What is Supply and Demand?
In microeconomics, supply and demand explain how prices are set in markets for goods and services. Demand represents the quantity consumers are willing to buy at various prices, typically decreasing as price rises (law of demand). Supply is the quantity producers are willing to sell, usually increasing with higher prices (law of supply). Their interaction determines market equilibrium where quantity supplied equals quantity demanded.
Key Principles of the Model
The supply curve slopes upward, showing more supply at higher prices due to increased profitability. The demand curve slopes downward, reflecting higher consumption at lower prices. Equilibrium occurs at their intersection, setting the market price. Shifts in curves—caused by factors like income changes for demand or production costs for supply—lead to new equilibria, illustrating price adjustments.
Practical Example: Coffee Market
Consider the coffee market. If a frost reduces supply, the supply curve shifts left, raising prices and lowering quantity. Consumers buy less at the higher price, while producers sell what they can. Conversely, if consumer health trends boost demand for coffee, the demand curve shifts right, increasing both price and quantity traded, benefiting producers but potentially straining supply chains.
Importance and Real-World Applications
Supply and demand is foundational to microeconomics, guiding decisions in pricing, policy, and resource allocation. It's applied in analyzing minimum wage effects (shifting labor supply/demand), subsidies (shifting supply), or tariffs (affecting import demand). Understanding it helps predict market responses to events like pandemics or technological advances, aiding businesses and governments in efficient resource use.