augustin Cournot
Antoine Augustin Cournot was a French philosopher and mathematician.Antoine Augustin Cournot was born at Gray, Haute-Saone. In 1821 he entered one of the most prestigious Grande École, the École Normale Supérieure, and in 1829 he had earned a doctoral degree in mathematics, with mechanics as his...

 first developed a mathematical model of supply and demand in his 1838 Researches into the Mathematical Principles of Wealth, including diagrams.

During the late 19th century the marginalist school of thought emerged. This field mainly was started by Stanley Jevons
William Stanley Jevons
William Stanley Jevons was a British economist and logician.Irving Fisher described his book The Theory of Political Economy as beginning the mathematical method in economics. It made the case that economics as a science concerned with quantities is necessarily mathematical...

, Carl Menger
Carl Menger
Carl Menger was the founder of the Austrian School of economics, famous for contributing to the development of the theory of marginal utility, which contested the cost-of-production theories of value, developed by the classical economists such as Adam Smith and David Ricardo.- Biography :Menger...

, and Léon Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...

. The key idea was that the price was set by the most expensive price, that is, the price at the margin. This was a substantial change from Adam Smith's thoughts on determining the supply price.

In his 1870 essay "On the Graphical Representation of Supply and Demand", Fleeming Jenkin
Fleeming Jenkin
Henry Charles Fleeming Jenkin was Professor of Engineering at the University of Edinburgh, remarkable for his versatility. Known to the world as the inventor of telpherage, he was an electrician and cable engineer, economist, lecturer, linguist, critic, actor, dramatist and artist...

 in the course of "introduc[ing] the diagrammatic method into the English economic literature" published the first drawing of supply and demand curves therein, including comparative statics
Comparative statics
In economics, comparative statics is the comparison of two different economic outcomes, before and after a change in some underlying exogenous parameter....

 from a shift of supply or demand and application to the labor market. The model was further developed and popularized by Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

 in the 1890 textbook Principles of Economics
Principles of Economics (Marshall)
Principles of Economics was a leading political economy or economics textbook of Alfred Marshall , first published in 1890. It ran into many editions and was the standard text for generations of economics students.-Writing:...

.

Criticisms


At least two assumptions are necessary for the validity of the standard model: first, that supply and demand are independent; and second, that supply is "constrained by a fixed resource"; If these conditions do not hold, then the Marshallian model cannot be sustained. Sraffa's critique focused on the inconsistency (except in implausible circumstances) of partial equilibrium analysis and the rationale for the upward-slope of the supply curve in a market for a produced consumption good. The notability of Sraffa's critique is also demonstrated by Paul A. Samuelson's comments and engagements with it over many years, for example:
"What a cleaned-up version of Sraffa (1926) establishes is how nearly empty are all of Marshall's partial equilibrium boxes. To a logical purist of Wittgenstein and Sraffa class, the Marshallian partial equilibrium box of constant cost is even more empty than the box of increasing cost.".


Aggregate excess demand in a market is the difference between the quantity demanded and the quantity supplied as a function of price. In the model with an upward-sloping supply curve and downward-sloping demand curve, the aggregate excess demand function only intersects the axis at one point, namely, at the point where the supply and demand curves intersect. The Sonnenschein-Mantel-Debreu theorem
Sonnenschein-Mantel-Debreu Theorem
The Sonnenschein–Mantel–Debreu theorem is a result in general equilibrium economics. It states that the excess demand function for an economy is not restricted by the usual rationality restrictions on individual demands in the economy...

 shows that the standard model cannot be rigorously derived in general from general equilibrium theory.

The model of prices being determined by supply and demand assumes perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...

. But:
"economists have no adequate model of how individuals and firms adjust prices in a competitive model. If all participants are price-takers by definition, then the actor who adjusts prices to eliminate excess demand is not specified".


Goodwin, Nelson, Ackerman, and Weissskopf write:
"If we mistakenly confuse precision with accuracy, then we might be misled into thinking that an explanation expressed in precise mathematical or graphical terms is somehow more rigorous or useful than one that takes into account particulars of history, institutions or business strategy. This is not the case. Therefore, it is important not to put too much confidence in the apparent precision of supply and demand graphs. Supply and demand analysis is a useful precisely formulated conceptual tool that clever people have devised to help us gain an abstract understanding of a complex world. It does not - nor should it be expected to - give us in addition an accurate and complete description of any particular real world market."

See also


  • Aggregate demand
    Aggregate demand
    In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...

  • Aggregate supply
    Aggregate supply
    In economics, aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period...

  • Alpha consumer
    Alpha consumer
    An Alpha Consumer is someone that plays a key role in connecting with the concept behind a product, then adopting that product, and finally validating it for the rest of society...

  • Artificial demand
    Artificial demand
    Artificial demand constitutes demand for something that, in the absence of exposure to the vehicle of creating demand, would not exist. It has controversial applications in microeconomics and advertising...

  • Barriers to entry
    Barriers to entry
    In theories of competition in economics, barriers to entry are obstacles that make it difficult to enter a given market. The term can refer to hindrances a firm faces in trying to enter a market or industry - such as government regulation, or a large, established firm taking advantage of economies...

  • Cambridge capital controversy
    Cambridge capital controversy
    The Cambridge capital controversy – sometimes simply called "the capital controversy" – refers to a theoretical and mathematical debate during the 1960s among economists concerning the nature and role of capital goods and the critique of the dominant neoclassical vision of aggregate...

  • Consumer theory
    Consumer theory
    Consumer choice is a theory of microeconomics that relates preferences for consumption goods and services to consumption expenditures and ultimately to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most closely studied relations in...

  • Deadweight loss
    Deadweight loss
    In economics, a deadweight loss is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal...

  • Demand chain
    Demand chain
    -Concept:Analysing the firm's activities as a linked chain is a tried and tested way of revealing value creation opportunities. The business economist Michael Porter of Harvard Business School pioneered this value chain approach: "the value chain disaggregates the firm into its strategically...

  • Demand Forecasting
    Demand forecasting
    Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data...

  • Demand shortfall
  • Economic surplus
    Economic surplus
    In mainstream economics, economic surplus refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay...


  • Effect of taxes and subsidies on price
    Effect of taxes and subsidies on price
    Taxes and subsidies change the price of goods and, as a result, the quantity consumed.- Tax impact :A marginal tax on the sellers of a good will shift the supply curve to the left until the vertical distance between the two supply curves is equal to the per unit tax; when other things remain equal,...

  • Elasticity
    Elasticity (economics)
    In economics, elasticity is the measurement of how changing one economic variable affects others. For example:* "If I lower the price of my product, how much more will I sell?"* "If I raise the price, how much less will I sell?"...

  • Externality
    Externality
    In economics, an externality is a cost or benefit, not transmitted through prices, incurred by a party who did not agree to the action causing the cost or benefit...

  • Foundations of Economic Analysis
    Foundations of Economic Analysis
    Foundations of Economic Analysis is a book by Paul A. Samuelson published in 1947 by Harvard University Press. It sought to demonstrate a common mathematical structure underlying multiple branches of economics from two basic principles: maximizing behavior of agents and stability of equilibrium...

    by Paul A. Samuelson
  • History of economic thought
    History of economic thought
    The history of economic thought deals with different thinkers and theories in the subject that became political economy and economics from the ancient world to the present day...

  • Induced demand
    Induced demand
    Induced demand, or latent demand, is the phenomenon that after supply increases, more of a good is consumed. This is entirely consistent with the economic theory of supply and demand; however, this idea has become important in the debate over the expansion of transportation systems, and is often...

  • "invisible hand
    Invisible hand
    In economics, invisible hand or invisible hand of the market is the term economists use to describe the self-regulating nature of the marketplace. This is a metaphor first coined by the economist Adam Smith...

    "
  • Inverse demand function
    Inverse demand function
    In economics, an inverse demand function, P = f−1,is a function that maps the quantity of output demanded to the market price for that output. Quantity demanded, Q, is a function of price; the inverse demand function treats price as a function of quantity demanded, and is also called the price...

  • Labor shortage
    Labor shortage
    In its narrowest definition, a labor shortage is an economic condition in which there are insufficient qualified candidates to fill the market-place demands for employment at any price...

  • Microeconomics
    Microeconomics
    Microeconomics is a branch of economics that studies the behavior of how the individual modern household and firms make decisions to allocate limited resources. Typically, it applies to markets where goods or services are being bought and sold...

  • Neoclassical economics
    Neoclassical economics
    Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...


  • Producer's surplus
  • Protectionism
    Protectionism
    Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...

  • Profit
    Profit (economics)
    In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...

  • Rationing
    Rationing
    Rationing is the controlled distribution of scarce resources, goods, or services. Rationing controls the size of the ration, one's allotted portion of the resources being distributed on a particular day or at a particular time.- In economics :...

  • Real prices and ideal prices
    Real prices and ideal prices
    Real prices and ideal prices refers to a distinction between actual prices paid for products, services, assets and labour , and computed prices which are not actually charged or paid in market trade, although they may facilitate trade...

  • Say's Law
    Say's law
    Say's law, or the law of market, is an economic principle of classical economics named after the French businessman and economist Jean-Baptiste Say , who stated that "products are paid for with products" and "a glut can take place only when there are too many means of production applied to one kind...

  • "Supply creates its own demand
    Supply creates its own demand
    "Supply creates its own demand" is the formulation of Say's law by John Maynard Keynes, and is considered by him one of the defining characteristics of classical economics...

    "
  • Supply shock
    Supply shock
    A supply shock is an event that suddenly changes the price of a commodity or service. It may be caused by a sudden increase or decrease in the supply of a particular good. This sudden change affects the equilibrium price....

  • An Inquiry into the Nature and Causes of the Wealth of Nations
    The Wealth of Nations
    An Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...

    by Adam Smith


External links