What is supply and demand? How prices get set

Supply and demand is the model economists use to explain how prices are set in a market. Demand is how much buyers want at each price, and they want less as the price rises. Supply is how much sellers offer at each price, and they offer more as it rises. The price tends to settle where the amount wanted equals the amount offered, and it moves when either side changes.

In short

• Demand falls as price rises; supply rises as price rises. Where they meet is the equilibrium price.
• Below that price, buyers want more than there is, a shortage. Above it, sellers can't sell it all, a surplus. Either gap pushes the price back.
• A change in tastes, incomes, costs or the number of sellers shifts a whole curve, and the price moves to a new meeting point.

What do demand and supply mean?

Demand is not one number. It is a schedule: at $50 a ticket, fans want this many; at $100, fewer; at $200, fewer still. Plot those pairs with price going up the side and quantity along the bottom, and you get a demand curve that slopes down. People buy less of something when it costs more because they have other things to spend money on, and at a high enough price they switch to those.

Supply is the same kind of schedule from the sellers' side. The higher the price, the more of something sellers are willing to bring to market, because more of them can cover their costs, so the supply curve slopes up. The British economist Alfred Marshall drew the two curves together in his 1890 Principles of Economics and compared them to the two blades of a pair of scissors: asking which one sets the price is like asking which blade does the cutting.

How does the price get set? A worked example

Take the resale market for tickets to one sold-out concert. Fans who want to go are the buyers; fans who already hold tickets and might sell are the sellers. Here is how many tickets each side wants to trade at each price.

Price per ticket	Tickets fans want to buy	Tickets holders will sell	What happens
$50	5,000	1,000	Shortage of 4,000
$100	3,500	2,000	Shortage of 1,500
$150	2,500	2,500	Equilibrium
$200	1,800	3,000	Surplus of 1,200
$250	1,200	3,400	Surplus of 2,200

At $100, 3,500 fans want tickets but only 2,000 are offered. Sellers notice that tickets go in minutes and raise their asks, and some buyers bid more to beat the others. At $200, 3,000 tickets sit unsold while only 1,800 fans will pay, so sellers cut prices to find buyers. Only at $150 do the two numbers match: 2,500 tickets change hands and nobody who wants to trade at that price is left out. That meeting point is the equilibrium, and the pushes from shortage and surplus are what move a market toward it.

Nobody sets that price. It emerges from thousands of separate decisions, which is what economists mean when they say markets coordinate people's plans without anyone in charge, one of the central ideas of capitalism.

What makes the curves shift?

A change in the price moves you along a curve. A change in anything else moves the whole curve. Suppose the band announces this is its last tour. Now, at every price, 1,000 more fans want a ticket: 3,500 at $150 instead of 2,500. At the old price there is a shortage of 1,000, and the price climbs. Between the rows of the table, demand and supply now meet at about $192, with about 2,900 tickets changing hands. Higher demand raised both the price and the number sold.

What changes	Which curve shifts	Price	Quantity sold
Buyers want more (tastes, incomes, more buyers)	Demand shifts right	Up	Up
Buyers want less	Demand shifts left	Down	Down
Selling gets cheaper (better technology, cheaper inputs)	Supply shifts right	Down	Up
Selling gets costlier (higher costs, a new tax, fewer sellers)	Supply shifts left	Up	Down

The fourth row is how a tariff works: a tax on imports raises sellers' costs, supply shifts left, and buyers pay more for fewer goods. When many prices rise together for a long time, the cause is usually wider than one market, and that is inflation.

Why are concert tickets so often sold out at face value?

The first sale of tickets shows what happens when a price is held below equilibrium. A venue with 20,000 seats that sells them at $80, when fans would bid them up to $150, faces more buyers than seats. The shortage doesn't vanish. It shows up as queues, websites that crash, bots and resale at higher prices. The number of seats is fixed, so when demand jumps, more seats can't appear and the gap shows up mostly in the resale price. Selling below the market price is a choice by the band or the venue, often to keep fans happy, but the gap gets filled one way or another.

What happens when governments set prices?

A price ceiling is a legal maximum price; a price floor is a legal minimum. The OpenStax economics textbook gives the standard examples: rent control is a ceiling, and the minimum wage and farm price supports are floors. A ceiling set below equilibrium creates a lasting shortage, and a floor set above it creates a lasting surplus, such as crops the government must buy and store.

The side effects come because the forces in the table are still there. With rents capped, more people want apartments than are offered, so landlords can choose among tenants, may spend less on upkeep, and may sell or convert apartments. A 1990 survey reported in the Library of Economics and Liberty found that 93% of US economists agreed that "a ceiling on rents reduces the quantity and quality of housing available."

Still argued

Economists largely agree on how price controls work, but not on when the side effects are worth it. Evidence from San Francisco shows both sides at once: after rent control was widened in 1994, covered tenants were nearly 20% more likely to stay at their address, while landlords cut the rental housing they offered by 15%, which pushed rents across the city up 5.1%, according to Diamond, McQuade and Qian. Supporters of rent control weigh the stability for sitting tenants most; critics weigh the higher rents and fewer homes for everyone else. Debates over the minimum wage turn on a similar question: how many jobs, if any, a given floor costs, against the raise it gives.

Supply and demand is the first tool most courses in economics teach, because it answers a question that comes up everywhere: why does this cost what it costs, and what would change it?

Check yourself

• In the ticket table, what happens at $100, and what pushes the price up from there?
• What is the difference between a change in price and a shift in demand?
• Why does a rent ceiling below the market price lead to fewer or worse apartments over time?

Sources

• Demand, Supply, and Equilibrium in Markets for Goods and Services — OpenStax, Principles of Economics 3e
• Price Ceilings and Price Floors — OpenStax, Principles of Economics 3e
• Rent Control — Walter Block, Library of Economics and Liberty
• The Effects of Rent Control Expansion on Tenants, Landlords, and Inequality — Diamond, McQuade and Qian, NBER, 2018
• Supply and demand — Wikipedia