Supply and demand is a framework in economics for explaining how prices and quantities are determined through interactions between buyers and sellers. Demand describes the quantities buyers are willing and able to purchase at different prices; supply describes the quantities sellers are willing and able to offer. Their interaction in a market establishes a price and quantity under specified conditions. The framework is central to microeconomics, particularly the analysis of competitive markets, and distinguishes changes caused by a good’s own price from changes caused by other factors.
Demand
A demand schedule records the quantity demanded at each possible price over a specified period. Its graphical representation, the demand curve, conventionally places price on the vertical axis and quantity on the horizontal axis. Market demand is obtained by adding individual buyers’ quantities demanded at each price.
The law of demand states that, other things equal, a higher price generally reduces quantity demanded. Buyers may switch to alternatives, while the higher price also reduces their purchasing power. Demand therefore means more than wanting a product: it includes the ability to pay.
Demand depends on income, preferences, expectations, the number of buyers, and related goods’ prices. Substitute goods can replace one another in consumption, whereas complementary goods are used together. A rise in the price of a substitute generally increases demand for the other good; a rise in a complement’s price generally decreases it. Higher income increases demand for normal goods but decreases demand for inferior goods, classifications that depend on consumer behavior rather than product quality.
Supply
A supply schedule records quantities offered at different prices over a specified period. The standard supply curve slopes upward: other things equal, higher prices make additional production worthwhile or attract additional sellers.
Supply depends on input prices, production technology, taxes, subsidies, expectations, and the number of sellers. Improvements in productivity can reduce costs and increase supply. Higher material or labor costs generally reduce supply at any given output price.
For a profit-maximizing firm under perfect competition, the short-run supply curve corresponds to the rising portion of its marginal cost curve above minimum average variable cost. Supply need not always slope upward: fixed stocks can produce vertical supply curves, and some long-run industry supply curves are approximately horizontal.
Equilibrium and adjustment
Market equilibrium occurs where quantity demanded equals quantity supplied. At this price, buyers’ and sellers’ planned quantities are mutually consistent. Equilibrium does not imply that everyone obtains everything desired or that the outcome is equitable.
Above the equilibrium price, quantity supplied exceeds quantity demanded, creating excess supply. Sellers may lower prices or reduce output. Below equilibrium, excess demand creates a shortage, potentially encouraging higher prices and expanded production. These are adjustment mechanisms rather than guarantees of instantaneous market clearing: contracts, inventories, search costs, and institutional rules can delay adjustment.
A simple linear model writes demand as and supply as , with . Setting the two equal gives:
These expressions apply where the resulting price and quantity are economically feasible.
Movements and shifts
A change in a good’s own price produces a movement along an unchanged demand or supply curve. A change in another determinant shifts the curve. This distinction separates an “increase in quantity demanded” from an “increase in demand.”
Holding supply unchanged, an increase in demand generally raises equilibrium price and quantity. Holding demand unchanged, an increase in supply generally lowers price and raises quantity. If both curves shift, one outcome may be ambiguous. For example, simultaneous increases in supply and demand raise equilibrium quantity in the standard model, but the price effect depends on the relative shifts.
This comparison of equilibria is called comparative statics. It identifies differences between outcomes without necessarily explaining the adjustment path.
Elasticity and time horizons
Price elasticity measures the percentage response of quantity demanded or supplied to a percentage change in price. Demand elasticity is commonly reported in absolute value: values above one indicate elastic demand, while values below one indicate inelastic demand.
Elasticity is not identical to a curve’s slope. Even a straight demand curve generally has different elasticities at different points. Demand responsiveness depends on available substitutes, expenditure shares, and adjustment time.
Supply is often more elastic over longer periods because firms can expand capacity and new firms can enter. Short-run constraints may be pronounced in labor markets or markets for electricity, although their specific institutions require additional analysis.
Welfare and government intervention
Consumer surplus measures willingness to pay above actual expenditure; producer surplus measures receipts above sellers’ minimum acceptable amounts. Under standard competitive assumptions, equilibrium maximizes their sum. This result requires qualifications when externalities, information asymmetry, or other forms of market failure are present.
Binding price controls alter market outcomes. A ceiling below equilibrium creates excess demand; a floor above equilibrium creates excess supply in the basic model. Actual effects depend on enforcement, rationing, quality changes, and accompanying policies.
A per-unit tax creates a gap between the price buyers pay and sellers receive. Tax incidence depends on relative elasticities, not simply on which party legally pays. The less elastic side generally bears more of the burden. Taxes can create deadweight loss, although correcting external costs can improve welfare.
Scope and empirical limitations
The framework usually analyzes one market while holding other conditions fixed. Strong connections among markets may require broader models. Firms with market power, including a monopoly, cannot generally be represented by the same price-taking supply curve.
Observed prices and quantities reflect simultaneous demand and supply changes. Consequently, a simple correlation does not identify either curve. Econometrics uses additional information, institutional changes, and identifying assumptions to estimate these relationships.