4 questions about Supply and Demand answered
Updated 4/24/2018 Jacob Reed
1. What is demand?
The law of demand tells us that ceteris peribus, an increase in a good’s price causes a decrease in quantity demanded and a decrease in price causes an increase in quantity demanded. This change in price causes movement along the demand curve. It is important to note a change in price does not change demand. It only changes quantity demanded.
There are things besides price that cause a change in demand (quantity demanded at every price). Those changes shift the entire curve (increases to the right and decreases to the left) giving us a change in demand. Those changes are called non-price determinants of demand.
2. What are the demand shifters?
There are 5 non-price determinants of demand; or demand shifters. Rightward shifts are always an increase, and leftward shifts are always a decrease.
- Consumer tastes and preferences: when goods go in then out of style the demand for those goods increase then decrease.
- Market size: when the number of consumers available to purchase a product changes, the demand curve also shifts.
- Prices of related goods: Changes in the prices of substitutes have a direct relationship with changes in demand (when the price of a substitute increases, demand for the good in question also increases) and price changes for complements have an inverse relationship with demand changes (an increase in the price of a complement causes a decrease in the demand for the good in question).
- Changes in income: when consumers’ incomes rise, they demand more normal or superior goods and fewer inferior goods.
- Expectations of the future: predictions about the future impact the demand for a product today (an expected price increase a month from now will cause an increase in demand today).
*Note: The distinction between a change in demand (a new shifted curve) vs a change in quantity demanded (movement along the curve due to a price change) is key to fully understanding supply and demand. Price only changes quantity!
3. What is Supply?
The law of supply says that Ceteris Paribus, an increase in a good’s price causes an increase in quantity supplied and a decrease in a good’s price causes a decrease in quantity supplied. Just like demand, a change in price only causes movement along the supply curve. A change in price will not change demand; only quantity demanded.
When something other than price changes, it can cause the entire supply curve to shift (a change in supply as it’s called) to the right (increase) or to the left (decrease). Those changes are called non-price determinants of supply.
4. What are the supply shifters?
When it comes to supply, there are 6 non-price determinants; or supply shifters. Rightward shifts are always an increase, and leftward shifts are always a decrease.
- Prices of resources or inputs: increases in resource prices decrease supply and decreases in resource prices increase supply.
- Government tools: actions of the government impact supply. Taxes decrease supply, subsidies increase supply, and regulations generally decrease supply.
- Competition (or number of sellers): when businesses selling the same product enter the market the supply increases. When businesses exit the market, supply decreases.
- Technology: better technology shifts the supply curve to the right.
- Prices of other goods: can cause a change in the allocation of resources shifting the supply of the product in question (if the price of corn increases, the supply of wheat will decrease as farmers shift resources over to the production of corn).
*Note: The distinction between a change in supply (a new shifted curve) vs a change in quantity supplied (movement along the curve due to a price change) is key to fully understanding supply and demand. Price only changes quantity!
*Note: Different books and teachers may have more determinants than I have listed above. I have consolidated the list to make things easier. The key is to think like a consumer or producer and logically figure out how that would impact supply or demand.
Ready to learn what happens when supply and demand interact? Read about it in the Market Equilibrium review.