Supply and Demand Tutorial — How Markets Work with Examples

What is Supply and Demand?

Both supply and demand curves are put drawn onto the same graph to find the Price P Equilibrium, which is known when P has reached the level where quantity supplied equals quantity demanded. See figure below

Supply and Demand

What is Surplus?

Excess of supply happens when quantity supplied is greater than quantity demanded.

Example 1

If P = $6 then Q_d = 6 roses and Q_s = 20 roses,
which leads to a surplus of 14 roses (see figure below).
surplus

Whenever a surplus occurs, sellers will attempt to increase sales through cutting the current price.
This makes Q_d go up and Q_s to go down which lead us to reduce the surplus (see figure below).

surplus-2

Note that prices will continue to fall until market reaches equilibrium.

What is Shortage?

Shortage happens when quantity demanded is greater than quantity supplied.

Example 2

If P = $1 then Q_d = 46 roses and Q_s = 4 roses,
which leads to a shortage of 42 roses (see figure below).

Whenever a shortage occurs, sellers will attempt to increase the price.
This makes Q_d go down and Q_s to go up which leads to reduce the shortage(see figure below).

shortage-2

Note that prices continue to increase until market reaches equilibrium.

Steps required to Analyze Changes in Equilibrium

To determine the effects of any event,

Pick whether event shifts S curve, curve, or both.
Pick in which direction curve shifts.
Use supply-demand diagram to see how the shift changes equilibrium P and Q.

Terms for Movement versus Shift Along Curve

Change in demand: a shift in the D curve happens when a non-price determinant of demand changes (like income or # of buyers)
Change in the quantity demanded: a movement along a fixed D curve happens when P changes
Change in supply: a shift in the S curve happens when a non-price determinant of supply changes (like technology or costs)
Change in the quantity supplied: a movement along a fixed S curve happens when P changes

Example 3: A Shift in Demand

Event to be analyzed: Increase in price of gas in the case of hybrid cars

A Shift in Demand
D curve shifts due to the price of gas D shifts right The shift leads to an increase in price and quantity of hybrid cars.

Note that when price of gas goes uo, car producers supply larger quantity of hybrids, where the S curve has not shifted.

Example 4: A Shift in Supply

Event to be analyzed: New technology reduces cost of producing hybrid cars.

A Shift in Supply
S curve shifts S shifts right The shift causes price to decrease and quantity to increase.

Example 5: A Shift in both Supply & Demand

Events to be analyzed: price of gas increases AND new technology reduces production costs

A Shift in both Supply & Demand
Both curves shift. Both shift to the right. Q increases, but effect on P is unclear: If demand increases more than supply, P increases.

However, if supply increases more than demand, then P decreases (see below).
shift-demand-supply-2

Exercises

Exercise on Shifts in Supply & Demand

Check your answers here:
Solution to the Exercise on Shifts in Demand and Supply (Event A)

Solution to the Exercise on Shifts in Demand and Supply (Event B)

Solution to the Exercise on Shifts in Demand and Supply (Event C)

Introduction to Supply and Demand Together