THE LAW OF SUPPLY AND

DEMAND AND HOW

EQUILIBRIUM PRICE AND
QUANTITY ARE
DETERMINED
 LAW OF
SUPPLY
• THE LAW OF SUPPLY IS THE MICROECONOMIC LAW
THAT STATES THAT, ALL OTHER FACTORS BEING
EQUAL, AS THE PRICE OF A GOOD OR SERVICE
INCREASES, THE QUANTITY OF GOODS OR SERVICES
THAT SUPPLIERS OFFER WILL INCREASE, AND VICE
VERSA. THE LAW OF SUPPLY SAYS THAT AS THE
PRICE OF AN ITEM GOES UP, SUPPLIERS WILL
ATTEMPT TO MAXIMIZE THEIR PROFITS BY
INCREASING THE QUANTITY OFFERED FOR SALE.
• THE LAW OF SUPPLY IS ONE OF THE MOST
FUNDAMENTAL CONCEPTS IN ECONOMICS. IT
WORKS WITH THE LAW OF DEMAND TO
EXPLAIN HOW MARKET ECONOMIES
ALLOCATE RESOURCES AND DETERMINE THE
PRICES OF GOODS AND SERVICES.
 LAW OF DEMAND

• THE LAW OF DEMAND STATES THAT OTHER FACTORS

BEING CONSTANT (CETRIS PERIBUS), PRICE AND
QUANTITY DEMAND OF ANY GOOD AND SERVICE ARE
INVERSELY RELATED TO EACH OTHER. WHEN THE PRICE
OF A PRODUCT INCREASES, THE DEMAND FOR THE
SAME PRODUCT WILL FALL.
• LAW OF DEMAND EXPLAINS CONSUMER CHOICE
BEHAVIOR WHEN THE PRICE CHANGES. IN THE MARKET,
ASSUMING OTHER FACTORS AFFECTING DEMAND BEING
CONSTANT, WHEN THE PRICE OF A GOOD RISES, IT LEADS
TO A FALL IN THE DEMAND OF THAT GOOD. THIS IS THE
NATURAL CONSUMER CHOICE BEHAVIOR. THIS HAPPENS
BECAUSE A CONSUMER HESITATES TO SPEND MORE FOR
THE GOOD WITH THE FEAR OF GOING OUT OF CASH.
EQUILIBRIUM PRICE AND
QUANTITY
DETERMINANTS
EQUILIBRIUM
•EQUILIBRIUM IS A STATE OF BALANCE WHEN
DEMAND IS EQUAL TO SUPPLY. THE PRICE AT
WHICH DEMAND AND SUPPY ARE EQUAL IS
THE EQUILIBRIUM PRICE.
• IN ECONOMICS, THE MARKET EQUILIBRIUM IS
DEFINED AS A STATE IN A MARKET WHERE THERE
IS NO PRESSURE FOR CHANGE. THAT IS, THERE IS
NO PRESSURE FOR PRICE TO MOVE UP OR DOWN.
THE PRIMARY FORCES BEHIND THIS ARE SUPPLY
AND DEMAND. AS LONG AS DEMAND IS GREATER
THAN SUPPLY (OR VICE VERSA) THERE IS PRESSURE
ON THE PRICE TO MOVE UP (OR DOWN). THIS
PROCESS CONTINUES UNTIL THE MARKET
REACHES ITS EQUILIBRIUM, I.E. UNTIL QUANTITY
SUPPLIED EQUALS QUANTITY DEMANDED.
• IN THE FOLLOWING PARAGRAPHS, WE WILL LOOK AT
HOW TO CALCULATE THE EQUILIBRIUM PRICE AND
QUANTITY MATHEMATICALLY. TO DO THIS, WE
FOLLOW A SIMPLE 5-STEP PROCESS: (1) CALCULATE
SUPPLY FUNCTION, (2) CALCULATE DEMAND
FUNCTION, (3) SET QUANTITY SUPPLIED EQUAL TO
QUANTITY DEMANDED AND SOLVE FOR EQUILIBRIUM
PRICE, (4) PLUG EQUILIBRIUM PRICE INTO SUPPLY
FUNCTION, AND (5) VALIDATE RESULT BY PLUGGING
EQUILIBRIUM PRICE INTO DEMAND FUNCTION
(OPTIONAL).
1) CALCULATE SUPPLY FUNCTION

 IN ITS MOST BASIC FORM, A LINEAR SUPPLY FUNCTION LOOKS AS

FOLLOWS: QS = MP + B. IN THIS EQUATION, X AND Y REPRESENT THE
INDEPENDENT AND DEPENDENT VARIABLES, M SHOWS THE SLOPE OF THE
FUNCTION AND B REPRESENTS ITS Y-INTERSECT. WE CAN USE THIS BASIC
FORM TO CALCULATE ACTUAL SUPPLY FUNCTIONS. ALL WE NEED FOR THIS
IS TWO ORDERED PAIRS OF PRICE AND QUANTITY (E.G. AT A PRICE
OF A DEMAND IS B AND AT A PRICE OF C DEMAND IS D). WITH THIS
INFORMATION WE CAN CALCULATE THE SLOPE OF THE FUNCTION (WHICH
IS USUALLY POASITIVE) AND THEN SOLVE FOR THE Y-INTERSECT BY
PLUGGING TWO OF THE INITIAL VALUES INTO THE UPDATED FUNCTION.
2) CALCULATE DEMAND FUNCTION

SIMILAR TO THE SUPPLY FUNCTION, WE CAN

CALCULATE THE DEMAND FUNCTION WITH THE HELP
OF A BASIC LINEAR FUNCTION QD = MP + B AND TWO
ORDERED PAIRS OF PRICE AND QUANTITY. AS A MATTER
OF FACT, THE PROCESS OF CALCULATING A LINEAR
DEMAND FUNCTION IS EXACTLY THE SAME AS THE
PROCESS OF CALCULATING A LINEAR SUPPLY
FUNCTION. HOWEVER, UNLIKE MOST SUPPLY
FUNCTIONS THE MAJORITY OF DEMAND FUNCTIONS
3) SET QUANTITY SUPPLIED EQUAL TO QUANTITY
DEMANDED AND SOLVE FOR AEQUILIBRIUM PRICE

 ONCE WE HAVE CALCULATED BOTH THE SUPPLY AND THE

DEMAND FUNCTION, WE CAN SET QUANTITY SUPPLIED (QS)
EQUAL TO QUANTITY DEMANDED (QD). BY DEFINITION, THE
INTERSECTION OF THE SUPPLY AND DEMAND CURVE
REPRESENTS THE MARKET EQUILIBRIUM. AT THIS POINT
QUANTITY SUPPLIED HAS TO BE EQUAL TO QUANTITY
DEMANDED (I.E. QS = QD). STARTING FROM THIS SIMPLE
EQUATION, WE CAN REPLACE BOTH SIDES WITH THEIR
CORRESPONDING FUNCTIONS (SEE SECTION 2 AND 3).
THIS ALLOWS US TO SOLVE THE RESULTING EQUATION FOR P
4) PLUG EQUILIBRIUM PRICE INTO SUPPLY
FUNCTION

 NOW THAT WE KNOW EQUILIBRIUM PRICE, WE CAN FINALLY

CALCULATE EQUILIBRIUM QUANTITY. TO DO THIS, WE SIMPLY
PLUG THE EQUILIBRIUM PRICE WE JUST CALCULATED (SEE
SECTION 3) BACK INTO THE SUPPLY FUNCTION (SEE STEP 1).
NEXT, WE SOLVE THE RESULTING EQUATION FOR QS TO FIND
THE EQUILIBRIUM QUANTITY. PLEASE NOTE THAT IT DOES
NOT MATTER IF WE USE THE SUPPLY FUNCTION OR THE
DEMAND FUNCTION FOR THIS STEP. BOTH FUNCTIONS WILL
RETURN THE SAME EQUILIBRIUM QUANTITY BECAUSE – AS WE
LEARNED ABOVE – IN THE EQUILIBRIUM QS IS ALWAYS EQUAL
5) VERIFY BY PLUGGING EQUILIBRIUM PRICE INTO
DEMAND FUNCTION (OPTIONAL)

 LAST BUT NOT LEAST, WE CAN VERIFY OUR RESULT BY

PLUGGING THE QUANTITY AND PRICE WE JUST
CALCULATED INTO THE DEMAND FUNCTION. AS
MENTIONED ABOVE, THE TWO FUNCTIONS SHOULD
ALWAYS RETURN THE SAME EQUILIBRIUM QUANTITY
AND PRICE. THIS STEP IS OPTIONAL, BUT IT’S A GREAT
WAY TO VALIDATE YOUR RESULT DURING EXAMS AND
QUIZZES AND MAKE SURE YOUR CALCULATIONS ARE