Economics · High school and introductory college economics

Supply and Demand Study Guide

Supply and demand explains how prices are set in a market: buyers want lower prices, sellers want higher ones, and the market price settles where the two sides agree. When the price is too high there is a surplus, and when it is too low there is a shortage, which pushes the price back toward equilibrium. Most questions ask which curve shifts and what that does to price and quantity.

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Key terms

Demand: The quantities of a good that buyers are willing and able to buy at each possible price.
Law of demand: When price rises, quantity demanded falls, other things equal. The demand curve slopes downward.
Supply: The quantities of a good that sellers are willing and able to sell at each possible price.
Law of supply: When price rises, quantity supplied rises, other things equal. The supply curve slopes upward.
Equilibrium price: The price at which quantity supplied equals quantity demanded. The market clears with no shortage or surplus.
Shortage: A situation where quantity demanded exceeds quantity supplied at the current price. It happens when price is below equilibrium.
Surplus: A situation where quantity supplied exceeds quantity demanded at the current price. It happens when price is above equilibrium.
Price ceiling: A legal maximum price. Set below equilibrium, it creates a shortage.
Price floor: A legal minimum price. Set above equilibrium, it creates a surplus.
Substitute goods: Goods that can replace each other. When the price of one rises, demand for the other rises.
Complementary goods: Goods used together. When the price of one rises, demand for the other falls.
Price elasticity of demand: How much the quantity demanded changes when price changes. Demand is elastic when quantity changes proportionally more than price.

A movement along a curve versus a shift of the curve

A change in a good’s own price moves you along the curve: quantity demanded or quantity supplied changes, and the curve itself stays put. Anything else that affects buyers or sellers shifts the whole curve.

•Shifts in demand come from income, tastes, the prices of related goods, expectations and the number of buyers.
•Shifts in supply come from the cost of inputs, technology, taxes and subsidies, expectations and the number of sellers.

What happens when the price is not at equilibrium

1If the price is above equilibrium, a surplus appears.
2Sellers cut prices to move the extra goods.
3The price falls until quantity supplied equals quantity demanded.

The reverse happens below equilibrium: a shortage appears, buyers compete, and the price rises.

The four shifts and their results

•Demand increases: price rises and quantity rises.
•Demand decreases: price falls and quantity falls.
•Supply increases: price falls and quantity rises.
•Supply decreases: price rises and quantity falls.

Sketch the graph for every question. Move the right curve first, then read off the new price and quantity.

Price controls

A price ceiling set below equilibrium makes the good cheaper on paper, but quantity demanded exceeds quantity supplied, so there is a shortage. Rent control is the usual example. A price floor set above equilibrium keeps the price up but leaves a surplus. A minimum wage is often analyzed as a price floor in the labor market.

Common mistakes

Mistake: A rise in price shifts the demand curve.
A change in the good’s own price is a movement along the demand curve, a change in quantity demanded. Other factors shift the curve.
Mistake: A surplus means demand is higher than supply.
It is the reverse: a surplus means quantity supplied is greater than quantity demanded.
Mistake: A price ceiling is a minimum price.
A ceiling is a maximum. The minimum is a price floor.
Mistake: Both the supply and demand curves slope upward.
Demand slopes down and supply slopes up. That is why they cross.
Mistake: At equilibrium everyone who wants the good gets it.
At equilibrium quantity supplied equals quantity demanded. Some buyers still decide the price is too high and leave.

Common questions

What is the law of demand?↓

It says that when the price of a good rises, buyers want less of it, and when the price falls, they want more, other things equal. That is why the demand curve slopes downward.

What is the difference between a change in demand and a change in quantity demanded?↓

A change in quantity demanded is caused by the good’s own price and moves you along the curve. A change in demand is caused by something else, such as income or tastes, and shifts the whole curve.

What happens to price when supply increases?↓

If demand stays the same, an increase in supply shifts the supply curve right, which lowers the equilibrium price and raises the equilibrium quantity.

What is equilibrium in a market?↓

It is the price and quantity where the supply and demand curves cross, so quantity supplied equals quantity demanded and there is no shortage or surplus pushing the price up or down.

How do I study supply and demand graphs?↓

Draw each scenario yourself, shifting one curve at a time and writing the new price and quantity. Then cover your answer and draw it again. Matching and quiz games on the key terms cover the vocabulary.