Law of Demand and Supply

Supply
by Al Ehrbar
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T he most basic laws in economics are the law of supply and the law of
demand. Indeed, almost every economic event or phenomenon is the
product of the interaction of these two laws. The law of supply states that
the quantity of a good supplied (i.e., the amount owners or producers offer
for sale) rises as the market price rises, and falls as the price falls.
Conversely, the law of demand (see DEMAND) says that the quantity of a
good demanded falls as the price rises, and vice versa. (Economists do not
really have a law of supply, though they talk and write as though they do.)

One function of markets is to find equilibrium prices that balance the supplies of
and demands for goods and services. An equilibrium price (also known as a
market-clearing price) is one at which each producer can sell all he wants to
produce and each consumer can buy all he demands. Naturally, producers always
would like to charge higher prices. But even if they have no competitors, they are
limited by the law of demand: if producers insist on a higher price, consumers will
buy fewer units. The law of supply puts a similar limit on consumers. They always
would prefer to pay a lower price than the current one. But if they successfully
insist on paying less (say, through PRICE CONTROLS), suppliers will produce less and
some demand will go unsatisfied.
Economists often talk of demand curves and supply curves. A demand curve
traces the quantity of a good that consumers will buy at various prices. As the price
rises, the number of units demanded declines. That is because everyones
resources are finite; as the price of one good rises, consumers buy less of that and,
sometimes, more of other goods that now are relatively cheaper. Similarly, a supply
curve traces the quantity of a good that sellers will produce at various prices. As
the price falls, so does the number of units supplied. Equilibrium is the point at
which the demand and supply curves intersectthe single price at which the
quantity demanded and the quantity supplied are the same.

Markets in which prices can move freely are always in equilibrium or moving toward
it. For example, if the market for a good is already in equilibrium and producers
raise prices, consumers will buy fewer units than they did in equilibrium, and fewer
units than producers have available for sale. In that case producers have two
choices. They can reduce price until supply and demand return to the old
equilibrium, or they can cut production until the quantity supplied falls to the lower
number of units demanded at the higher price. But they cannot keep the price high
and sell as many units as they did before.

Why does the quantity supplied rise as the price rises and fall as the price falls? The
reasons really are quite logical. First, consider the case of a company that makes a
consumer product. Acting rationally, the company will buy the cheapest materials
(not the lowest quality, but the lowest cost for any given level of quality). As
production (supply) increases, the company has to buy progressively more
expensive (i.e., less efficient) materials or labor, and its costs increase. It charges a
higher price to offset its rising unit costs.

Are there any examples of supply curves for which a higher price does not lead to a
higher quantity supplied? Economists believe that there is one main possible
example, the so-called backward-bending supply curve of labor. Imagine a graph in
which the wage rate is on the vertical axis and the quantity of labor supplied is on
the horizontal axis. It makes sense that the higher the wage rate, the higher the
quantity of labor supplied, because it makes sense that people will be willing to
work more when they are paid more. But workers might reach a point at which a
higher wage rate causes them to work less because the higher wage makes them
wealthier and they use some of that wealth to buy more leisurethat is, to work
less. Recent evidence suggests that even for labor, a higher wage leads to more
hours worked.1

Or consider the case of a good whose supply is fixed, such as apartments in a

condominium. If prospective buyers suddenly begin offering higher prices for
apartments, more owners will be willing to sell and the supply of available
apartments will rise. But if buyers offer lower prices, some owners will take their
apartments off the market and the number of available units will drop.

History has witnessed considerable controversy over the prices of goods whose
supply is fixed in the short run. Critics of market prices have argued that rising
prices for these types of goods serve no economic purpose because they cannot
bring forth additional supply, and thus serve merely to enrich the owners of the
goods at the expense of the rest of society. This has been the main argument for
fixing prices, as the United States did with the price of domestic oil in the 1970s
and as New York City has done with apartment rents since World War II (see RENT
CONTROL).

Economists call the portion of a price that does not influence the amount of a good
in existence in the short run an economic quasi-rent. The vast majority of
economists believe that economic rents do serve a useful purpose. Most important,
they allocate goods to their highest-valued use. If price is not used to allocate
goods among competing claimants, some other device becomes necessary, such as
the rationing cards that the U.S. government used to allocate gasoline and other
goods during World War II. Economists generally believe that fixing prices will
actually reduce both the quantity and the quality of the good in question. In
addition, economic rents serve as a signal to bring forth additional supplies in the
future and as an incentive for other producers to devise substitutes for the good in
question.

Lesson Plan #3

Title of Lesson: Supply and demand

Subject Area: Economics

Grade Level: 4th grade

Objective:
* Students will be able to list as a group economic goods, economic bads, items that
are scarce in our society and factors that affect our economy.
* Students will be able to answer questions on the worksheet dealing with supply and
demand with at least 80% accuracy.

Materials Needed:
Vocabulary words, four pieces of paper taped to different corners of the classroom,
four colored pens, and the worksheet.

Procedures:
1. Students will be introduced to some of the basic vocabulary surrounding supply and
demand.
Market- a place or service that allows buyers and sellers to exchange goods and
services
Demand- the quantity of a good or service that consumers are willing and able to buy
at a given price during a specific period of time
Law of demand- as the price of a good decreases, people buy more
Supply- the quantity of a good or service that producers are willing and able to offer
at each possible price during a specific period of time
Law of supply- as the price of a good increases, producers will offer more
Economic good- an economic good refers to goods and services
Economic bad- any item for which we would pay to have less of
Scarcity- there is not enough of that item to satisfy everyone who wants it
Equilibrium- the point at which the quantity demanded equals the quantity supplied
at a particular price
Surplus- at prices above the equilibrium price the quantity supplied is greater than the
quantity demanded
Shortage- at prices below the equilibrium price the quantity demanded is greater than
the quantity supplied
2. Teacher will discuss with the students what causes prices to change.
Price may change when demand, supply, or both change. An increase in demand
cause prices to increase. An increase in supply cause prices to decrease. If demand
and supply both increase but the demand change is larger, price will increase: it will
act as if the only change had been a change in demand. If demand and supply both
increase but the supply change is larger, price will decrease: it will act as if the only
change had been a change in supply. Ex. Suppose the government allowed a certain
amount of imported steel to enter the economy. This would cut down on supply and
result in a higher steel price. Also, if there was a decrease in potato prices it would
suggest an increase in quantity demanded and a decrease in quantity supplied.
3. Teacher will arrange students into four corners by counting off 1-4. There will be a
piece of paper in each corner and each group will have two-three minutes to list as
many answers as they can in the time allotted. They will rotate clockwise until they
have been to all four corners. Each group will have a different colored pen so it is easy
to see what group wrote down what answers. They must have answers that are
different from the other groups. It might be necessary to increase the time after
rotating a couple of rounds to four-five minutes because it will be harder to come up
with answers.
4. The first corner will be asked to identify economic goods (food, bicycles, haircuts.)
The second corner will identify economic bads (air pollution, garbage, disease.) Third
corner will identify things that are scarce (gold, silver, Elmo doll during Christmas of
1996.) The last corner will list different factors that affect our economy (jobs
available, wages.)
5. After the students have attended the corners then the last group will look at all the
answers and identify the top five responses they like most. They will select a
spokesperson from their group to share and explain their responses to the class. The
teacher will ask questions to get a better idea of their understanding and then tie the
activity together and summarize it. Teacher will ask questions such as: What makes it
an economic good? Why does this particular response affect the changing economy?
How do you tell if it is an economic good or bad?
Then teacher will add any additional comments and ask students if they have
questions or comments to make before moving on to the next activity.
6. The teacher will give the students a worksheet to test their knowledge and
understanding of the material discussed in class.
7. Teacher will give the students enough time to complete worksheet. Then they will
correct their papers and go through the answers as a class to make sure everyone
understands why they are answered in that manner.
8. Teacher will conclude the lesson in reviewing the vocabulary that was introduced at
the beginning of the lesson and ask the students to verbally summarize what supply
and demand is and how it affects the consumer.

Evaluation:
Teacher will observe the answers given by the four groups to make sure their
responses match the question asked. I will have the students grade, then correct their
worksheets and I will require that they receive at least 80%.

Lesson

Lesson Plan 4
 \

Supply and Demand Worksheet

Match each item correctly. Write the letter in the blank.

_____1. Needs (B)

_____2. Wants (E)

_____3. Goods (D)

_____4. Services (A)

_____5. Market (C)

A. Works that are performed for someone.

B. Basic requirements for survival.

C. Location or other mechanism that allows buyers to exchange economic products

D. Means of expressing needs

E. Tangible commodities

6. Which of the following is not an economic good? (A)

A. Weather
B. Car
C. Sandwich
D. Haircut

7. Which of the following is an economic bad? (B)

A. Candy
B. Pollution
C. Television
D. Magazine

8. Which of the following is an example of a service? (C)

A. Blow dryer
B. Scissors
C. T.V. repair person
D. Money

9. When supply is greater than demand than it is called a: (B)

A. Shortage
B. Surplus
C. Variable
D. Balance

10. If the quantity demanded equals the quantity supplied it is called: (D)
A. Economic Approach
B. Law of Demand
C. Law of Supply
D. Equilibrium