Demand and supply are the two basic forces in a market economy. They decide the price and quantity of goods and services sold. The point where demand equals supply is called market equilibrium.
Law of Demand
The law of demand states that, other things being equal, when the price of a good falls, its demand rises, and when the price rises, demand falls. The relationship between price and demand is inverse. The demand curve slopes downward from left to right.
Law of Supply
The law of supply states that, other things being equal, when the price of a good rises, its supply rises, and when the price falls, supply falls. The relationship between price and supply is direct. The supply curve slopes upward from left to right.
Market Equilibrium
Market equilibrium is the price at which the quantity demanded equals the quantity supplied. At this point there is no shortage or surplus. The price here is called the equilibrium price and the quantity is the equilibrium quantity.
Elasticity of Demand
Elasticity measures how much demand changes when price changes.
- Elastic demand – demand changes a lot with a small price change (e.g. luxury goods).
- Inelastic demand – demand changes little with price change (e.g. salt, medicines).
- Unitary elastic – demand changes in the same proportion as price.
Factors Affecting Demand
- Price of the good.
- Income of the buyer.
- Prices of related goods (substitutes and complements).
- Tastes and preferences.
Quick Revision Points
- Law of demand shows an inverse price-demand relation.
- Law of supply shows a direct price-supply relation.
- Demand curve slopes downward; supply curve slopes upward.
- Equilibrium is where demand equals supply.
- Elastic demand changes a lot with price.
- Salt and medicines have inelastic demand.
- Income and substitute prices affect demand.
- No shortage or surplus exists at equilibrium.