There seems to be a lot of confusion as to what the concepts of demand/supply in economics actually represent, so before we move on to discussing more complex points such as fiscal and monetary policy, I think it would be helpful to clear up these notions to avoid confusion at a later point when both sides are using the same terms to mean different things.
[b][u]Demand[/b][/u]
Now, as I mentioned in my last post, demand is represented by the demand curve, as in the above graphs. However, perhaps this explanation alone is not self-evident enough to convey what exactly demand is. So I'll provide you with the very same explanation that my economics teacher gave in my first class, which involves providing a simplified example and drawing a demand curve for it.
Suppose you come across a man selling ice cream. At the price at which he currently offers, you decide that it's not worth your money to buy an ice cream. This is the point corresponding to 1 on the graph, where quantity is zero and the price is high. However, you come back a little later and he's realised that he's not selling very much ice cream, so he's cut his prices a little. You now decide that it is worth buying an ice cream, at the point corresponding to 2 on the graph. Finally, you come back again at the end of the day and discover that the man's freezer has broken. He's thus giving away all his remaining ice cream for free. Now, even if he had an infinite stock of ice cream, would you take it all? Of course not, you have no need for that much ice cream and most of it would melt before you took it home. But you'd take maybe five or six, and beyond that point you have no desire for ice cream. Point 3 on the graph.
So, that's a rough lesson in how to read the demand curve, at least. But I still haven't really explained how demand is
represented by the demand curve and not by quantity demanded. Well, fortunately now that you can read demand curves, I can simply draw you another demand curve, again for ice cream, but on a hotter day.
Because it's hotter, you might well buy ice cream at the price you decided was too high the previous day. And if the man's freezer were to break again, you'd take home more ice cream. Your demand for it has increased.
To put it in technical terms - demand is a representation of how much people are willing to buy at certain prices. Obviously, demand curves for entire markets or entire economies are more complex than an individual's demand curve such as the one I drew previously. But the example of the individual helps to demonstrate that changes in demand are more complex than just "people want things more if they're paying more for them". Neither the amount that people buy or the price they pay for it are expressions of demand itself.
I -think- that's everything, but do please ask if there's something I haven't made clear. Now, onto supply.
Supply Well, supply's essentially the complement to demand - how much people are willing to supply at certain prices. It's thus represented on the same graph, but with an opposite slope:
Again, this is easy enough to understand. At higher prices, it's more attractive for suppliers to provide increased quantities of certain goods. I could, again, do an example of an individual's supply curve, but I feel that this would be labouring the point. If you would like such an explanation then let me know, but until then I'm going to assume it's unnecessary and move on to the main point.
[b][u]How Demand and Supply
actually relate to each other[/b][/u]
As I mentioned when discussing supply, demand and supply are plotted on the same graph.
I have marked on the graph the point at which they meet on both the Price and Quantity axes. This point is known as equilibrium. It's the point at which demand and supply match each other - i.e. at the price shown, suppliers are willing to supply the exact amount that people will buy. At any other point on the graph, one will outstrip another - at higher prices, people aren't buying all that's being supplied and at the lower prices suppliers aren't providing the amount that people want.
Now, if one curve shifts (i.e. moves), as in the example of a hotter day increasing the demand for ice cream, above, then the equilibrium point will change.
This is all that happens. If one curve shifts the other does not automatically shift to compensate. This is what we mean when we say supply does not affect demand and vice versa. Changes in either will change the quantity and price of a good, in different ways depending on what shifts and which way it shifts. I illustrated some of these shifts in my last post.
The key point, though, is that you have to stop thinking of price as being the controller of either demand or supply, as artificially modified prices will result in either shortages or surpluses in the short term. Companies may
cut back on supply to increase prices, but that's supply affecting the price, not price affecting the supply. Generally, it is supply and demand that determine the price of a good and the quantity of a good provided.
I do hope that's cleared things up for those that haven't formally studied economics, because it took me quite a while to type all of this out and draw the graphs in Paint. Heh. So if you have any questions, please ask me, or if you understand then please make that clear so that we can move beyond the basics of economics and into the fiscal/monetary policies that I imagine everyone is more keen to discuss.
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