Supply and demand

In microeconomic theory, the partial equilibrium supply and demand economic model originally developed by Alfred Marshall attempts to describe, explain, and predict changes in the price and quantity of goods sold in competitive markets. The model is only a first approximation for describing an imperfectly competitive market. It formalizes the theories used by some economists before Marshall and is one of the most fundamental models of some modern economic schools, widely used as a basic building block in a wide range of more detailed economic models and theories. The theory of supply and demand is important for some economic schools' understanding of a market economy in that it is an explanation of the mechanism by which many resource allocation decisions are made. However, unlike general equilibrium models, supply schedules in this partial equilibrium model are fixed by unexplained forces.

Assumptions and definitions

The theory of supply and demand usually assumes that markets are perfectly competitive. This implies that there are many buyers and sellers in the market and none of them have the capacity to influence the price of the good.

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In many real-life transactions, the assumption fails because some individual buyers or sellers or groups of buyers or sellers do have enough ability to influence prices. Quite often a sophisticated analysis is required to understand the demand-supply equation of a good. However, the theory works well in simple situations.

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Mainstream economics does not assume a priori that markets are preferable to other forms of social organization. In fact, much analysis is devoted to cases where so-called market failures lead to resource allocation that is suboptimal by some standard. In such cases, economists may attempt to find policies that will avoid waste; directly by government control, indirectly by regulation that induces market participants to act in a manner consistent with optimal welfare, or by creating "missing" markets to enable efficient trading where none had previously existed. This is studied in the field of collective action.

Related Topics:
A priori - Market failure - Collective action

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Demand

Demand is that quantity of a good that consumers are not only willing to buy but also have the capacity to buy at the given price.

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For example, a consumer may be willing to purchase 2 lb of potatoes if the price is $0.75 per lb. However, the same consumer may be willing to purchase only 1 lb if the price is $1.00 per lb. A demand schedule can be constructed that shows the quantity demanded at each given price. It can be represented on a graph as a line or curve by plotting the quantity demanded at each price. It can also be described mathematically by a demand equation. The main determinants of the quantity one is willing to purchase will typically be the price of the good, one's level of income, personal tastes, the price of substitute goods, and the price of complementary goods.

Related Topics:
Potatoes - Substitute good - Complementary good

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The shape of the aggregated demand curve can be convex or concave, possibly depending on income distribution, as shown in this paper: http://www.economicswebinstitute.org/essays/consumers.htm

Related Topics:
Aggregated demand curve - Convex - Concave

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Supply

Supply is the quantity that producers are willing to sell at a given price. For example, the potato grower may be willing to sell 1 million lb of potatoes if the price is $0.75 per lb and substantially more if the market price is $0.90 per lb. The main determinants of supply will be the market price of the good and the cost of producing it. In fact, supply curves are constructed from the firm's long-run cost schedule.

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