Demand, Supply and Market Equilibrium

Concept of Demand
In economics, concept of demand simultaneously implies desire for a good, ability to purchase
the good and willingness to buy the good. Mere desire for a commodity does not constitute
demand for it. As for example, if a poor person desires to have a car, then, his desire for a car
will not constitute demand for the car; because, he has not purchasing power to make his wish or
desire effective in the market. Again, if a person has desire for a car and also have requisite
purchasing power, but not willing to buy it through paying high price; then also, this case will
not be treated as demand. Thus, in economics, want for a good backed by purchasing power and
willingness to purchase is called demand. Demand for a commodity is the amount of it that a
consumer will purchase or will be ready to take off from the market at a given price during a
specific period of time.

Demand for a good is, in general, influenced by several factors such as price of the good under
concern, income of the consumer, taste of the consumer, price of substitute and complementary
goods, condition of weather, locality, etc. If there is change in any of these factors, demand of
the consumer for the good will also change.

Law of Demand
Law of demand expresses functional relationship between quantities demanded of a good and its
price, when other factors like income of the consumer, taste of the consumer, prices of related
goods, etc. are held constant. More specifically, according to law of demand, other things beings
equal, if the price of a commodity falls, quantity demanded of it will rise, and if price of the
commodity rises, its quantity demanded will fall. That is, ceteris paribus, there is inverse
relationship between quantity demanded of a good and its price.

Determinants of Demand
As mentioned earlier, demand for a good is, in general, influenced by several factors. When there
is change in any of these factors, demand of the consumer for the good also changes. These
factors are called determinants of demand. Most important determinant of demand for a good is

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its price. As per demand law, ceteris paribus, quantity demanded of a good is inversely affected
by its own price. That is, rise in price of a good leads to decrease in its demand and vice versa.
Another vital determinant of demand for a good is consumer’s income. In case of normal goods,
rise in a person’s income will lead to an increase in demand and, contrarily, a fall in income will
lead to a decrease in demand. Demand is also affected by consumer’s preference. While
favorable change in consumer’s preference leads to an increase in demand, unfavorable change
leads to a decrease.

One further determinant of demand is price of related goods. Goods may be related with each
other in two different forms. They may be either substitutes of each other, that is, they can be
used to replace each other; or complementary to each other, that is, can be used together.
Example of substitute goods is coffee and tea, rice and wheat, apple and orange, etc.; and
example of complementary goods is coffee and milk, tea and sugar, bread and butter, etc.

In case of substitute goods, price of a substitute good and demand for the other good are directly
related. As is the case, if price of coffee rises, demand for coffee falls and demand for tea
increases. On the other hand, in case of complementary goods, price of a complementary good
and demand for the other good are inversely related. As in case of rise in price of sugar, there is
decrease in demand for sugar; which consequently, lowers demand for tea.

Another determinant of demand is expectation regarding movement in future price of a good and
consumer’s income. If consumers expect future price to rise, then their present demand will
increase; contrarily, if they expect future price to fall, then their current demand will decrease.
Regarding future income, consumers’ current demand will increase if they expect higher future
income; and, their demand will decrease if they expect lower future income.

Demand Function
As mentioned earlier, demand for a good is influenced by factors like price of the good, income
of the consumer, taste of the consumer, price of substitute and complementary goods, condition
of weather, locality, etc. If there is change in any of these factors, demand of the consumer for
the good will also change. Demand function is an algebraic expression showing interdependence

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between dependent variable, quantity demanded and other independent variables which influence
it. Accordingly, generalized demand function can be expressed as:
Qxd = f (Px, Y, T, Ps, Pc, W, L, ………………….others)
Where, Qxd = Quantity demanded of good X, Px = Price of good X,
Y = Consumer’s income, T = Consumer’s taste/preference,
Ps = Price of substitute good, Pc = Price of complementary good,
W = Condition of weather, L = locality,
Others = Other influencing factors, f = Expression for functional relationship.

Demand Equation
Demand equation is a symbolic or algebraic expression which shows interdependence between
dependent variable, quantity demanded and some independent variables which influence it in
concrete or exact form. Accordingly, generalized demand equation showing inverse relationship
between quantity demanded of a good and its price, ceteris paribus, can be expressed as:
Qxd = a ‒ bPx
Where, Qxd = Quantity demanded of good X, Px = Price of good X,
x
dQd
a = Constant/ intercept term, b = Constant = = slope of demand curve.
dPx

Thus, demand equation also exemplifies demand law through negative sign placed before slope
term (b). Accordingly, demand law can be symbolically expressed as:
dQxd
Qxd = f (Px) ceteris paribus, and < 0.
dPx

Demand Schedule
Demand schedule is a table which through using numerical figures exemplifies the demand law.
This table is prepared on the basis of a given demand equation. In general, basic microeconomics
deals with two types of demand equations; namely, linear demand equation and non-linear
demand equation. Example of linear demand equation may be of following form: Qx = 10 – 2Px;
this being a linear equation and having negative slope, will give a downward sloping straight line

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demand curve. From this demand equation, following demand schedule can be prepared through
taking different values of Px, and corresponding values of Qx.
Table 1: Demand Schedule of Equation Qx = 10 – 2Px
Combination A B C D E F
Px 0 1 2 3 4 5
Qx 10 8 6 4 2 0

Demand Curve
When combinations of values of Qx and Px from table 1 are plotted in a graph, it gives a
downward sloping demand curve as follows. Here, vertical axis measures price and horizontal
axis measures quantity demanded. Here, AF is the corresponding demand curve.

Figure 1: Demand Curve from Table 1 Demand Schedule

Price
5 F
4 E
3 D
2 C
1 B
0 2 4 6 8 10(A) Quantity Demnaded

Shift of Demand Curve

Shift in demand curve is caused due to change in factors other than price, like, consumer’s
income, consumer’s preference, price of substitutes or complementary goods, etc. As for
example, an increase in consumer’s income will cause a rightward shift in demand curve (from
D2 to D1) and vice versa, if the consumption item under concern is a normal good. Let, in the
following graph, D1 is demand curve of tea. Now all other things remaining constant, if there is
decrease in price of coffee (a substitute of tea), demand curve of tea will shift to position D2.

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 Figure 3: Shift of Demand Curve

Price

P a b
D1
D2
O Q2 Q1 Quantity

From the graph, it is seen that, when at initial period demand curve of tea was D1, at price ‘OP’,
demand for tea was OQ1 (point b). Now, price of tea remaining at ‘OP’, there is decrease in price
of coffee, which is a substitute of tea. This lower price of coffee will lead to increase in coffee
consumption; which will consequently lead to decline in demand for tea. As a result, at existing
price of tea, OP, people will be demanding lower amount of tea, OQ2 (point a).

Income: An increase in income will shift demand to the right for a normal good and to the left
for an inferior good. Conversely, a decrease in income will shift demand to the left for a normal
good and to the right for an inferior good.

Prices of Related Goods: An increase in the price of a substitute will shift demand to the right,
as will a decrease in the price of a complement. Conversely, a decrease in the price of a
substitute will shift demand to the left, as will an increase in the price of a complement.

Tastes: An increase in tastes for a product will shift demand to the right, and a decrease in tastes
for a product will shift demand to the left.

Expectations: A change in expectations that increases current demand will shift the demand
curve to the right, and a change in expectations that decreases current demand will shift the
demand curve to the left.

Number of Buyers: An increase in the number of buyers in a market will shift market demand
to the right, and a decrease in the number of buyers in a market will shift market demand to the
left.

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Concept of Supply
Supply of a commodity is the quantity of that commodity which the sellers are willing to offer
for sale at different prices of it; during a specific period of time, for example, a day, a week, a
month, and so on. Related to supply, there is another concept, which is called stock. Stock is the
total volume of a commodity which is present in hoarded form and can be brought into the
market for sale at short notice.

Stock of a good is not a flow variable; and, therefore, need not be associated with any time like
supply. As price of a good gradually rises, stock of that good is transformed into supply; and at
some high price (as considered by the seller) whole of stock is converted into supply. For
perishable goods like fish, fruit, meat, milk, etc.; supply and stock are generally the same
because whatever is in stock must be disposed of quickly.

Oppositely, commodities, which are non-perishable, can be held back if price is not favorable. If
price is high, larger quantities of nonperishable commodities are also offered by the sellers from
their stock. And if the price is low, only small quantities are brought out for sale. In short stock is
potential supply.

Law of Supply
Law of supply expresses functional relationship between quantities supplied of a good and its
price, when other factors like price of related goods, price of inputs used, state of technology,
weather condition, government policy, etc. are held constant. More specifically, according to law
of supply, other things beings equal, if the price of a commodity rises, quantity supplied of it will
also rise; and if price of the commodity falls, its quantity supplied will also fall. That is, ceteris
paribus, there is positive or direct relationship between quantity supplied of a good and its price.

Determinants of Supply
In general, innumerable factors and circumstances could affect a seller’s willingness or ability to
produce and sell a good. When there is change in any of these factors, supply of the good by the
seller also changes. These factors are called determinants of supply. Most important determinant
of supply of a good is its price. As per supply law, ceteris paribus, quantity supplied of a good is

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directly affected by its own price. That is, rise in price of a good leads to increase in its supply
and vice versa.
Another vital determinant of supply of a good is price of related goods. Goods may be related
with each other in two different forms. They may be either substitutes of each other, that is, they
can be used to replace each other; or complementary to each other, that is, can be used together.
Example of substitute goods is coffee and tea, rice and wheat, apple and orange, etc.; and
example of complementary goods is coffee and milk, tea and sugar, bread and butter, etc. In case
of substitute goods, price of a substitute good and supply of the other good are indirectly related.
As is the case, if price of coffee rises, coffee supply will rise and tea supply will fall. On the
other hand, in case of complementary goods, price of a complementary good and supply of the
other good are directly related. As in case of rise in price of sugar, there will be increase in
supply of tea.

Prices of inputs being included in production cost also significantly influence quantity of supply
of a good. Increase in price of anyone of these or of some or of all inputs used in production will
lead to increase in production cost; hence, it will cause supply of the good to fall and vice versa.
Another significant factor influencing supply of a commodity is the state of technology. If there
is technological advancement related to the production of the good, supply will increase.
Weather condition during production is also an important determinant of supply of a commodity.
While favourable weather condition increases supply through increasing production;
unfavourable condition works in opposite direction.

Government policy intervention can take many forms including, working-hour and minimum
wage laws, taxes, subsidies, etc. Some of these policies can affect quantity supplied of a good
positively and some other negatively. Another determinant of supply is expectation regarding
movement in future price of a good. If suppliers expect future price to rise, then their present
supply may decrease; contrarily, if they expect future price to fall, then their current supply may
increase.
Supply Function
As mentioned earlier, supply of a good is influenced by factors like price of the good, price of
related goods, price of inputs used, state of technology, condition of weather, government policy,

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etc. If there is change in any of these factors, supply of the good will also change. Supply
function is an algebraic expression showing interdependence between dependent variable,
quantity supplied and other independent variables which influence it. Accordingly, generalized
supply function can be expressed as:
y
Q s = f (Py, PR, PI, T, W, G, ………………….others)
Where, QYs = Quantity supplied of good Y, PY = Price of good Y,
PR = Price of related goods, PI = Price of inputs (I = 1, 2, 3,………..n)
T = State of technology, W = Condition of weather,
G = Government policy like, tax, subsidy, etc.
Others = Other influencing factors, f = Expression for functional relationship.

Supply Equation
Supply equation is a symbolic or algebraic expression which shows interdependence between
dependent variable, quantity supplied and some independent variables which influence it in
concrete or exact form. Accordingly, generalized supply equation showing direct relationship
between quantity supplied of a good and its price, ceteris paribus, can be expressed as:
QYs = c + dPY , where, QYs = Quantity supplied of good Y, PY = Price of good Y,
c = Constant/intercept term (either, c > 0 or c < 0 or c = 0), d = Constant/slope term.
Thus, supply equation also exemplifies supply law through positive sign placed before slope
term (d). Accordingly, supply law can be symbolically expressed as:
∂QY
s
QYs = f (PY) ceteris paribus, and > 0.
𝜕PY

Supply Schedule
Supply schedule is a table which through using numerical figures exemplifies the supply law.
This table is prepared on the basis of a given supply equation. In general, basic microeconomics
deals with two types of supply equations; namely, linear and non-linear supply equations.
Linear supply equation may be of the form: QY = 10 + 2PY; this being a linear equation and
having positive slope, will give an upward sloping straight line supply curve. From this supply
equation, following supply schedule can be prepared through taking different values of PY, and
corresponding values of QY.

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 Table 3: Supply Schedule of Equation QY = 10 + 2PY
Combination A B C D E F
PY 0 1 2 3 4 5
QY 10 12 14 16 18 20

Supply Curve
When combinations of values of QY and PY from table 4 are plotted in a graph, it gives an
upward sloping Supply curve as follows. Here, vertical axis measures price and horizontal axis
measures quantity supplied. Here, AF is the corresponding supply curve.

Figure 8: Supply Curve from Supply Schedule of Table 4

Price
5 F
4 E
3 D
2 C
1 B
0 2 4 6 8 10(A) 12 14 16 18 20 Quantity Demnaded

Shift of Supply Curve

Shift in supply curve is caused due to change in factors other than price, like, price of substitutes
or complementary goods, price of inputs, state of technology, weather condition, etc. As, in the
following graph, S1 is current supply curve of wheat. Other things remaining constant; if now,
there is occurrence of natural disaster during production period, supply curve of wheat will shift
to position S2. It is seen from the graph that, at initial period, supply curve of wheat being S 1; at
price ‘OP’, supply of wheat was OQ1 (point a). Now, after occurrence of natural disaster, supply
of wheat will be OQ2 at existing price (point a).

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 Figure 10: Shift of Supply Curve
Price
S2 S1

P b a

O Q2 Q1 Quantity

Market Equilibrium, Equilibrium Price and Equilibrium Quantity

The word equilibrium has come from two Latin words, viz., acquus meaning equality and libra
meaning stability. Hence, equilibrium means a situation, where two opposing forces are equal,
and, therefore, stability is attained. Accordingly, in economics, equilibrium is defined as a state
where opposing economic forces are in balance; and, thus, in absence of any external influence,
values taken by economic variables will not change. In a market there are two opposing forces in
action; one as exercised by buyers in the form of demand and other by sellers in the form of
supply. Interaction between these two forces goes on in the market; till equilibrium occurs when
the desires of buyers and sellers align exactly so that neither group has reason to change its
behavior. In general, buyers tend to lower price of a good to be bought and sellers intend to raise
price of the good to be sold. Hence, market equilibrium refers to a condition where a price is
established through competition between buyers and sellers such that the amount of goods or
services sought by the buyers is exactly equal to the amount of goods or services supplied by the
sellers.

This price is equilibrium price and is often called competitive price or market clearing price and
will tend not to change unless demand or supply changes and the quantity is equilibrium quantity
also called competitive quantity or market clearing quantity. Market equilibrium price and
equilibrium quantity are determined at the point where the demand curve of the buyers intersects
the supply curve of the sellers.

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 Figure 3: Market Equilibrium, Price and Quantity (General Case)

Price Surplus/Excess Supply

D S
P1………..A B

PE ……………… E
⁞
P2………G… ⁞ H
⁞
Shortage/Excess Demand
⁞
⁞
O QE Quantity

Graphically, market equilibrium condition can be presented with the help of demand curve and
supply curve. While demand curve depicts relationship between price and quantity demanded as
per consumers’ behaviour; supply curve expresses relationship between price and quantity
supplied as per producers’ behaviour. Market equilibrium is attained where these two curves
intersect each other; that is quantity demanded is exactly equal to quantity supplied. The
intersection point is equilibrium point and corresponding price and quantity are respectively
equilibrium price and equilibrium quantity.

It is the point where there is no surplus or shortage in the market. As in the above graph, D and S
are respectively, market demand and supply curves. They have intersected at point E; which
designates market equilibrium state; and, hence, PE and QE are respectively equilibrium price and
quantity. At any price level above PE, say P1, supply is P1B and demand is P1A; that is supply is
greater than demand; hence there occurs surplus or excess supply of the good in the market at
this price.

As a result, price tends to fall till it becomes PE, where there is no surplus or excess supply.
Conversely, at any price level below PE, say P2, supply is P2G and demand is P2H; that is supply
is smaller than demand; hence there occurs shortage or excess demand for the good in the market
at this price. As a result, price tends to rise till it becomes PE, where there is no shortage or
excess demand.

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It is then, clear from above presentation that, if the sellers set their price above equilibrium price
(PE), then they will fail to sell their entire supply because of demand being low at these prices.
This will create surplus in the market; and, hence, to clear market, sellers have to reduce their
price. On the other hand, if the sellers set their price below equilibrium price (PE), then they will
fail to meet entire market demand as supply is lower than demand, which is high at these prices.
This will create shortage in the market; and, hence, to clear market, sellers have to raise their
price.

In general, supply increases with prices; because in that case, suppliers can easily cover their
costs and, thus, earn greater profits. On the other hand, demand increases with lower prices
because the product then, becomes comparatively more affordable and the buyers get higher
utility from spending their money. In general, people buy a product if utility (benefit) got from it
is at least equal to its cost.

Concept of Market Equilibrium in Equation

Let, market demand function is, QD = 20 ‒ 2P and supply function is, QS = ‒ 10 + 3P. Now,
equilibrium price and quantity are to be estimated. We know that, as per definition of market
equilibrium, QD = QS.
Hence, QD = 20 ‒ 2P = QS = ‒ 10 + 3P
Or, 20 ‒ 2P = ‒ 10 + 3P
Or, 5P = 30, therefore, P = 6 = equilibrium price, and,
QD = 20 ‒ 2(6) = 8; QS = ‒ 10 + 3(6) = 8; that is QD = QS = 8 = equilibrium quantity.

Concept of Market Equilibrium in Tabular Form

Given, market demand function, QD = 20 ‒ 2P and supply function, QS = ‒ 10 + 3P; following
table is prepared.
Table 3: Schedules of Market Demand and Supply
P 0 1 2 3 4 5 6* 7 8 9 10
QD 20 18 16 14 12 10 8* 6 4 2 0
QS ‒ 10 ‒7 ‒4 ‒1 2 5 8* 11 14 17 20

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It is seen from the table that, as found from algebraic calculation, here also equilibrium price (PE)
is 6 units and equilibrium quantity (QE) is 8 units.

Figure 4: Market Equilibrium, Price and Quantity (Specific Case)

Price D
(A)10
9
8
7
6* E
5
4
3
2
1 B
(C)‒10 ‒ 8 ‒ 6 ‒ 4 ‒ 2 0 2 4 6 8 *
10 12 14 16 18 20(B) Q

Now, on the basis of above schedules of market demand and supply; following graph is plotted.
Here, AB is the demand curve and CD is the supply curve; which intersect at point E. Hence,
equilibrium price is estimated as six units and equilibrium quantity is eight units.

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Shift of Equilibrium
As is depicted in above diagram, market equilibrium is established at the intersection point of
market demand and supply curves. Obviously then, change in any one of these two curves or
simultaneous change in both the curves will change equilibrium situation. Accordingly, there can
be three causes of shift of equilibrium; firstly, due to shift in demand curve, supply curve
remaining unchanged, secondly, due to shift in supply curve, demand curve remaining
unchanged, and thirdly, due to shift of both demand and supply curves.

Figure 5: Shift of Market Equilibrium

Price S Price
D S2 S
P1 E1 P2 E2 S1
P* E* D1 P* E*
P2 E2 D P1 E1
D2
O Q2 Q* Q1 Q O Q2 Q* Q1 Q
Panel 1: Shift in demand curve Panel 2: Shift in supply curve

Price D2 S1 Price Price

D1 S2 D2 S1 S2 D2 S1
P2 E2 D1 D1 S2
P1 E1 P* E1 E2 P1 E1
P2 E2

O Q1 Q2 Q O Q1 Q2 Q O Q1 Q2 Q
Panel 3: Shift in both demand and supply curves

Above figure shows different instances of shift of equilibrium. Panel 1 shows shift of
equilibrium due to shift in demand curve, supply curve remaining unchanged. Here, unchanged
supply curve is ‘S’; and let initial demand curve is ‘D’. This gives, E*, P*, and Q* as equilibrium

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point, price and quantity. Now, if demand curve shifts rightwards to position D1; then, new
equilibrium point, price and quantity combination will be respectively E1, P1, and Q1. That is, in
this situation, both price and quantity increases. Conversely, starting from original situation; if
demand curve shifts leftwards to position D2, then, new equilibrium point, and price and quantity
combination will be respectively E2, P2, and Q2. That is, in this situation, both price and quantity
decreases.

Similarly, panel 2 shows shift of equilibrium due to shift in supply curve, demand curve
remaining unchanged. Here, unchanged demand curve is ‘D’; and let initial supply curve is ‘S’.
This gives, E*, P*, and Q* as equilibrium point, price and quantity. Now, if supply curve shifts
rightwards to position S1; then, new equilibrium point, price and quantity combination will be
respectively E1, P1, and Q1. That is, in this situation, price has decreased and quantity has
increased. Conversely, starting from original situation; if supply curve shifts leftwards to position
S2, then, new equilibrium point, and price and quantity combination will be respectively E2, P2,
and Q2. That is, in this situation, price has increased and quantity has decreased.

Lastly, panel 3 shows shift of equilibrium due to simultaneous shift in both supply and demand
curves. This again can take three forms as shown in three figures under panel 3; where D1 and S1
are considered to be original demand and supply curves. This gives initial equilibrium point,
price and quantity. Now, considering simultaneous rightward shift in both demand and supply
curves; changed curves are denoted by D2 and S2. This gives a set of new equilibrium point,
price and quantity.

Point to ponder over here is that, though both curves shift rightwards in all the three cases, but
degree of shift of demand curve is more than that of supply curve in first figure. In second figure
both the curves shift rightwards by same proportion, and in third one, degree of shift of supply
curve is more than that of demand curve. Consequently, though in all the cases quantity rise from
Q1 to Q2; in first case, price rises from P1 to P2, in second case, price remains unchanged (P*),
and in third case, price falls from P1 to P2. Panel three can also be used to show the consequence
of leftward shift in demand and supply curves. In that case D2 and S2 is to be considered as
original curves and D1 and S1 as changed ones.

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