Supply and demand

Economics · Senior school and first-year economics · about 8 min

Why does a concert ticket cost what it does, and why do rent controls lead to waiting lists? The supply and demand model explains how buyers and sellers together settle on a price, and what happens when that price is held away from where the market wants it.

The key idea

The market settles at the equilibrium, where the quantity buyers want equals the quantity sellers offer:

Q_d(P) = Q_s(P)

Below that price there's a shortage ( $Q_d > Q_s$ ); above it there's a surplus ( $Q_s > Q_d$ ).

A graph with price on the vertical axis and quantity on the horizontal axis. A straight downward-sloping dark blue line for demand and a straight upward-sloping dark red line for supply cross in the middle. A dot at the crossing, with thin dashed lines to both axes. — The market settles where supply and demand cross.

Why the curves slope the way they do

Demand slopes down: at a higher price, people buy less, or switch to something else.
Supply slopes up: at a higher price, it's worth producing more.

A change in price moves you along a curve. A change in anything else (incomes, input costs, tastes) shifts the whole curve.

Price ceilings and floors

A price ceiling set below the equilibrium (like some rent controls) stops the price rising, so demand outstrips supply and there's a lasting shortage. A price floor set above equilibrium (like a minimum wage in labour markets) creates a surplus. A ceiling above equilibrium, or a floor below it, does nothing.

Worked example: equilibrium and a price ceiling

Demand is $Q_d = 100 - 2P$ and supply is $Q_s = 20 + 2P$ . Find the equilibrium price and quantity. Then a price ceiling of $15$ is imposed: what happens?

Show the solution

Equilibrium: set $Q_d = Q_s$ .

100 - 2P = 20 + 2P \;\Rightarrow\; 4P = 80 \;\Rightarrow\; P^* = 20

Q^* = 100 - 2(20) = 60

With a ceiling of $15$ (below $20$ , so it binds):

Q_d = 100 - 30 = 70 \qquad Q_s = 20 + 30 = 50

There's a shortage of $20$ units: buyers want $70$ , but only $50$ are supplied.

Common mistakes

Confusing a shift of the curve with a move along it

A price change moves you along the curve. Other changes, like a rise in income, shift it.

Thinking every price ceiling causes a shortage

Only a ceiling below equilibrium binds. One above it has no effect.

Solving for quantity before price

Set $Q_d = Q_s$ , solve for $P$ , then substitute back into either equation for $Q$ .

Check your understanding

1. Demand is $Q_d = 50 - P$ and supply is $Q_s = 10 + P$ . What is the equilibrium price?

2. A price ceiling set below the equilibrium price causes...

3. Consumers' incomes rise and the good is a normal good. What happens to its demand curve?

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