Difficulty: Introductory | Prerequisites: None
This chapter is the foundation for nearly everything else in the course. Demand and supply are the two forces that set prices and quantities in a market. You will meet them again in elasticity, market interventions, welfare analysis, and macroeconomic models. If you are joining the course late, start here.
Demand is the relationship between a good's price and how much consumers want to buy; supply is the relationship between a good's price and how much firms are willing to sell. Both follow their own "law": higher prices mean less quantity demanded but more quantity supplied. When outside factors (income, technology, preferences, input costs) change, the entire curve shifts, altering the market's equilibrium price and quantity.
Demand
The relationship between the price of a good and the quantity consumers would like to purchase, all else held equal. Think of it as the full picture of how much people want at every possible price.
Quantity demanded
The specific amount consumers want at one particular price. In simple terms, demand is the whole curve; quantity demanded is one point on it.
Demand schedule
A table listing every price alongside the quantity demanded at that price. It is the numerical version of the demand curve.
Demand curve
A downward-sloping graph plotting price (y-axis) against quantity (x-axis). Moving along the curve means the price changed; shifting the whole curve means demand itself changed.
Law of demand
As the price of a good rises, the quantity demanded falls, and vice versa (all else equal). Think of it as: higher price, fewer buyers.
Supply
The relationship between the price of a good and the quantity firms are willing to sell, all else held equal. "Willing" here means prepared to offer at that price, not necessarily selling it right now.
Quantity supplied
The specific amount firms are willing to sell at one particular price.
Law of supply
As the price of a good rises, the quantity supplied increases, and vice versa. In simple terms, higher prices give firms more incentive to produce.
Supply curve
An upward-sloping graph of price against quantity.
Normal goods
Goods for which demand increases as consumer income rises (positive relationship). Most everyday purchases fall into this category.
Inferior goods
Goods for which demand decreases as consumer income rises (inverse relationship). Think of it as: when you earn more, you trade up and buy less of these. Fast food is a common textbook example.
Substitutes
Goods that can replace each other. If the price of one rises, demand for the other increases. Think Coca-Cola and Pepsi.
Complements
Goods consumed together. If the price of one rises, demand for the other falls. Think printers and ink cartridges.
Substitutes in production
Goods a firm could produce using the same resources. If one becomes more profitable, the firm shifts production toward it, reducing supply of the other.
Complements in production
Goods produced together as by-products. Their supplies move in the same direction.
Expected future price (EFP)
The price consumers or producers believe a good will have in the future. A higher EFP increases current demand (buy now before it gets expensive) but decreases current supply (hold stock for the higher price later).
Exogenous factors (demand/supply shifters)
Variables outside the price-quantity relationship that move the entire curve left or right. For demand: preferences, income, prices of related goods, expected future price. For supply: input costs, technology, prices of related goods in production, expected future price.
Three conditions must all hold for a quantity to count as "demanded":
The consumer wants the good at the current price
The consumer can afford it at that price
The consumer would actually purchase it (wanting something and planning to buy it are different, e.g. saving money instead)
A demand schedule is the tabular form of the demand curve: each row pairs a price with the quantity demanded at that price
The demand curve is downward-sloping
Price sits on the y-axis and quantity on the x-axis. This is a historical convention (technically price is the independent variable, so it "should" be on the x-axis, but the field carried the reversed axes forward)
Textbook demand curves are drawn as straight lines for simplicity. Real demand curves are non-linear, but straight lines preserve the key relationships without requiring calculus
As price rises, quantity demanded falls. As price falls, quantity demanded rises (all else equal).
Two nuances worth noting:
Luxury goods can appear to violate the law of demand when rising prices increase perceived quality and boost sales. The law still holds: the demand curve itself has shifted (preferences changed), rather than the relationship being broken
When two variables change simultaneously (e.g. price rises and income rises), the net effect depends on which force is stronger. A price increase pushes quantity demanded down; an income increase pushes it up. The outcome depends on the magnitudes
A rightward shift means more quantity demanded at every price. A leftward shift means less quantity demanded at every price. These are caused by exogenous factors, not by a change in the good's own price.
1. Preferences
If consumers develop a stronger preference for a product, demand increases (shifts right)
If preference weakens, demand decreases (shifts left)
2. Prices of related goods
Complements (negative relation): if the price of a complement rises, demand for the good falls. Example: if printer prices spike, demand for ink cartridges drops
Substitutes (positive relation): if the price of a substitute rises, demand for the good increases. Example: if Pepsi gets more expensive, demand for Coca-Cola rises
Note: whether two goods are complements or substitutes can depend on the consumer. A milkshake might be a complement to a meal for one person and a substitute for dessert for another
3. Income of consumers
Normal goods: demand rises with income (positive relation)
Inferior goods: demand falls as income rises (inverse relation)
The same good can be normal or inferior depending on the consumer profile. Fast food is often inferior for high earners but normal for middle-income households when incomes are falling
4. Expected future price
If consumers expect a higher price in the future, current demand increases (buy now)
If consumers expect a lower price, current demand decreases (wait to buy)
This can behave like a self-fulfilling prophecy: widespread expectation of lower future prices reduces current demand, which in turn lowers the equilibrium price
As the price of a good rises, the quantity supplied increases. As the price falls, the quantity supplied decreases (all else equal).
The supply curve is upward-sloping: firms have more incentive to produce when they can sell at higher prices.
Supply describes what firms are willing to offer at each price. "Willing" does not mean they are necessarily selling that quantity right now.
1. Production costs (costs of inputs)
Negative relationship: as input costs rise (wages, raw materials, rent), supply decreases
The curve shifts left, meaning firms supply a lower quantity at each price
2. Changes to production technology
Positive relationship: better technology increases supply
The curve shifts right, meaning firms can supply a higher quantity at each price
3. Prices of related goods in production
Substitutes in production: when the price of a substitute good rises, firms shift resources toward producing it. Supply of the original good decreases (leftward shift)
Complements in production: goods produced together as by-products. Their supplies are proportional, so an increase in one means an increase in the other
4. Expected future price
Negative relationship: if firms expect the price to be higher in the future, they reduce current supply (hold inventory for later)
If they expect the price to fall, they increase current supply (sell now)
Demand and supply are independent of each other. Treat them separately. A factor that shifts one curve does not automatically shift the other.
Students often confuse a change in demand (the whole curve shifts) with a change in quantity demanded (movement along the curve). If the good's own price changes, you move along the curve. If something else changes (income, preferences, related prices), the curve shifts
Students often say luxury goods "break" the law of demand. They do not. When a luxury item sells more at a higher price, it is because perceived quality or status has shifted the demand curve rightward, not because the law of demand is violated
Students sometimes treat demand and supply as linked. They are independent. A change in a demand shifter moves only the demand curve. A change in a supply shifter moves only the supply curve. They interact at equilibrium, but they shift independently
Students often forget that "inferior good" is not a quality judgement. It is a technical term describing the income-demand relationship. The same good can be inferior for one consumer profile and normal for another
⚠️ Know the difference between a shift of the curve and a movement along the curve. Exams test this constantly
⚠️ Be able to identify which curve is affected (demand or supply) and which direction it shifts for any given scenario
⚠️ Expected future price works in opposite directions for demand (positive relation) and supply (negative relation). This trips students up on multiple-choice questions
⚠️ Complements and substitutes appear in both demand shifters and supply shifters, but they work differently in each context. Know both
The demand and supply framework is the lens economists use to explain price movements in any market, from petrol to housing to concert tickets. When you hear "prices rose because of a shortage," you are hearing the supply-demand model at work. Resale ticket markets are a good intuition builder: tickets priced below equilibrium create a shortage, which is why resale prices are higher. Clothes on sale are the opposite: surplus stock priced above what consumers will pay, reduced to clear.
True or false: A rise in the price of a good causes the demand curve to shift leftward. (False. It causes a movement along the demand curve, not a shift.)
Fill in the blank: A good for which demand falls as income rises is called a(n) __________ good. (Inferior)
True or false: If consumers expect the price of a good to rise next month, current demand increases. (True.)
Fill in the blank: If the price of a complement rises, demand for the related good __________. (Decreases / falls)
True or false: Better production technology shifts the supply curve to the left. (False. It shifts the supply curve to the right.)
Q: A new health study finds that eating avocados reduces heart disease risk. What happens to the demand curve for avocados, and why?
A: The demand curve shifts rightward. Consumer preferences for avocados increase because of the perceived health benefit. At every price, more avocados are demanded.
Q: The price of leather rises significantly. What happens to the supply of leather jackets?
A: Supply decreases (the supply curve shifts left). Leather is an input, and higher input costs reduce the quantity firms are willing to supply at each price.
Q: Coffee and tea are substitutes. If the price of coffee rises, what happens to the demand for tea?
A: Demand for tea increases (the demand curve for tea shifts right). Consumers switch away from the now more expensive coffee toward tea.
Q: Explain why "inferior good" does not mean the good is low quality.
A: "Inferior" is a technical term describing the relationship between income and demand. It means demand falls as income rises. A good can be perfectly decent but still inferior in the economic sense. Fast food, for example, is inferior for high earners (they eat less of it as they get richer) but normal for middle-income consumers.
Q: A firm expects the selling price of its product to rise next quarter. How does this affect current supply?
A: Current supply decreases (the supply curve shifts left). The firm holds back inventory to sell at the expected higher price later.
This connects to elasticity (Chapter 4 in most texts) because elasticity measures how sensitive quantity demanded or supplied is to a price change. The shifts you learn here determine the direction; elasticity determines the magnitude.
It also connects to market interventions (price ceilings, price floors) because those policies work by fixing price above or below equilibrium, creating the surpluses and shortages described here.
The supply-demand model reappears in aggregate form in macroeconomics (aggregate demand and aggregate supply), where the same logic applies at the economy-wide level.
Demand, supply, law of demand, law of supply, demand curve, supply curve, demand schedule, quantity demanded, quantity supplied, demand shifters, supply shifters, normal goods, inferior goods, substitutes, complements, substitutes in production, complements in production, expected future price, EFP, exogenous factors, ceteris paribus, all else equal, shift vs movement, market model, price-quantity relationship, Prin Macroeconomics, University of Florida, ECON, Chapter 3